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Money: Sick of the premiums?

Income-replacement plans can be money down the drain. Edmund Tirbutt looks at an alternative
Insurance salesmen are never short of doom-laden statistics when they are trying to make money from your natural fear of illness and death. However, you ought to think about the worrying statistics, even if you don't buy the policy. For every person of working age who dies, a further 21 individuals suffer a period of long-term illness or disability - and most are feeling the pinch. The standard rate of long-term state incapacity benefit is only pounds 66.75 a week.

The problem is that these insurance contracts cost a lot of money: a women in her early thirties is likely to have to pay at least pounds 30 a month for cover that would pay out pounds 1,000 a month until the age of 60. You get nothing back unless you make a claim, and if you do fall ill, you will only get a pay-out after you have been off work for either three or six months. An unusually risky job or a poor medical history means the insurance could become impossibly expensive.

But if you are thinking about taking out income protection, you can get round some of these problems with a policy run by a friendly society.

Not many people know about this because friendly societies don't have big advertising budgets. But they have an advantage over traditional insurance schemes as they both protect your income and pay out a tax-free lump sum at the end of the policy period, even if a policyholder has claimed. They can also pay out from the first day you fall sick.

If you want to make sure you get back at least some of what you have paid in over the years, friendly societies are worth considering. They can offer this type of contract because they are mutual organisations that have no shareholders. So they can also distribute surpluses to their policyholders in the form of annual bonuses.

The returns will depend on a society's claims experience and investment performance but those in their thirties who hold good policies until they are 60 could recover the cost of all their contributions. In some cases they may even receive more than they have paid in. It's a win-win situation.

The main snag is that you have to spend more than you would on the ordinary income replacement plan.

A woman of 32 taking pounds 1,000 a month cover with the British Benefits Friendly Society's Basic Plan would get back pounds 32,600 at the age of 60 providing the fund achieved growth of 6 per cent a year. The total cost of her pounds 61.60 monthly premium over the entire period would be pounds 25,700 (after being rolled up by 6 per cent a year in accordance with regulations). In other words, if you've got the money now, it will go to work for you.

So far so good, but most products have their downside. These returns are by no means guaranteed, premiums tend to be much higher than in the standard market, and the comparisons do not take into account the effects of inflation.

Furthermore, policies that project the biggest final pay-outs normally pay sickness benefits on a falling scale. For example, benefit payments on the British Benefits Friendly Society's Basic Plan fall to half their initial level after six months and then to 30 per cent of their initial level after a further six months. And they stay there for the remainder of the claim. This contrasts with standard income replacement policies that continue to pay out at the initial rate, regardless of the length of the claim.

Friendly society policies can be useful for those in occupations that standard insurers normally load heavily or turn down. This means they can often undercut the standard market on premium alone for manual and industrial workers, without taking into account possible extra investment returns.

Alex Wilkinson, an independent financial adviser, says: "I recommend the investment return should be treated as a bonus rather than as a reason for buying, but the ability to pay out from day one can be very important and I tend to use them for self-employed clients and for those with no sick-pay schemes at work."

But other experts say policies with immediate pay-outs should not be necessary if you have decent arrangements for your financial planning .

Stephen Lundy, regional director at IFA Berkeley Morgan, says: "If a self-employed person feels the need for such short-term cover it probably means their business is undercapitalised."

Pioneer Friendly Society and some other friendly societies which offer these plans only deal through IFAs. IFA Promotion (0117-971 1177) can recommend IFAs in your area.

Friendly societies which sell their income protection plans directly to the public: British Benefits Friendly Society, 0800 975 6565; Holloway Friendly Society, 0800 716654.