Living with illness

December 20th, 2013

An often forgotten aspect of financial planning is the issue of on-going illness and what impact this will have both immediately and in the long term. What we mean by illness is a period of poor health resulting from disease of body or mind. Often people will not consider poor mental health as being within these parameters, but dementia is a prime example of this.

Many people will consider having a cold or other conditions as the ones expected to happen, and do not think beyond their employers standard sick pay arrangements, which in today’s ever challenging environment are not as generous as they used to be especially for small employers, as previous articles will allude to.

People off work for a period of time will often be eligible for state benefits. Should the situation arise that you become one of the 2,456,470 (as at May 2013 based on DWP Stats) currently claiming Employment and Support Allowance (ESA replaced Incapacity benefit in 2008, albeit this does also cover those with a disability), because this is limited to a maximum of £106.50 per week, your finances will soon suffer.

Whilst an employer may provide you with sick pay this will typically be provided only for the first 6 months. An Income Protection policy can provide cover that pays a regular cash amount (usually monthly) until you are able to return to work. There are other forms of protection (for example Mortgage Payment Protection) but these are not being considered within this article.

If you are thinking about effecting some form of income protection policy, however, there are a number of things to understand and consider, the most important of which are explained below.

Level of cover

Human nature being what it is, it is important for the insurer to ensure that somebody who is legitimately unable to work does not find themselves in a situation where they are financially better off if they claim under the insurance policy rather than returning to work. Insurers try to retain an incentive for policyholders to return to work because it is an inexorable fact of life that claims which provide too high a benefit tend to extend much more than those where the policyholder is not so well off when claiming.

Typically an insurer will restrict the amount of cover to 55% of pre-disability income although they may also make reductions to the level of cover to take account of:

• Payments from any other sickness or accident insurance paid to the policyholder (for example, any mortgage payment protection or credit card protection that the policyholder is eligible to claim)

• Pension payments and certain state benefits arising from incapacity

• Any continuing payments from any employment (such as sick pay) or from self-employment.

Payments made by the insurer are usually free of income tax.

It should also be remembered though that long-term claimants find that their need for income drops if they are less active and not paying fares or incurring other expenses that they would otherwise have had to pay for if they were still at work.

Timing of cover

Quite often due to an employer’s sick pay regime (or even peoples rainy day money) the policy may include a deferment period following illness or injury after which a claim will be paid. This is most commonly 4 or 13 weeks although it is also possible to choose a deferment period of 26, 52 or even 104 weeks. The chosen deferment period will depend on the insured’s circumstances but the longer the deferment period is the lower the premium will be.

Some special sickness policies may even pay benefits after day one of absence and, although this is a very restricted market, these policies may be suitable for the self-employed. However, one issue to be aware of is that, in the event of a claim, the definition of incapacity will usually change after 12 months should the insured still be unable to return to work.

Definitions of cover

It is normally preferable to take out a policy using the ‘own occupation’ definition of incapacity (unable to carry on your own occupation as opposed to ‘any’ occupation) as this definition provides the most comprehensive level of earnings protection and there is less chance that the insurer will decline a claim. In some situations, it will not always be possible to take out cover with an own occupation definition as some occupations are not considered appropriate for this type of cover.

Are you already covered?

Some employers provide a range of benefits to their employees. Apart from checking the sick-pay situation it is important to establish whether employers provide group income protection. It is conceivable that not all employees will be aware of the benefits they receive and it makes sense for them to check with their HR department.

This is not an exhaustive list and individual advice is essential to consider what income levels to protect and what cover is best suited.

The tax treatment depends on the individual circumstances of the investor and may be subject to change in the future