The best ways to protect your income

When it comes to insurance, there are plenty of obvious candidates for cover, for example your home, your car, your travel and even your pets.

But while it's prudent to be protected, almost 90% of the UK's workforce fail to take out insurance for the thing that pays for all this cover: their income.

"For most of us, our income is the foundation of our lifestyle, from our holidays to our investments and pension.

"Protecting it should be your number one financial priority," says Linton Penman, head of retail sales and marketing at specialist insurance firm Unum.
Going unprotected isn't particularly palatable. If you're unable to work as a result of an injury or long-term sickness, you might qualify for employment and support allowance at the rate of up to £89.80 per week.

What's available?

A couple of options are available to ensure that your income is secure if the unexpected does happen. An accident sickness and unemployment policy (ASU) will cover you if you're unable to work due to sickness or injury or you’re made redundant.

Cover costs between £4 and £10 a month per £100 of monthly benefit and premiums are dependent on age.

Although there are exceptions, for example British Insurance's plan which can pay until you retire, benefit is usually only paid for 12 months or two years.
ASU is also available under a number of different names, including payment protection insurance, which is commonly sold alongside a credit card or loan, and mortgage payment protection insurance, when it's sold in connection with a mortgage.
There are some potential pitfalls with ASU. Matt Morris, senior policy adviser at LifeSearch, explains: "There are loads of exclusions. These include any pre-existing medical conditions, but also depression and back problems, which are the commonest causes of long-term absence."

Ed Stuart-Brown, head of protection at Friends Provident, isn't a fan either. For him, the payment term is the real bugbear.

"People don't magically return to work after 12 months. A lot of the conditions that stop people working will go on for five years and longer," he explains.
For the peace of mind of long-term cover, income protection insurance is available. This doesn't cover you for redundancy (although you can buy unemployement cover as an add-on), but it does give you much broader cover if you're unable to work due to sickness or injury.

Benefits, which can be nearly as much as your net pay, can be paid until you return to work or retire.
Premiums are based on age, sex and occupation, with older women working in stressful occupations such as teaching paying more than younger men in sedate office jobs.

"ASU is better than nothing, but I'd never recommend it unless someone had looked at IP first," says Peter Chadborn, director of independent financial adviser CBK.

The only instances where he'd recommend ASU are when someone has a history of health problems or they have a particularly risky occupation such as a deep-sea diver or, for the high levels of stress, a teacher.  This is because a risky occupation will increase your premiums.

As well as these exceptions, some ASU products are better than others. For example, Morris likes LV='s Mortgage & Lifestyle Protection, which pays until you return to work, and Pioneer's Bills & Things, which offers more generous cover than standard plans.

Comparing income protection

If you do decide to go for the broader cover offered by income protection insurance, there are a number of product features you need to consider when comparing products.

The definition of occupation is very important. "Own occupation is the best definition, as this means the policy will pay out if you're unable to do your own job," says Morris.

Some policies have "any occupation" definitions, but this is much more restrictive, in effect saying that you’ll only receive benefit if you can’t do any job.

Inflation-proofing your benefit is a good move, especially if you're intending to take the plan out to cover a career spanning 20 years or more. If you do this, your premium and your benefit will increase by the rate of inflation each year.

"Most people do take this option as it's a cost-effective way of ensuring your benefit's purchasing power," says Kevin Murdoch, senior proposition development manager at Aviva UK Health.
Flexibility is also important. Over the average career you're likely to be promoted several times, get married, buy a bigger house and have kids.

All of these events could mean you need to increase your IP cover, so make sure your plan includes guaranteed insurability options.

"Most do," says Morris, "but they are worth having as you can increase your cover without any further underwriting."
Additionally, as a job for life is no longer guaranteed, check whether your insurer will allow you to change occupation in the future. Penman explains: "Some insurers don’t allow this without further underwriting.

"But if after 20 years in an office job you decide to become a pub landlord, you could find the cost of your cover multiplies fivefold to account for the greater risk and your increase in age."

You might also want to examine the insurer's approach to claims. Most have built up expertise in helping people back to work.

This support comes in a variety of shapes, including working with your employer to make changes to your role or the workplace, providing retraining to help you start a new career, or paying for a private operation if this will help you get back to work quicker.

Cutting the cost of cover

Full-blown cover can be expensive but there are ways to trim the cost. For starters you could reduce the amount of benefit on your policy. Murdoch suggests restricting cover to key bills such as your mortgage, utility bills and food.

"If you're unable to work your living expenses will be lower so you might not need as much income," he explains.
Increasing the length of time before benefit is paid, which is known as the deferred period, can significantly reduce your premiums and most insurers offer deferred periods ranging from four weeks to two years.

For example, a 30-year-old non-smoking man taking out cover with Aviva would see the cost fall from £41.60 to £15.10 a month for £1,000 benefit if he extended the deferred period from four to 26 weeks.
Your other financial arrangements might make this possible. "Look at the sick pay you get from your employer. While some offer IP most only pay for up to six months," says Chadborn.

"Also, look at your savings. If you could live on these for a few months you'll benefit from lower premiums."

You could also reduce the length of time your benefit is paid, with several of the insurers offering benefit terms of two, three or five years.

However, Stuart-Brown isn't convinced by this option. "This works as an employer-paid plan, but it could leave you without cover when you really need it," he says.

Because of the complexities of the product, although income protection insurance can be found on comparison websites it’s essential to get independent financial advice.

Chadborn adds: "It's not a form of insurance that can be bought on price alone. An adviser will tailor cover to your needs and, if required, review it regularly to make sure it’s still suitable. It's such an important purchase."

This article was originally published in Money Observer - Moneywise's sister publication - in May 2010