Guard against life's booby traps

9 September 2009

As we bump along the road to eventual economic recovery, the focus this autumn is on how to preserve your wealth. Investors and savers are urged to check their pension, check their investments and protect their assets.

But what about protecting your lifestyle? Unemployment is at its highest rate in 10 years and the risk of falling ill and losing a valuable salary is still a real threat.

Reining in spending and prudent budgeting are useful tips to ride out the recession, but failing to make provisions if the going gets tough, health-wise or job-wise, is careless. Indeed, as our investment nest eggs continue to look lacklustre, now is the time to make sure insurance policies are up-to-date and in place to protect against the 'what if' question.

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"Many customers with mortgages have no protection whatsoever - a recession is not the time to risk what they've worked for over the years," says Gerry Warner, protection development manager at Zurich Assurance.

"If they have a standard variable rate mortgage or a tracker, they are likely to be paying less today than six months ago, and some of that saving could be buying valuable protection cover."

When advice is right

But it's often tricky working out what sort of protection is right for you and the best way to buy it.

First up, is how to buy the product. You could go straight to the provider, see an independent financial adviser or discount broker, or go to a bank.

Even the likes of Tesco are selling life insurance where "you can get covered in just 15 minutes". You can bung a leaflet in your shopping trolley and when you get home simply ring up or go online and buy your policy.

So when does it pay to use a fast and possibly cheaper online route, with no advice, compared with the old-fashioned visit to an IFA?

Most experts advocate getting advice if you have any concerns about the protection you need. Susan Barclay, head of marketing at Scottish Provident, names critical illness and income protection as policies that would benefit from advice. "Not all plans are the same and they're not simple one-size-fits-all products."

According to Matt Morris, senior policy adviser at Baigrie Davies LifeSearch, buying without advice is a risky move. "If you are not an insurance expert you will more than likely buy the wrong thing, but won't realise it until it's time to claim," he says. "If you buy without advice you cannot claim compensation for mis-selling under the Ombudsman. Without an adviser you have no one to help you fight a claim if it's declined."

Morris also warns against price comparison sites: "Often the cheapest quote will only be cheap if you have perfect health. Insurers that appear to be cheap usually fund this by charging very high prices to those who have less than perfect health, although you will only find this out after underwriting."

However, he concedes that if you understand insurance, have perfect health and know exactly what you need you might be able to get it cheaper through a non-advised sale. Warner agrees and says a simple life-only term assurance plan might lend itself to the non-advised route.

The online route

Waving the flag for the online discount brokers is Ian Williams, director of Cavendish Online.

The firm charges a fee instead of taking commission, and provides an execution-only service.
"A discount broker like us - and there are two or three others - is the cleanest and cheapest way to buy protection," he claims. "A discount broker or IFA can get you a premium that is 25% to 30% less than going to the provider directly or to a tied bank. There is no advantage going to the provider directly; that should be your last resort."

Despite the different ways to shop for protection, Warner says the most common is still through an adviser.

"Some customers will be sufficiently interested to calibrate their own needs and to research the market, but most won't have the interest or inclination," he says. "The danger is that the customer buys a less appropriate type of cover or calculates the wrong amount of cover."

As for the supermarkets, Mark Loydall, director of Cambourne Financial Planning, advises people to tread very carefully: "A few years ago I looked at a critical illness policy on behalf of a client. It had been sold directly by a well-known supermarket. The policy did not even include proper cover for a heart attack."

However, a spokeswoman for Tesco Personal Finance argues that for customers who want to buy life insurance directly Tesco provides a competitive and straightforward product.

Comprehensive cover?

Mortgage payment protection insurance (MPPI) and payment protection insurance (PPI) are two types of protection that most people are familiar with, and may own themselves. However, that doesn't mean it's the best product to have.

MPPI is normally the default policy sold by the mortgage lender. "Banks and mortgage lenders have made huge profits from MPPI and PPI and so have sold it in huge numbers," explains Morris. "It is just a tick-box exercise so is very easy to sell compared to, say, family income benefit and income protection."

According to Williams, they are both famous for not paying out.

Loydall says PPI is considered essential by most clients - possibly a hangover from when it was a compulsory product from most lenders - and is therefore a popular product. "Any other cover is considered optional and most people think 'it will never happen to me'," he says. "Of course it does happen and the state only provides modestly."

So what other cover might you need and are there better value policies out there? Income protection, where you receive tax-free replacement income in the event of ill health until you return to work, the policy expires or death, is more comprehensive than MPPI or PPI, but as it typically needs advice and can be a complicated process few are sold each year.

Warner comments: "Income protection should be a cornerstone of financial planning - it protects our lifestyle."

He says sales increased marginally in 2008 but are still low in comparison to perceived customer needs. "It's commonly reported that only one in 10 working adults have any individual income protection, although a number will have benefits through an employer's group scheme."

Morris adds: "Income protection is certainly much better value than PPI or MPPI based on what you get for your money."

A 40-year-old male non-smoker could expect to pay around £12 per month for a cheap accident and sickness policy (similar to MPPI) with £12,000 worth of cover. This would pay out £1,000 a month for up to a year if he was unable to work due to accident or sickness.

Income protection, on the other hand, would cost £33.33 (for Zurich Life's policy) and give £300,000 worth of cover. This would offer more comprehensive cover and pay out for as long as he was unable to work.

As well as being more comprehensive, income protection also has less exclusions. Stress and backache are said to be two of the major reasons why people are unable to work: income protection typically covers this but MPPI and PPI won't.

With pitiful sales volume, the industry has started to fight back and is hoping to educate people about the merits of income protection. According to Barclay, a lot of innovation has taken place in the past year around simplification of products and tele-interviewing to help speed up the underwriting processes, and there's even an 'Income Protection Task Force', set up by CWC Research and consultancy Le Beau Visage, which has a mission to "dramatically increase sales".

Family income benefit is another product that pays out a monthly amount instead of a lump sum. It is unpopular due to the need for specialist advice and a lack of awareness among the public.

As the name suggests, it helps protect your family from financial hardship by providing a guaranteed monthly income for the remainder of the policy term if you die. The income is paid to the dependant(s) and can help towards paying mortgages and loans, meaning those types of protection may not be needed.

Warner says the policy is useful while children are being raised and educated, and Barclay says it's especially beneficial for families on a tight budget.

The correct fit

However, with both income protection and family income benefit there are many issues to consider first. For example, you need to check if an income protection plan covers your occupation correctly and if it fits with what your employer pays you when you are ill. "A correct fit with your employer's sick pay arrangements can mean a significant reduction in premiums," comments Loydall.

The cost also needs to be considered and this can vary widely from applicant to applicant, depending on factors such as age, gender, current state of health, medical history, height and weight, and smoker status.

So how has the recession affected the world of protection? Experts say there has been a slight increase in policy lapses this year. If you are considering cancelling or not renewing a plan it is often useful to speak to an adviser first (or your provider if you bought directly) about the possibility of amending it to a more affordable level.

At the same time, however, Warner and Williams report an upturn in certain policies as consumers focus on protecting what they have. Encouragingly, Warner says sales of family income benefit are on the rise.

Loydall thinks people are taking the 'what if' question more seriously: "Many advisers almost forgot about protection during the good stockmarket period. And the feel-good factor among some clients meant they did not want to address protection as it was considered unnecessary."

As the level of unemployment spirals in the UK, Morris says sales of unemployment cover have also shot up. But consumers should be cautious as there are lots of restrictions - for example, you typically have to be in full-time employment and the same job for more than a year, and you won't get cover if you're already on notice of redundancy.

It's also hard to get hold of at the moment. Morris says many companies have pulled their policies and it's especially difficult to get protected if you work in a high-risk industry such as banking or motor.

The last issue to mull over is whether to have your life insurance written in trust. If it is written in trust, your provider will pay out directly to the beneficiaries named on your policy. This means the proceeds should not form part of your estate and therefore will not be subject to inheritance tax. Many insurers provide documentation for placing policies in trust.

Research by Scottish Provident about the take-up of life insurance in the UK makes for stark reading. Around three-quarters of people believe they have to make their own provision to ensure their standard of living is maintained if something was to threaten it such as a serious illness. However, only 15% of those questioned have a critical illness plan and just 9% have income protection.

Next time you're checking how the recession has affected your investments and pension, the price of your home and your debts, remember also to check that you have adequate protection in place to deal with that 'what if' question.

This article was originally published in Money Observer - Moneywise's sister publication - in September 2009