Three common income protection myths and how to navigate them

If your client’s income stopped today, what would they do?

Do they have savings set aside, a second income, an employer-funded sick pay arrangement, or would they have to fall back on any government support they might be entitled to?

Income protection policies can provide a suitable replacement income for clients who find themselves unable to work due to an illness or an injury. Despite the importance of these products, they are often perceived as complicated and difficult to advise on because they work differently to other more common policies like life or critical illness insurance.

One of the best ways to show how they differ is to look at what happens when a claim is made.

Life insurance pays out if the life assured dies or is diagnosed with a terminal illness and has less than 12 months to live.

Critical illness policies require the life assured to meet the definition of a specific illness before any money is paid.

Income protection policies require the life assured to meet the insurer’s definition of ‘incapacitated,’ or in other words their inability to work because of an illness or injury. The most common ones are:

• Own occupation, which means the life assured will be able to claim if they are unable to carry out their own occupation. This is typically regarded as the best definition for clients as it is the easiest against which to make a claim.
• Any occupation means the life assured can only claim if they are unable to perform any occupation, not just the one they were doing before they were unable to work.
• Suited occupation means the life assured can only claim if they are unable to do an occupation that they would be suited to based on work experience, training, or education. 

To assess whether someone meets the insurers definition of incapacitated insurers will gather the appropriate medical evidence to confirm the definition is met.

While insurers are gathering medical evidence, they will also be looking to ensure that the claim is financially valid. This means making sure the life assured has evidence to back-up the benefit payable under their policy.

Advisers can help to minimise the risk of a claim not paying out by ensuring clients regularly review their cover to ensure it is proportionate to their needs. Encouraging clients to be as open and honest during the application process can ensure they are paid out what they expect if they have to claim. Even more minor conditions can be important to disclose.

The three common income protection myths

Myth 1: self-employed clients are difficult to cover

There is estimated to be 4.24 million self-employed people in the UK. That is 4.24 million people who do not have access to an employer-funded sick scheme or statutory sick pay.

Self-employed clients who are sole traders have liability for their ongoing costs, this might include their rent, utility bills or even vehicle rentals. They may not be able to pause some of these costs if they need to take time off work due to illness or injury.

Some insurers can provide flexibility to cover certain fixed costs self-employed clients pay to run their business.

Case study: Joe

Joe’s a self-employed builder and sole trader. His monthly fixed overheads are a total £1,341 a month (£16,092 a year) and include things like van hire purchase, rent for premises, and other business expenses needed to keep his business afloat. He has paid these costs for the past 12 months.

His pre-tax profits were £21,000 and his allowable fixed overheads were £16,092. This comes to £37,092. The maximum cover available through his insurer is 65% of £37,092, so £24,109.80. Joe’s total sum insured £24,109.80.

Unfortunately, Joe is involved in car accident and is unable to work. 

His business cannot continue to trade without him, but his overheads remain the same. When he claims, Joe provides his insurer with evidence of his pre-disability earnings and fixed overheads. As all the above fixed overheads are listed in his company accounts and are verified as continuing despite his incapacity, his claim can be paid in full.

Six months after the income protection claim starts to be paid, Joe’s van loan comes to the end of its term as it has been fully repaid. This monthly amount is deducted from his outgoings and his monthly claim payment would be reduced to reflect that.

Once he is ready, Joe decides to employ staff to allow his business to continue to trade in his absence. 

If the business continues to make a profit, and the income from this cover together with business profit exceeded the maximum annual benefit, his insurer could reduce the amount they pay accordingly.

Myth 2: multiple occupations cannot be covered

The latest Office for National Statistics labour market findings suggest more than 1.2 million people across the UK have a second job. 

Clients who have more than one job are still able to apply for income protection. From an underwriting and claims perspective, what needs to be considered is whether the client wants to cover the loss of income from their primary occupation, or from both. 

Where a client wants to cover only their primary occupation, an underwriter might assess the similarity of the two occupations and the occupation classes attached to each.

If each role is very different and have different occupation risks associated, then an underwriter might exclude the second occupation. This could mean that not only would the insurer decline to pay a claim if the client was unable to perform the duties of their second occupation, but they would also not pay a claim if the client sustained an injury during their second occupation which prevented them from performing the duties of their primary occupation.  

If a client wanted to cover both occupations and both are eligible for income protection, an underwriter might amalgamate the salaries for both occupations and apply the most cautious occupation class. As with the previous example, if either occupation did not qualify for cover an exclusion could be applied.

Case study: Han

Han’s primary occupation is regarded as class two. He has a second occupation that is a class three. 

If he wanted to cover both occupations and with both being acceptable the insurer might amalgamate the salaries for both, but base the price on the class three occupation.

Myth 3: I can cover all my client's salary

An income protection policy will not cover a 100% loss of a client’s income, instead it will cover a percentage of their earnings before they went off work sick.

Many insurers also include what is known as a ‘minimum benefit amount’ within their income protection policies. This is a safety net for clients who are earning less at the time of a claim than when they took out the cover.

Case study: Katja

Katja is an employed management consultant earning £50,000 a year.

She takes out an income protection policy for £32,500, which is the maximum amount of cover available from the insurer. The policy has a £1,750 minimum benefit amount.

After five years Katja makes a claim, but has since changed occupation and has had a drop in earnings to £25,000 a year. 

The normal maximum amount of cover available from this insurer assuming a salary of £25,000 is £16,250 (or £1,354 a month). As this is less than the insurer’s £1,750 a month guaranteed payment the insurer would pay Katja £1,750 a month.

Statistically, the risks of taking two or more months off work due to an illness or an injury are higher than premature death or being diagnosed with a serious illness, which is why it is so important that as an industry we keep discussing income protection with clients.

Life changes at an alarmingly quick rate and a change in occupation, salary or sick pay entitlement might mean that an income protection policy set-up for a client is no longer as suitable as it once was.

You should also be encouraging clients to inform their insurer if they do experience these types of life events as soon as they happen.