INCOME WHEN YOU ARE ILL
Income protection insurance (IPI) or permanent health insurance (PHI) is an insurance that virtually everyone who works needs, but very few people have. One of the reasons for this is, undoubtedly, because although the concept is relatively straightforward, the detail can be rather complex. The purpose of these notes is to explain some of the detail and options available to clients who wish to protect themselves against being unable to work through long term sickness or injury.
1. WHAT IS PHI? ... 2
2. STATE BENEFITS AND STATISTICS ... 2
3. PREMIUM CALCULATION... 2 3.1 Level Of Benefit ... 2 3.2 Deferred Period ... 2 3.3 Term ... 3 3.4 Age... 3 3.5 Medical History... 3 3.6 Occupation ... 3 4. POLICY FEATURES ... 3
4.1 Guaranteed Or Reviewable Premium ... 4
4.1.1 Reviewable Premium ... 4
4.1.2 Guaranteed Premiums ... 4
4.2 Level Versus Increasing Benefit ... 4
4.2.1 Fixed/RPI/AEI ... 4
4.2.2 During Claim Only ... 4
4.2.3 Throughout The Plan Term ... 4
4.3 Non Profit Versus Cash Back Plans ... 5
4.4 Unit Linked Plans ... 5
4.5 Conditions For Benefits To Be Paid Out ... 5
4.5.1 Unable To Continue Own Occupation ... 5
4.5.2 Unable To Follow Any Occupation ... 5
5. MAXIMUM BENEFITS ... 6
6. CLAIMS ... 6
1. WHAT IS PHI?
PHI provides an income to the insured in the event that he or she cannot work as the result of an accident or illness. Monthly income is paid until the insured returns to work, reaches the retirement age for the plan, or dies.
PHI could probably be better called “income insurance”. The reason for the permanent in the title is to differentiate this cover from the accident and illness insurances which have to be renewed each year and which will only pay out for a limited period of time.
2. STATE BENEFITS AND STATISTICS
Data shown on www.gov.co.uk shows that:
· 2.52 million people are claiming incapacity benefit - 53% are men (March 15). · 1.48 million people are claiming attendance allowance - 66% are women (Nov 14). · 3.18 million people are claiming disability living allowance – 50% are men (Nov 14).
3. PREMIUM CALCULATION
There are many different factors that affect the premium paid for this type of cover:
3.1 Level Of Benefit
Obviously, the higher the benefit the higher the premium charged.
3.2 Deferred Period
The deferred period is the period during which the claimant is ill but no benefit is paid. For example, this might be 1 month, 3 months, 6 months, 1 year or 2 years. If a long deferred period is selected, not only will the benefit be payable for a shorter term, but there is a lesser chance that a claim will be made at all. In other words, you may suffer an illness and return to work during the deferred period. In this case no benefit would be paid.
Thus, the longer the deferred period, the lower the risk of claims and a lower premium is charged. Where clients have substantial savings, we look to choose the longest deferred period possible in order to keep costs to a minimum.
3.3 Term
The term of the insurance will end at a date in the future, which usually coincides with the intended retirement date, say 60 or 65. If you select a long term, then not only might the benefit be payable for longer, but as you get older the risk of you contracting an illness or having an accident will increase. Therefore, the longer the term, the higher the premium.
3.4 Age
Allied to the term of the policy, clearly the older the applicant the higher the risk of disability and hence premium charged.
3.5 Medical History
Obviously, someone in good health today will have a lesser chance of claiming on a policy than someone who is or has been ill. Underwriters will, therefore, ask a number of health related questions to establish tendency to fall ill in the future.
Smokers will usually be charged a higher premium and premiums are higher for women as statistically they claim more on this type of plan.
3.6 Occupation
Underwriters tend to band occupations into classes. Class 1 might be a sedentary professional such as an accountant, or solicitor. At the other end of the scale, a car mechanic or a barman would be classified as class 4. Occupations such as the armed services and asphalt layers would not even be considered for cover. A class 4 occupation might warrant a premium of 2.5 times that of a class 1 occupation.
Underwriters are concerned not only with the occupational risk i.e., the chances of your occupation causing an illness or accident, but also on your ability to return to work. A solicitor may be able to work if physically disabled whereas a car mechanic would not be able to return to work in such circumstances.
High risk sports such as mountaineering and scuba-diving might also lead to higher premiums or exclusions within the policy undertaken.
4. POLICY FEATURES
Once the risk has been established, the PHI provider will offer terms. Each insurer offers different types of policy, some with features that add to or reduce the cost.
4.1 Guaranteed Or Reviewable Premium 4.1.1 Reviewable Premium
In recent years there has been a tendency within the insurance industry to reduce the risk to the insurer of major shifts in social trends, mortality and claims experience. In order to encourage potential clients to purchase such products the premiums tend to be 10% to 15% cheaper at outset.
Commonly, with a reviewable premium plan the insurer would review the premium being charged every 5 years. If (as was the case with AIDS) a new illness has appeared on the scene (CJD perhaps?) and the insurer’s claims are materially higher, the premium for all reviewable plans will increase. Conversely, if claims are substantially lower then projected premiums should fall.
4.1.2 Guaranteed Premiums
Whilst a guaranteed premium may start at a higher level, it will be guaranteed not to increase throughout the term of the plan. Our view is that, wherever possible, clients should choose guaranteed premium plans.
4.2 Level Versus Increasing Benefit
The cheapest form of PHI is a plan that provides a level amount of benefit over the course of the plan. In these circumstances, the real value of benefits will obviously be eroded by inflation.
Most plans are established so that benefits increase over the plan period. There are a myriad of ways that benefits can escalate:
4.2.1 Fixed/RPI/AEI
The most common types of escalation are a fixed annual compound escalation of 5% or escalation by the Retail Prices Index (RPI). Many other options are available, however, including the All Earnings Index (AEI).
4.2.2 During Claim Only
The benefits remain level until a claim is made. Subsequently, they escalate according to the policy conditions.
4.2.3 Throughout The Plan Term
We usually recommend a plan that escalates each year irrespective of whether a claim has been made. This ensures that the real value of benefits is maintained.
4.3 Non Profit Versus Cash Back Plans
Traditional PHI, like its life assurance counterpart, charges a premium in return for the protection of the plan over the agreed term. If one survives the term without claiming, the policy ceases without value in much the same way as, say, a motor insurance policy.
Insurers have recognised the abhorrence some people feel about parting with their money for no benefit. Plans have, therefore, been developed to provide the possibility of a cash sum when the plan comes to an end. Our view would be that clients would, on the whole, be better off to pay for the insurance alone and to place investments into more appropriate sources.
4.4 Unit Linked Plans
These arrangements work in a similar way to the whole of life insurance schemes. A premium is charged based on the cost of providing PHI cover on a year-by-year basis. Over a 20 year term, the cost of providing the cover in year one is a fraction of the cost in year 15. Each year the total premium is placed into the chosen investment fund from which is deducted charges and protection costs. If the underlying fund performs well the client will receive a cash sum on surrender or maturity. If the fund performs poorly, the premium will have to be increased at a later date.
Again, we prefer the non profit approach, however, in certain circumstances this option can be attractive where the client is prepared to accept regular premium reviews and wishes to benefit from a low premium now.
4.5 Conditions For Benefits To Be Paid Out
Care has to be taken with the definition, which an insurer gives to the circumstances under which it will pay the benefit. The following are the most common definitions available:
4.5.1 Unable To Continue Own Occupation
This is our preferred benefit definition. A plan which pays out under these terms would, for instance, continue to pay a solicitor who had a mental breakdown and could not resume work as a solicitor, but could perhaps do manual labour.
4.5.2 Unable To Follow Any Occupation
There are varying degrees of this definition. At the higher protection level the policy terms will state “for which the insured is suitable by training, education or experience.” At worse, the definition will simply stage “unable to carry out any occupation”.
Insurers will not provide the highest level of incapacity definition for some occupations, however, we try and ensure that the best definitions are used for each client’s individual circumstances.
5. MAXIMUM BENEFITS
Insurance companies need to protect themselves against fraudulent claims. They are also keen to ensure that all claimants have incentives to return to work and cease claiming on their plans.
PHI cover is, therefore, closely linked to the insured person’s pre-disability earned income. This is an important point when looking at directors of close limited companies who may take substantial income in the form of dividends that are classified as unearned income.
Restrictions to benefit vary substantially between insurers, however, the aim is to ensure that a claimant is never better off when receiving insured benefits than they were when working. Typically, for company plans where benefits are taxed as earned income the maximum benefits would be 75% of pre-disability income (we can include dividends in some cases) including all State benefits.
For plans taken out by an individual or the self-employed where there is no tax relief on the premiums benefits would be paid tax free and hence usually restricted to no more than 50% of pre-disability income.
Whilst a maximum benefit check is usually undertaken when the plan is established, should an insured’s earned income fall substantially prior to claiming on their plan then any benefit received during ill health will also reduce, even though a higher benefit is being paid for.
Insurers will check with each other in the event of a claim to make certain that another insurer is not paying additional benefit. In some cases, this could invalidate a policy or reduce the benefits paid out.
6. CLAIMS
Once a claim is agreed, insurers are likely to require regular re-assessments of the medical condition of the claimant in order to ensure that the policyholder returns to work as early as possible.
Where a claimant is able to return to work part-time (or perhaps takes up a less well paid job) insurers are usually happy to make up any earnings to the level of the benefits payable under the insurance.
7. TAXATION
Personal PHI policies taken out and owned by the insured do not benefit from any form of tax relief on the premium, however, benefits are usually received tax free.
Benefits that are provided by an employer for their staff are usually treated as a business expense (but a P11D benefit if controlling directors alone are in the scheme). Benefits are paid to the employer as a trading receipt and are then paid on to the disabled employee as schedule E income. It is important to note that the employee remains employed with this type of scheme.
The above notes demonstrate that there is much to consider when selecting the most appropriate PHI plan and provider. Many people look at the cost of providing maximum benefits and are put off by the expense. Swallow Financial Planning LLP are able to provide illustrations that can confirm what benefits you can expect in ill health including State benefits. There is no reason why the cover should not be tailored to meet a budget or your specific net income requirements.
Please note that whilst every effort is made to ensure that the information contained within this explanation is correct, these notes are by necessity brief and you should seek further clarification on any plans prior to undertaking any arrangement. Last updated 10.2015. Document reference Income Protection 10.2015.doc.
