Life, income and health cover: a beginner's guide

No one likes to think about the worst-case scenario, let alone pay out for it. As motorists we are forced by law to put a security blanket policy in place to cover us should the worst happen, but with no such law in place regarding our health, many of us leave ourselves exposed.

The payment protection insurance scandal that has hit the headlines over the past few years has not helped the cause of the various types of protection cover that are available.

But how many of us could say that we have enough saved to cover us if we were suddenly unable to work for a year because of an illness or injury? Do you have appropriate measures in place to support your family if something happens to you?

It's not nice to think about, but insurance can provide welcome protection at the most important time. But working out which type you need and can afford can be tricky.

Income Protection

What is it?

Income protection (IP) insurance will pay you a regular income if you are unable to work because of an accident or illness.

'It has become increasingly difficult to qualify for state benefits in recent years,' says Mark Jones, former head of protection at LV=. 'An income protection product will help you to preserve your lifestyle if you are unable to work for a lengthy period.'

Typically, IP policies will pay between half and two-thirds of your income until you return to work, reach retirement age or die. Cheaper, shorter-term policies are also available that would pay out for a set period, typically one or two years.

How long you will have to wait to receive your payout will depend on your policy; generally the longer you wait, the cheaper it is. For example, one policy could kick in immediately after statutory pay stops, while another might pay out after six months - in which case you would be responsible for funding the interim period.

'This is arguably the most important cover you can take out, as it is statistically the one you're most likely to need,' says Phil Jeynes, head of sales and marketing at protection technology business UnderwriteMe.

What to be aware of

Make sure you understand the details of a policy before you sign on the dotted line, because different providers have different definitions of being unable to work.

Check to see if your employer offers any kind of income protection-type benefit, which might make buying your own policy unnecessary. Given that many employers will help their workers if they are injured or otherwise debilitated, income protection is particularly useful for freelance or self-employed workers.

Which class of policy is suitable will depend on your occupation, which will probably fall into one of four classes. Class one includes office workers, and class four is for riskier manual workers who may, for example, work at heights or do a lot of driving. There is no choice in the class you'll be assigned, and riskier classes will pay much higher premiums.

Check also whether your policy will pay out if you are unable to work at your 'own occupation', or if it is based on your ability to do a 'suited occupation' - a similar role but not necessarily the one you're currently in.

Other more generic policies will comprise list-based definitions, typically a list of six tasks, such as lifting a pen and getting dressed; the claimant would have to be unable to do three of them to be classified as unable to work.

'With the list-based definition there is a strong argument that if you were unable to do three from a list of six it would be very serious indeed, which is why it is important to find "own" or "suitable" cover where possible,' says Kevin Carr, chief executive of Protection Review.

Figures from the Association of British Insurers (ABI) show insurers paid out 91 per cent of income protection claims in 2013.

Life assurance

What is it?

'Life cover does the opposite of what it says on the tin; it actually pays out a lump sum upon your death,' says Jeynes.

There are several different types of life assurance: 'set term' for a pre-determined period, or 'whole of life' which continues until you die, as long as you pay your premiums.

Whole of life cover can be taken on an income basis too, so that when you die your family will receive a monthly amount rather than one lump sum. Life assurance can be cheap, but that's because statistically there is little chance of you dying at a young age.

What to be aware of

Jeynes makes a few key recommendations to get the most out of your cover. First, he says, you should put your policy in trust. 'This sounds complicated but in reality it's just a form, and it means the money passes quickly to the right people in the event of your death,' he says.

Single policies are preferable to joint plans, as the cost is invariably the same and yet they offer double protection because there will be a payout on each person's death, rather than just upon the death of the second spouse. Index-linking your policy is also worth considering: the price of your premium will rise slightly each year but so will the level of your cover.

One thing to consider is who needs protecting if you were to die. If you have dependents then life cover might be a good idea, but once they've all moved out or if you live alone, then there might be no point.

Critical illness cover

What is it?

This type of policy pays out a lump sum in the event that you contract one of a specified set of illnesses and conditions. The range of diseases covered will vary depending on your policy, but typically such plans will cover around 30 to 40 conditions, ranging from heart attacks and cancers to less common illnesses such as encephalitis or Crohn's disease.

What to be aware of

Most critical illness policies are bought alongside life cover. Some people might be put off by critical illness cover (CIC) as it tends to be more expensive than life assurance, but there is a reason for that: you're much more likely to need it.

As Carr points out, when you buy the two together the combined policy cost is actually little more than buying one of them individually.

The two types of policy work together, but there can often be confusion about what exactly is covered by each. 'If we think about someone who suffers a heart attack and then dies a week later, is that a death claim, a critical illness claim, or both?' asks Carr.

He explains that insurers solve this by having a waiting period of usually 21 days written into the policy, which means that if the policyholder passes away during that time, it is treated as a death claim.

'If someone has a standalone CIC and dies within a week or two of suffering a heart attack, the plan will not be expected to pay out. But if life cover was included, this issue is removed, which also explains why standalone CIC is rarely sold,' adds Carr.

The money paid out can be used at your discretion to cover private medical treatment, pay the bills while you are off work, or even finance a holiday.

An alternative to CIC is serious illness cover (SIC), which is severity-based and encompasses more conditions. According to Jeynes, the Pru's policy pays out a percentage of the sum assured depending on the seriousness of the ailment: from maybe 10 per cent for a minor condition up to 100 per cent for the most serious conditions.

'Crucially, the plan continues and more claims can be made if the full amount isn't claimed,' he adds.

It almost goes without saying that if serious diseases run in your family you might be wise to buy a CIC policy.

The dangers of complacency

The idea that 'it will never happen to me' makes protection insurance a difficult sell, and research from the ABI suggests protection products are some of the hardest for customers to understand.

However, it's important to understand that although some of these policies sound interchangeable, they insure against different life events and thus their suitability will depend on personal circumstances.

'Before taking out any form of protection it is important to assess what type of cover you want and how much cover you will need, to ensure you don't end up under- or over-insured,' says Jeynes.

Ideally you should review your policies regularly to ensure they are appropriate and that you're covered to an acceptable level. It's a cliché but it's true: better safe than sorry.

Typical monthly policy prices for a 30-year old male non-smoker:

Income protection: £1,000 per month pay out, 3-month deferred period, primary, level cover, 20-year term = £12.20pm (Aviva)

Critical illness cover: £200,000, 20-year term, primary, essentials = £37.15pm (VitalityLife, formerly PruProtect)

Life cover: £200,000, 20-year term = £8.91pm (L&G)

Figures provided by LifeSearch.

We make every effort to ensure our beginner's guides are kept up-to-date. However, in the constantly shifting environment of investment and financial services, occasions may arise where elements of a guide become out-of-date. Please double-check the facts before taking any important financial decisions.

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