Guide to income protection
How providers and advisers can meet the changing income needs of clients
Clients may assume, should they be unable to work for a time, that either their employer or the state will pay out, ensuring they can continue to pay for everyday essentials, as well as keep on top of financial commitments, such as rent or a mortgage, and bills.
But this is not necessarily the case, as people often underestimate the real cost of being unable to work, and overestimate the help that the state can give.
This is where advisers can play a vital role in ensuring their clients are better informed about income protection, and how it fits alongside critical illness cover and the more well-understood life insurance.
Read on to find out more about why clients might need income protection, how advisers can help and the changing needs providers are trying to meet.
Why clients might need to consider income protection
No one expects that they will get seriously ill and unable to work for weeks or even months on end.
But illness does happen to people of all ages and from all walks of life, and if they are off work for a long period of time, many people can find that they are financially unprepared.
Most people automatically assume that they will be covered by their employer, on sick pay. This may apply for short periods of time - such as a couple of months.
What happens if the illness is, indeed, serious, or life-changing, and your client needs to take a longer amount of time off work to recover?
Many financial advisers are now insisting their clients have, as a basic part of their financial planning, some kind of protection in place. Clients may sail into a financial adviser's office wanting to invest in a whole range of portfolios, but what if they fail to consider what happens if the ability to earn the income that funds those investments suddenly disappears?
Moreover, what happens if their condition prevails after the employer's sick pay ends?
The insurance industry has come up with a range of products that cover different eventualities and outcomes, providing a long-term form of income if an individual is off work, or a more specific lump sum if a particular condition strikes.
Income protection, arguably, should be the first protection solution to consider.
Income protection (IP) offers the former, while critical illness cover (CIC) applies to the latter.
Kathryn Knowles, managing director of Cura Financial Services, says: "Income protection is an insurance policy that can replace some of your lost earnings, if you are unable to work due to ill health. Pretty much anyone that is earning an income should consider income protection insurance."
Roy McLoughlin, associate director of Cavendish Ware, says it should be right at the top of one's list of financial products.
"Income protection, arguably, should be the first protection solution to consider.
"The chance of long-term illness outweighs that of a critical illness or death by approximately a 5:3:1 factor. And yet life cover and critical illness sales massively outperform income protection," he points out.
"Also, there is no ambiguity - as long as you are unable to work it pays out. This contrasts with critical illness where you have to be diagnosed with specific conditions.
"Added to this, the two biggest causes of absenteeism in the UK are back or stress-related issues - both of which would be covered by IP but crucially not by CIC," Mr McLoughlin notes.
Ron Wheatcroft, technical manager at Swiss Re Europe, explains: "There is a waiting period, sometimes called a deferred period, from when sickness occurs before the benefit is payable. The benefits cease on return to work, the end of the benefit payment period or if the policyholder dies."
There is a certain degree of flexibility, he adds, with policies working up to retirement or for just a shorter period of time, depending on the individual's circumstances and budget.
He says: "Policies can be written to pay up to a selected age such as 65 or even 70. More common these days are policies which pay for a shorter period, such as two or five years, after which benefit stops."
Ms Knowles adds: "It can kick in to start once any employment sick pay ends. If your sick pay reduces to half after a set amount of time, you can often build it to mirror that."
There are numerous reasons why one should take out income protection, but according to Christina Rigby, protection product owner at Royal London Intermediary, there are two important factors to take into account when deciding to buy it.
She says: "The first is what someone’s employer will do in the event of illness and, secondly, what they may get back from the state.
"Obviously for the increasing number of self-employed they will be their own boss in this scenario and this population is growing rapidly – along with the need for income protection."
It is really important to note that at the moment, claims from income protection can affect the amount of Universal Credit you can access.
Many employers do provide cover under group schemes, although according to Ms Rigby, there is some debate as to how many employers really provide that kind of cover.
She says: "Frighteningly, in our latest State of the Protection Nation survey, only a very small percentage of customers said that they had cover from their employer (life insurance 5 per cent, critical illness cover 5 per cent, and income protection 8 per cent).
"Yet the Swiss Re Group Risk Watch 2018 report indicates that this is much higher. "
She notes: "The disparity may be due to a knowledge gap or confusion with the product name, or simply not realising the benefits of this sort of cover.
"Either way, the figures - regarding risk of dying, getting a critical illness or being absent from work for two months or more - speak for themselves."
Some have raised concerns about what impact income protection payments might have on benefit payments.
Ms Knowles says: "It is really important to note that at the moment, claims from income protection can affect the amount of Universal Credit you can access.
"The Building Resilient Households group has worked hard to establish that any income protection benefit that is paid, that is intended to cover mortgage repayments, is not taken into account when assessing eligibility for universal credit."
How can advisers help clients with IP needs?
Income protection (IP) is a challenging product to buy and is not likely to feature on many people's radars.
Most people are simply getting on with their lives and are mainly mindful of their mortgage payments, and if they are sensible, their pensions.
It is for this reason that anyone walking through the door of their financial adviser should be made aware that some form of income protection should be near the top of their to-buy list.
Christina Rigby, protection product owner at Royal London Intermediary, says: "Protection should underpin most holistic financial advice, and given that males are nine times and females 14 times more likely to be off work for two months or more than die, it makes sense that income protection be discussed before other subjects."
She adds that the most common time for taking out insurance is at the point of a house purchase.
It is important that advisers consider multiple options and explore the perks, risk factors and pricing of each.
She explains: "Our State of the Protection Nation research shows that 60 per cent of people with a mortgage have life cover in place, yet only 19 per cent of mortgage owners have income protection in place to help them if they are too ill to work.
"This leaves a huge 81 per cent of homeowners potentially under-insured and unable to cover their mortgage payments if they are off sick for more than four weeks.
"Advisers are uniquely placed to help clients obtain and decipher this information, for example during a mortgage fact-find. "
Ms Rigby notes: "This, in turn, will help determine if there is a need. The adviser can then point out the unfortunate high statistical chance of long-term illness and put this in the context of the other two main protection products for death or critical illness."
The initial reason for using a financial adviser in this situation is to provide clients with some initial context for why they might need income protection, and then establish what their financial circumstances are.
This is before they get to the difficult task of finding their way through the product minefield.
Ron Wheatcroft, technical manager at Swiss Re Europe, explains: "Everybody needs an income and taking customers through the financial consequences of having to live on whatever state benefits are available to them, together with whatever savings they have, should sit right at the top of a good adviser's priorities, alongside life cover where there is a family or other dependants."
Once it has been established that a client needs to take out an insurance policy, then it is up to the adviser to spell out what a client is likely to receive in terms of what is already on offer, such as state benefits and employer policies.
Roy McLoughlin, associate director of Cavendish Ware, says: "Advisers need to guide clients in two crucial areas: awareness of what they will receive from their employer and awareness of what they will receive from the state in the event of long-term illness.
"The often sad conclusion is that the answer clients assume is far from what the situation actually is, and the adviser's role is to help with this analysis and then potentially provide the solution. "
"They should also point out the unfortunate propensity for illness to occur as demonstrated," he adds.
Auto-enrolment has given advisers a great opportunity to educate employees that they can no longer rely on the state for a decent retirement pension.
So a knowledgable adviser will be able to educate the client in terms of why he or she needs protection, then explain the income available to them via other benefits, and subsequently steer them through the most suitable products available on the market.
Income protection can come in a variety of forms, and sometimes needs extensive underwriting. It is the role of the adviser to assess what the client can afford and need, be that a product that will take a client through to retirement, or one that just lasts a year or two.
Kathryn Knowles, managing director of Cura Financial Services, says: "Full blown IP, with all the bells and whistles attached, can be quite expensive, but there are plenty of ways to adapt the policies to match different budgets.
"It is important that advisers consider multiple options and explore the perks, risk factors and pricing of each, so that they can make an informed decision based upon their clients' needs and long-term affordability.
"Barriers to the sale of income protection can be due to underwriting medical conditions and the complexity of the different policies and insurers on offer. "
Ms Rigby adds: "Auto-enrolment has given advisers a great opportunity to educate employees that they can no longer rely on the state for a decent retirement pension.
"Could the next step be to harness this understanding of the need to be self-reliant in terms of long-term sickness?"
However, Mr McLoughlin, who has experience advising clients on protection, says that not all financial advisers are best placed to offer the best advice, as it is a specialist area.
He says recent industry research has made it "very evident that there is a lack of knowledge among many in the advisory community, so an educational campaign is needed".
Clearly, an adviser is essential for giving the client a true picture of his or her circumstances, as well as being able to advise on the type of protection product they might need to buy.
How can providers meet changing employee IP needs?
Typically, people have worked full-time for companies of varying size over a reasonable timeframe.
However, many more people have now set up their own businesses, are freelancing or working in the gig economy.
What impact does this have on the availability of products? And what can providers do for these workers?
According to Roy McLoughlin, associate director of Cavendish Ware, this cohort does need extra attention from providers.
He says: "As with pensions, the self-employed and associated gig economy seem to have been forgotten by many.
"Isn’t it so sad that auto-enrolment has been such a success for four-fifths of the nation, but what about the ‘forgotten’ people? The self-employed do not have employer benefits to fall back on, so providers need to do as much as possible to help this group.
"The key here is flexibility as many self-employed and gig economy workers do not have the regularity of earnings that their regularly full-time counterparts do.
"Insurers need to be much more pragmatic about payouts when taking this into account and also give advisers faith in this area."
There is a big potential market for covering the self-employed.
He adds: "I would also include the growing number of one person limited companies and how dividends are treated at claim."
Kathryn Knowles, managing director of Cura Financial Services, points out there are certain policies available that would suit this cohort.
She explains: "Non-financially underwritten income protection policies can be really useful for people with fluctuating incomes, for example the self-employed and gig economy workers.
"This is usually limited to £1,000 a month, and you can have this regardless of how much you earn.
"You can also apply for benefit guarantees with some income protection providers, that will ensure that you will always be covered for a set amount of income replacement; the benefit will not drop below specific amounts, even if your income reduces. This is usually around £1,500 a month."
"It’s important that gig workers, contract workers and the self-employed make sure that they continue to meet the insurer's eligibility requirements for the cover," Ms Knowles notes. "This could be minimum working hours per week and changes to occupational duties."
Does what it says
Statistics show this sector is a growing market.
Ron Wheatcroft, technical manager at Swiss Re Europe, says: "There is a big potential market for covering the self-employed. Based on total market data, we have estimated that only 9 per cent of self-employed people have an income protection policy.
"A number of firms have introduced support services, such as the Red Arc nursing service, alongside their products."
However, there are things providers can do to help the employed.
Christina Rigby, protection product owner at Royal London Intermediary, says: "Providers can still do a lot more to help customers understand the need for the current income protection product, and hence, drive better informed customers towards advisers.
"Perhaps one of the easiest ways we can do this is to give this product a name that says what it does on the tin – such as 'long-term sick pay insurance'.
"Encouraging employers to proactively tell employees what their sick pay entitlement is on the monthly pay slip, or their annual pension statement would increase awareness of this risk.
Ms Rigby continues: "This, plus signposting where they can get advice and help to buy income protection, would help drive informed customers towards advisers."
Providers could develop simpler, stripped back income protection products that pay out fixed benefits.
She adds that providers can do more to help advisers overcome the main barriers to sale.
"The average age of a customer making a Royal London claim in 2016 was 44," Ms Rigby explains.
"At this age many people will still have a mortgage based on both partners' earnings and dependent children.
"The tools offered by Royal London, such as its IP Report and benefit calculators, bring this need to life and show how quickly savings become eroded when you are off sick. This knowledge, coupled with information on state benefits, will quickly bust this myth."
Another obstacle preventing clients from taking up income protection is that it is too expensive.
But, says Ms Rigby, there are options for addressing this, such as having short-term payment periods and deferred periods.
Another obstacle is the concept that the state will provide. Ms Rigby says that state benefit calculators provided by the government can make this clearer.
Finally, a provider can make clear what the product offers so that it is obvious that the policy will suit a client's needs.
She says: "Menu plans, payment term and deferred period options, earnings definitions that can cater with fluctuating earnings and an easy to meet ‘this policy will pay out if you can’t do your own occupation’ claims criteria, are all common features of income protection products.
"This means that the current products in the market do actually fit most people’s needs - however, this level of flexibility definitely makes the sale feel a little more complicated. "
Ms Rigby suggests: "Providers could, therefore, develop simpler, stripped back income protection products that pay out fixed benefits or benefits related to just covering essential bills.
"We could also make the claims criteria related to ability to do daily tasks (or similar) which customers would probably find easier to understand – but it would be harder for customers to meet the claims criteria, the payments would be smaller and the claims process pretty similar."
Is there a protection gap?
The protection gap is something that many people talk about, but does it really exist?
Protection experts often talk about how the UK population is massively under-protected, but what does this really mean? Are they simply talking up the protection industry?
According to Swiss Re, in 2015 the UK actually had the biggest disability protection gap in Europe, putting it at £200bn.
Ron Wheatcroft, technical manager at Swiss Re Europe, says: "There are approximately 3.4m people covered in employer schemes or individual policies.
"Even if we double that to take account of those large employers which self-insure and the public sector, it means that some 80 per cent of UK workers are dependent on state benefits or whatever savings they have."
The protection gap is vast and the majority of people need to consider their situations.
Roy McLoughlin, associate director of Cavendish Ware, adds: "If only 8 per cent of employees are covered by group income protection then the maths is very simple when you add in the self-employed.
"The protection gap is vast and the majority of people need to consider their situations."
In Royal London's State of the Protection Nation Report, many felt they did not need income protection, with 49 per cent of 35 to 54-year-olds saying this, and 83 per cent of over 55s reporting this position.
Christina Rigby, protection product owner at Royal London Intermediary, acknowledges: "According to our report, 38 per cent of employees working full-time (30 plus hours) feel they don’t need income protection - but just 8 per cent said they didn’t need it because they had cover with their employer.
"Unless they have built up substantial savings, how can these people expect to replace their income?"
An obvious option is for employers to step in and offer more protection for their staff, something that employees seem to be vague about at the best of times.
Mr Wheatcroft, whose company assesses the scope of insurance policies, says there are "just 17,442 in-force insured group arrangements, so there is an opportunity for insurers as employers look for ways to improve the wellbeing of their workforce".
"Businesses themselves will face potential losses if a key employee becomes sick or dies. This presents a further opportunity to build a client relationship and to support the business by making it more resilient."
However, it is not simply a case of bringing in new people who have never been insured before. Kathryn Knowles says a "significant" proportion of the under insured are people with pre-existing health conditions.
She says: "The 'purple pound' is a completely undervalued asset to the UK economy, and is worth an estimated £249bn a year. With the correct support mechanisms, many disabled people are able to work.
"Group income protection is proof of this - these insurance policies not only provide an income replacement when it is needed most, they also take people who are ill or have developed disabilities, and reintegrate them into the workforce.
"Access to income protection insurance for people with disabilities needs to gain more attention."
Those who rent their home are just as likely to be hit as hard as homeowners if their income is interrupted because they are unable to work.
Royal London has identified four obvious categories of people who do not have adequate protection, although there are others: self-employed; employees; homeowners and renters; over 55s; and millennials.
Ms Rigby says the self-employed is a sector that is growing rapidly, and those in this category have no employer benefits to fall back on.
Meanwhile, many homeowners buy life cover before buying critical illness and income protection, although an individual is statistically more likely to have a serious illness than die early.
However, the renting community, which is an increasing part of housing tenure, is also neglecting its protection needs, and many will find themselves in the same boat as homeowners if they are off work for a long time and cannot afford to pay their rent.
Mr McLoughlin says: "Generation rent in some areas is bigger than home ownership, yet many renters ignore the issue.
"Landlords will have no sympathy for a tenant who cannot pay rent due to illness."
Ms Rigby adds: "Those who rent their home are just as likely to be hit as hard as homeowners if their income is interrupted because they are unable to work.
"And while some renters have protection in place, it’s likely to have been arranged without advice due to the fact advisers rarely get involved in the rental process."
Regarding the over-55s, she says: "Our research also tells us that age plays a huge part in appetite for income protection, with those aged 55 and over feeling considerably less need for income protection than younger age groups.
"However, as there is no longer a default state pension age and the number of people continuing to work past the age of 55 is increasing, it seems more important than ever to have protection into later life.
"It’s important for this group to understand that if they cannot work they are unlikely to be able to continue to pay into their pension, hence their quality of life will also be detrimentally affected into retirement."
Strike up a conversation
Regarding millennials, Ms Rigby says that 73 per cent of 18 to 34-year-olds who bought cover through an adviser have an ongoing relationship with their adviser, compared to 44 per cent of 35 to 54-year-olds, and 47 per cent of those aged over 55.
She adds: "Perhaps as people get older, they feel more confident in the decisions they’re making themselves when compared to the younger generations who perhaps feel they need guidance – so [advisers should] strike while the iron is hot.
"Talking about protection at every opportunity seems to be the key way to engage with these individuals.
"Start by asking customers to find out exactly how long their employer will continue to pay their wages if they are unable to work and what they think the state will provide - and take it from there."
House View: Protecting clients against their biggest risks
It could be argued that traditionally a go-to protection policy would include life cover with a bit of critical illness cover – after all, these are the products most people are familiar with.
And recent research carried out as part of our State of the Protection Nation report seems to back this up. It showed 42 per cent of people in full-time employment had life cover in place and 20 per cent had critical illness cover (2).
However, we have a tool on our website – the Risk Summary Report – which shows the relative risks of a person dying, getting a critical illness, or being unable to work due to illness or injury during their working life.
As an example, a female non-smoker aged 30 runs the following risks before she turns 65 (1):
• 3 per cent risk that she’ll die during that time
• 12 per cent risk of suffering a critical illness
• 44 per cent risk of being off work for two months or more because of an illness or accident.
So her risk of being off work through accident or sickness is four times greater than the risk of critical illness and 15 times greater than the risk of death.
Yet our research shows that 49 per cent of 35-54 year olds feel they don’t need income protection (2).
Perhaps the name ‘income protection’ confuses things – possibly it conjures up thoughts of a product akin to the dreaded PPI? Whatever the reason for the reluctance from consumers to consider income protection, more education on the risks and benefits of this product would certainly be useful given the higher risks to this age group of being unable to work for a period of time.
Is it time to reconsider our protection priorities?
If a client is thinking about protection it’s fair to say they’re likely to be earning a wage and have something to protect. And the truth is it doesn’t really matter what that is – it could be their mortgage, their rent or their lifestyle – without a regular income they’re going to be in a spot of bother regardless of their personal situation.
It makes you think that perhaps a product that protects against the higher risk of a client being unable to work due to illness or injury should be right at the top of the list for consumers when it comes to protection.
So perhaps the traditional ‘life cover with a bit of critical illness cover’ view needs to make room more often for ‘life cover with a bit of income protection’ instead?
Income protection that meets clients’ needs
Some of the reasons income protection isn’t sold as often as life cover or critical illness cover is that many clients think it’s complicated, expensive and won’t pay out.
In short – that it won’t meet their needs when it matters the most.
And it’s down to providers and advisers to make sure the common misconceptions about this type of cover hold no weight.
On the face of it, income protection should seem a lot simpler than, say, critical illness cover – customers don’t need to meet definitions of a particular set of illnesses to make a claim, for a start. And with many providers, including Royal London, now choosing to remove the ‘working tasks’ requirement , customers are eligible to claim if their condition means they can’t do their own job.
To give customers the confidence that the protection plan they’ve paid for will be there for them when they need it, providers need to make sure their products are going to make a real difference to customers.
Of course, there are still elements of this type of cover which make it seem complex, such as deferred periods and payment periods, but these features enable customers to tailor their cover to suit their needs and their budget.
That’s why good financial advice is essential to a successful income protection sale.
Going beyond client expectations
To give customers the confidence that the protection plan they’ve paid for will be there for them when they need it, providers need to make sure their products are going to make a real difference to customers – and provide them with the financial support they expect.
For example, we include fracture cover and hospitalisation payments with income protection as standard.
Neither of these benefits affects a customer’s main income protection cover, so they don’t need to wait for their chosen deferred period to end before making a claim on them.
We also include back-to-work payments for customers that choose a deferred period of 13, 26 or 52 weeks, because we recognise these people will probably need to ease back into the workplace.
Accessible at any time, not just at claim, our Helping Hand service* means they can get access to support as soon as illness or injury occurs. Helping Hand is there for as long as they need it to help them get back on their feet – and back to earning a full wage.
To find out more about how our Income Protection can meet your clients' needs, visit adviser.royallondon.com/protection.
* Helping Hand is a package of support services, provided by third parties that aren’t regulated by the Financial Conduct Authority. These services aren’t part of our terms and conditions, so can be amended or withdrawn at any time.
1. Royal London Risk Summary Report tool, 2018. Studio.royallondon.com.
2. State of the Protection Nation report, 2018.
Christina Rigby is protection product owner at Royal London Intermediary