Protection: Cheaper doesn't always pay

Critical illness cover can often be a simpler and less expensive option but advisers should inform clients there are many common situations where it won’t pay out. Carefully arranged income protection may prove a better choice.

It is generally acknowledged that we spend most of what we earn. In fact, if growing debt is anything to go by, most of us will go further than this by spending money we don’t have. But how would many of us be able to meet our regular monthly outgoings let alone rising borrowing costs, without the benefit of a regular monthly income?

While many of us will be concerned by the prospect of unemployment, it is important to remember that this currently only affects around one in 20 of us. In comparison, the risk of being unable to work for six months or more at some point due to illness or accident is much greater at around one in six. So what’s the best way for clients to protect their livelihoods?

The FSA’s ‘Money Made Clear’ website for consumers suggests that many advisers may recommend critical illness cover. But while it makes the point that ‘critical illness cover is cheaper and simpler than income protection’, it also points out that there are ‘lots of common situations when critical illness cover would not pay out.’ Armed with this information, it’s important to remember that stress and mental health conditions in particular accounts for around 40% of all claims for state incapacity benefit.

Income protection is the only product that comprehensively protects against the financial consequences of incapacity. So, given the FSA’s emphasis on treating customers fairly, don’t advisers have an obligation to discuss this type of cover?

One group which would certainly share this view is the Income Protection Task Force. In their 2006 White Paper, they made a number of observations, which included that establishing a protection hierarchy which prioritises the main forms of protection cover and puts income protection at the top would undoubtedly have a huge impact on the ability of intermediaries to sell income protection.

Moving forward, this type of cover looks set to play an increasingly important role when the government launches its new ‘Employment and Support Allowance’ in 2008. Actual benefit levels have not been published yet, but we do know that unlike now, the new allowance will not offer additional benefits dependent upon the claimant’s age or where they have a financially dependent adult. In addition, it is generally expected to be much more difficult to qualify for the new benefit.

For many advisers, recommending a suitable income protection plan centres almost entirely on finding the cheapest quote for the definition of incapacity requested by the client. But before an adviser logs on to one of the portals for a quote comparison, it is important to remember that the differences between products can have important implications for accurately meeting a client’s needs and the ability to later review a policy or make a claim. So what do advisers need to consider when recommending an income protection policy?

Take the time to think about how far cover is diluted through the addition of standard exclusions. Providers will apply around four exclusions on average, but watch out for the handful that will apply as many as 10.

When requesting a quote, it also pays to look at how the premium itself has been costed. Most providers will offer a choice of guaranteed or reviewable rates, but some providers who initially appear to be much cheaper, may become more expensive during the term of the policy as the client gets older. And while some providers will include premium waiver or the right to later apply guaranteed increase options within their standard quote, others may apply an additional charge.