Critical illness cover vs income protection – what’s the difference? (Part 1)

What’s the best way to protect yourself and your family if illness or injury stops you working? In this two-parter, Neil Adams of Drewberry Wealth Management explains the two key types of protection, and offers guidelines for ensuring that you are properly covered.

Stethoscope and Model House on Gradated Background with Selective Focus.

If you had to be off work in the short or long term, would you still be able to pay the housekeeping? The mortgage repayments? Many people are concerned that they wouldn’t be. However, not so many are aware of how to protect themselves and their families from the consequences.

A survey by Drewberry Wealth Management¹ in 2015 showed that only 45 per cent of workers have savings of more than three months’ salary, while only 42 per cent would receive more than three months of sick pay from their employer. With the state providing a maximum support of only £109.25 per week after six months off work, more workers ought to be asking what personal insurance options they have. Here are the basic choices and how they compare.

Option 1: Income protection

Income protection provides a monthly benefit to pay for your essential outgoings, if you are off work due to an accident or illness (and the medical evidence confirms this). There is no limit to what the policy covers – for example, you could be off work due to a broken leg, cancer or mental illness. You can make multiple claims on this type of policy without it causing your premium to go up.

What options do I have with an income protection policy?

The maximum payout length

There are two main options:

Full term – you will receive the benefit amount until you are able to go back to work. This could be for one year, 10 years or even right up to your retirement age if you are unable to work again.
Short term – this is the budget option. When you make a claim you will typically be limited to two years for each claim. You can still make multiple claims on the policy, but each one can be for only two years in length. Some insurers limit the total amount of cumulative claims to two years, so watch out for this.

The deferred period

The policy won’t pay out as soon as you go off work due to illness or injury. The deferred period is how long you’ll have to wait before it starts to pay out. Typical deferred periods range from as short as 7 days to as long as 12 months.

When setting the deferred period, it makes sense to take into account any employer sick pay you would receive, and also whether you have any savings that could be used to cover your bills initially.

It may help to think of the deferred period as working in a similar way to the excess on your car insurance. The longer you are able to wait before the payout starts, the more cost-effective the premiums will be.

How long the policy lasts

The term of the policy is how long the policy will last for – for instance, you might want it to cover the length of your mortgage. However, many people prefer to have the policy last until their retirement age, to ensure that they can always cover their essential monthly expenditure until they start receiving their pension income.

What do I need to watch out for when considering income protection?

Each income protection policy uses a ‘definition of incapacity’ when determining when a claim should be paid. It’s vital to check this, as the definition used makes a huge difference to the likelihood of a payout. You can use this occupation definition calculator to check your own occupation’s incapacity definition. The two most common definitions are as follows:

Suited Occupation – if you see a policy which is written under a definition called ‘Suited Occupation’ then you need to take great care. If you are off work due to an illness or an accident, the insurer would assess your skills and experience and determine if you are able to do another job to which you are ‘suited’. If they believe you can do this, then the insurer can decline your claim. Many low-cost payment protection policies use this definition.
Own Occupation – This is the most comprehensive definition of incapacity (at Drewberry we rarely recommend anything else). Put simply, if you cannot undertake the main duties of your current role due to any accident or illness then the policy will start paying out after your deferred period (i.e. the insurer won’t assess whether you are able to undertake another, possibly less demanding, role).

Does the insurer you are looking at publish their claim statistics? If not, be very wary, as you have no idea how likely it is that your claim would be successful. The vast majority of reputable insurers will publish their payout rate each year, and across the industry the average payout rate for income protection was 91.2% of all claims made in 2015² (ABI).

In the next part of this article we’ll look at the other main type of protection, should you become unable to work: critical illness insurance. How does it compare to income protection, how do you choose between them and can you have both? Find out in part 2.

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