Get protected... for the worst can happen

"Many people underestimate the need for income protection and bury their head in the sand with an 'it will never happen to me attitude'," says Ian Smart, head of product development at insurers Bright Grey, a division of Royal London.

Such people do not believe they will ever suffer long-term sickness and mistakenly think their employer or the state will look after them. Sadly, all too often this is not the case. As so many rely on a regular salary to maintain their lifestyle, long-term illness can have a devastating effect on their finances.

Many are confused about the cover they hold and think they have income protection when they are actually signed up for either critical illness or payment protection insurance.

The situation is often not helped by computer searches for income protection. The internet responses are frequently information on payment protection insurance which only covers specific outgoings, such as a loan or mortgage payment, instead of true income protection which replaces a proportion of your income irrespective of your outgoings.

In view of this confusion, it makes sense to speak to an independent financial adviser. They can take into account such factors as the type of work untaken, how long an employer will pay if you are ill, what other cover may be in place and how much you can afford for the right product.

The stark question is whether you and your family could survive on 95.15 a week? This is the Government support if you had been off work for at least 14 weeks and only 64.30 a week for the first 13 weeks.

If your average weekly spend is 333, where will the remaining 237.85 come from to support your family and pay for bills when your savings have run out?

"This paints a frightening picture but it is the reality for the average working person in the UK who does not have any – or limited – employer sick pay benefit," warns Paul Hudson, chief executive of Cirencester Friendly Society, a specialist in offering income protection.

Cirencester is one of nine providers of Holloway contracts, named after a Victorian MP. Those who insure this way participate in the profits and so enjoy a tax-free sum when their contract matures. Consider such other leading friendly societies as Exeter (through its subsidiary Pioneer Protection), Shepherds and Wiltshire.

Out of a 21 million workforce, over 80 per cent have no income protection. There is clearly a need as 2.6m claimed incapacity benefit in 2008 but as the figures above show, there is a major shortfall. Adequate insurance is particularly important for the self-employed or where an employer does not offer a sick pay scheme.

Under an income protection policy, regular premiums are paid to an insurance company which will fund a specific sum if you are unable to work. One of the major plus points is that there is no limit to the number of claims that can be made.

At the heart of a policy is the definition of incapacity. Check with your intended insurer on its wording. The five most common are:

n 'own occupation': you can claim if your incapacity is sufficient to prevent you from following your own occupation;

n 'any suited occupation': you cannot claim unless too ill to carry out your own occupation and any other occupation to which you are suited;

n 'any occupation': you cannot claim unless too ill to carry out any job whatsoever;

n 'activities of daily living': only claim if unable to carry out a selection of everyday tasks, such as washing and dressing yourself;

n 'activities of daily working': only claim if unable to carry out a selection of work-related tasks, such as walking, communicating and exercising manual dexterity.

The definition chosen has a major impact on the premium. The benefit is free of income tax. The benefit paid will always be less than normal earnings as "insurers are keen to encourage you to return to work", says the Association of British Insurers.

Premiums are probably less than might be expected. For a monthly

28.30, based on a male, non-smoker, 40 next birthday with 40,000 annual salary and a chosen deferred period of 26 weeks, Scottish Provident will pay 1,666 each month (50 per cent of salary) for 20 years. This is based on any occupation.

When deciding on amount of cover, calculate your income (taking into account what savings could be drawn upon) and expenses (ongoing such as mortgage repayments as well as new costs like daytime home heating).

Whilst an insurer will look at your age, sex, occupation, medical history and how widely worded is the definition of incapacity, you have four key choices when taking out income protection:

n How long to wait before benefit becomes payable (the longer, the cheaper the premium);

n Length of policy, which is usually normal retirement age (the longer, the more expensive);

n Fixed or variable premium, such as rising in line with inflation, reviewable in light of claims or renewable (the right to continue after a fixed term at a new rate);

n Rising benefit as otherwise inflation will erode the real value.

Looking at the length of term, the maximum period varies considerably, such as 40 years (AXA, Bright Grey and Scottish Provident) to 51 (Aviva and Holloway Friendly) and 52 years (Bupa).

Deferment can range from one day (Cirencester and Pioneer) to 104 (LV=, formerly Liverpool Victoria) and 112 (Aviva).

Maximum benefit can be substantially different: just 33 per cent (over 45,000 with Zurich Assurance) to 70 per cent (first 10,000 at Bupa and Friends Provident) and 80 per cent (Unum).

Providers have a positive story to tell on claims. The reasons for non-payment largely result from incorrect information given on original contracts. It would be helpful though if all insurers published their claims record.

Again, this is a question to pose of any potential insurer.

Insurance that proved invaluable to couple

Independent financial adviser John Lohan of Airevalley IFA, based at Silsden near Keighley, met Gladys and Alan Gee, also from Silsden – both then aged 45 – some years ago to review their company insurance, which was in the transport sector.

He found they had no insurance in place should one of them be unable to work long-term through illness or accident.

"They were unaware they could insure each other for loss of income," says John, who calculated each needed 10,000 annually with a deferment period of 13 weeks before claiming, indexed each year in line with retail inflation.

Guardian Royal Exchange (now Aegon) was the insurer. Payment would continue until their chosen retirement age or return to work or death.

Unfortunately after five years, Gladys suffered a long-term illness and the insurer paid 833.33 monthly, providing not only an income but also allowing the company to employ a replacement staff member. Payment was received quarterly in advance which helped cash flow.

"Without this income Mr and Mrs Gee's business would have suffered and may even have faltered," says John.

As a premium example, he says a 31-year-old non-smoker company director would receive 12,504 annually after a 13 weeks' deferment period, rising each year by RPI, until 60, for just 13.13 a month.

n Contact: Airevalley IFA 01535 656753.