Friday 1 February 2013

Sick Pay Cover – Do you have enough?

I recently completed a financial plan for a director of a successful local company. Amongst the usual planning for pensions and life cover, I also wanted to address a much overlooked (and vital) area, which is the protection of income in the event of inability to work due to ill health. In this case, the topic was especially relevant because the business was young and very much reliant on its director to drive sales. He was clearly good at this because of the trajectory of profits achieved so far.

With no cover elsewhere, other than capital achieved from sales within the company which would deplete quickly without its sales 'driver', this was an area of exposure that once identified, the director wanted to address promptly.

Far too few people consider the impacts on their household finances in the event of them being unable to work due to ill health. Statutory Sick Pay (SSP) only pays for a maximum of 28 weeks at a level of £85.85 gross per week (2012/13) paid by the employer with income tax and National Insurance to be deducted.

In this blog, I wanted to look at the factors that can affect the final monthly premiums offered on Income Protection Policies, all of which are subject to medical underwriting.

The obvious factors are existing health condition, age and if the applicant is a smoker (which would see premiums lift significantly).

The other main factors which now influence premium levels are as follows:

G-Day
The recent EU ruling on the equalisation of rates between men and women has seen the most dramatic increases on male applicants for income protection policies. In some cases the increase has been as high as 40-50% increase for a male applicant in comparison to pre-G-Day (Gender Equalisation day of 21st December 2012), although a more typical increase could be around 25-30%. Conversely, female applicants should see a reduction of their premium in comparison to their premiums pre-G-Day, although I don’t believe it will be as large a discount as the increases seen for males.

End date / Term
As noted above, the maximum term which SSP pays is 28 weeks, however most Income Protection Plans, also known as Permanent Health Insurance (PHI) policies, can be set with a cover period up until the applicants 65th Birthday, possibly even longer depending upon the insurer. Obviously the longer the cover period (especially with the policy term into the advanced age range of 55 to 65) will increase the premium accordingly, however this longer period can be invaluable when planning your protection needs because it allows for some income provision beyond the Statutory Sick Pay (or even an employers’ own sick pay arrangements).

Inflation uplift / Escalation
At the outset of the insurance policy you can select whether the cover amount will stay level (cheaper premiums) or escalate / increase (usually in line with inflation as an example). Escalation will increase the monthly premium, but if the policy is to be in force for many years (for example a 30 year term) then at the point of claim the escalation of benefit could prove very worthwhile if the claim is towards the end of the policy term.

Waiting Period
This is sometimes referred to as a deferral period and is the length of time the claimant has to be unable to work due to ill health before a claim will be paid. The longer you set the deferral period the cheaper the premiums will be, however planning should be taken to ensure that sufficient other funds / income are available to provide for loss of income during the selected waiting period. Examples of waiting periods might be 4, 8, 13, 26 or even 52 weeks.

Calculation of amount of cover (maximum)
One of the key drivers for insurance premium costs is obviously how much cover is required and, therefore, the amount the insurer will have to pay in the event of a claim. In my opinion, the key minimum cover should be the amount the individual pays towards household costs on a monthly basis. However, in most cases this is not the ideal and careful consideration should be taken in planning the appropriate level of cover.

Dividend v Salary
This is a very important issue, especially considering my example case mentioned above. This is because many business owners / directors pay themselves nominal salary and higher dividend amounts for tax, and potentially cash-flow, purposes. Many insurers may not include the dividends in their calculation of a claimants income, so the desired amount of cover may not be available, or even paid, in the event of a claim. Some insurers may apply an increase in premium to reflect that they will include dividends. Careful attention of the terms and conditions of the income calculation allowed must be considered before starting the policy.

Guaranteed / Reviewable Premiums
The final major point which could affect the premium illustrated is whether the premiums are guaranteed (i.e. they will not change, apart from escalation if chosen, during the term of the policy) or reviewable. Reviewable premiums allow the insurer to calculate premiums collected against claims amounts paid and if they believe that there is a discrepancy then they can amend the premiums accordingly. This review tends not to be done on an individual basis but rather on a demographic basis for the insurers “risk book”. Guaranteed premiums tend to be slightly more costly at outset, but at least you know what you will be paying during the term of the policy.

Individual or Employer pays the premium
Generally speaking, insurers have an understanding that all income protection policies which an individual can hold will pay a combined maximum of 50% of a claimants gross annual earned income. This will normally be paid on a tax-free basis if the individual pays the premium. If the premium is to be paid for by the employer, then the maximum available is usually 65-75% of the claimants gross income paid on a taxable basis.

As you would expect, each element noted above is likely to have an effect on the final premium offered. Being independent financial advisers (IFA's) we have the ability to use the whole market to search out competitive providers in most circumstances.

No individual advice has been provided during the course of this blog. Protection in the event of either death or ill health should be planned for carefully and if you would like to receive individual advice on this subject, then please contact the team at Chapters Financial Limited on 01483 578800

Simon Hewitt BSc (Hons) Dip PFS
Financial Planner
Chapters Financial Limited 
Chapters Financial Limited is authorised and regulated by the Financial Services Authority, number 402899.

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