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.

Active or Passive Funds, which is best?

Investing funds for your future can prove to be a minefield for those who do not take suitable advice. Chapters Financial hope that through our informed processes, we are able to educate enquirers in investment planning and what can be achieved and possibly, more importantly, which investment styles can be used. As an example, some investors are not aware of the difference, or even the existence, of active and passive investment funds. You may have spotted the long list of funds listed in the financial sections of the weekend newspapers and the Broadsheets during the week.

So what are these active and passive funds and what might you want to consider?

• What do they do with your money?
• How do they differ?
• How can their performance be measured?

Active Fund examples

Active funds are, as the name suggests, actively managed by professional fund managers who make decisions on the individual holdings within the overall fund.

Invariably, they will be buying, and selling, different shares / gilts / commodities / etc. based on what they believe to exhibit the most, or least if selling, value at the time within their chosen sector. It could be suggested that you are effectively buying the expertise, skill and experience of fund manager’s team you are investing in, along with the assets of the fund. You are paying for this skill, expertise and experience within the fund’s Annual Management Charge (AMC/ known as On-going Charge in many investments). Investments are usually made for a return and the payback you wish to see for your decision is that your investment return is good (and some ‘benchmark’ their return against a corresponding index for comparison purposes). This benchmarking should demonstrate that the fund, and correspondingly the investment fund manager, is outperforming its peers (or not) within the marketplace.

Passive Fund examples

Conversely, passive funds are not (as you may have already guessed by now) actively managed.

They usually aim to track an chosen index, or benchmark, by being invested in a ‘basket’ of holdings which are designed to closely replicate the index, or benchmark, to varying degrees of accuracy depending on the type of passive fund. This ‘basket of holdings’ (usually unit holdings) is not changed unless the index, or chosen benchmark, is changed. One example of an index is the FTSE100 which is comprised of the top 100 leading companies listed on the London Stock Exchange (LSE). A FTSE100 Tracker Fund will buy shares in the FTSE100 companies and it will be unlikely to amend the basket of FTSE100 company shares unless certain companies fall in and out of the FTSE100 list. Due to less analysis, fewer transactions, minimised administration and reduced manpower required for passive funds the Annual Management Charges (AMC) tend to be lower than the Active funds noted above.

Benchmarking

Some investors prefer to have a measure to judge performance of their fund against the area they are targeting, such as Growth or a Stock Market, such as the FTSE, as examples. For Private Investors, one reasonable tool that can be used is APCIMS (Association of Private Client Investment Managers) FTSE benchmarks. There is a range available and a link to these can be found below:
http://www.ftse.com/Indices/FTSE_APCIMS_Private_Investor_Index_Series/index.jsp

Which to go for?

One question often posed is ‘why not just buy passive funds only to keep costs down you may ask?’
Although the costs of fund management are important and should be considered carefully, the answer is reasonably simple. If you are trying to achieve better returns than a chosen index or benchmark, then passive funds are highly unlikely to ever achieve this index return. Why? Due to the fact that the index, or benchmark, will not be reduced by the Annual Management Charge made to your fund and therefore the index return should always be greater.

It could then be suggested that the higher charges applied by an actively managed fund will require the investment to work harder to achieve the same return achieved in a passive fund/investment. There is some mileage in this argument, but without the constraints of an index to adhere to, this usually gives the manager a greater range and flexibility of investment choices. Some would argue that smaller funds can be more agile than larger funds, but without being tied to a (potentially) restrictive index, the scope of the manager for investment and, most importantly, returns should be increased.

Chapters Financial usually prefers actively managed funds, however a mixture of both active and passive funds can be used to great effect to generate capital growth (or income or both) depending upon the clients risk profile, objectives and timescale. Benchmarking, as noted above, may be a way of way of helping measure the success of this investment planning strategy.

Investment is about clients’ needs and desires for their money and its future. Any financial/investment planning should be based on your objectives and attitude to investment risk. For reference, an Investment Risk Schedule can be found on the Chapters Financial website here.

As you would expect, no individual investment/planning advice has been provided during the content of this Blog. This is because each client’s needs are individual and so is their planning. Chapters Financial Limited would be pleased to help you with your investment planning, in all its many formats, into the future, continuing to provide the independent financial advice (IFA) into 2013 and beyond.

Past performance is not a guarantee of future performance. Fund values can fall as well as rise. Chapters Financial is not responsible for the content of external Website links.

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