Income Protection Insurance

Income Protection Insurance (IPI) is a type of insurance policy, designed to cover those who are  unable to work due to illness or accident through no fault of their own. It is most common in the United Kingdom and Ireland. A similar product in U.S. would be called disability Insurance. However, in many countries disability insurance is different than in the U.S. and only applies to long term disability and results in the policyholder receiving a lump sum distribution rather than a monthly replacement for your regular income.

Income Protection InsuranceTo qualify for Income protection insurance you have to be certified as being incapacitated. If after an illness or accident, you meet one following four criteria you are classified as incapacitated:

    1. The policyholder is incapacitated if they are unable, to perform their own occupation and are not working in another job.  This is called  incapacity in their own occupation.
    2. The policyholder is incapacitated if they are unable, to perform an occupation suitable to them given their education and training etc. This is called  incapacity in a Suited occupation.
    3. The policyholder is incapacitated if they are unable, to perform any occupation at all. This is called  incapacity in Any occupation.
    4. The policyholder is incapacitated if they are unable, to perform a number of defined functions such as dressing and undressing, washing, eating, climbing stairs, shopping, cooking etc. The policy will define the number of functions they must to be considered incapacitated based on Activities of daily living (ADLs).

Benefits

Most policies base the benefit on a percentage of the policyholder’s normal salary. Obviously, insurance companies do not want to encourage claimants by paying more than they would earn if they worked so typically this is 70 – 75% of gross earnings, but it could be less for high earners and may be reduced based on other benefits from other policies.

  • Premiums paid by employers to provide cover for their employees are tax-deductible to the employer and are a taxable benefit to the employee. Benefit payments paid from individual policies, following an accident or illness, are free of income tax and National Insurance contributions but for group policies, benefits are taxable and subject to National Insurance contributions.
  • Benefits are payable when the policyholder becomes incapacitated and after the deferred period has passed and continue until the earliest of death, recovery of health, retirement or the term of the contract.
  • Benefits are paid regularly (usually weekly or monthly) and are free of tax.
  • The insurance company cannot cancel or refuse to renew the policy provided that the policyholder continues to pay the premiums.
  • A waiver of premium option may be provided whereby premiums for the IPI policy are not required while benefits are being paid from the policy, but the policy cover continues as normal.

 

Limitations —

Deferral period

The deferral period is the time  that must elapse after disability occurs and before between benefit payments start. Generally, the longer the deferral period the lower the premium.

Proportionate benefit

Insurance companies also want to encourage the policyholder to return to work even if their health is only partially recovered so, many companies offer to pay a reduced benefit if the disabled person is willing to take a part-time or lower-paid job.

Free limit

Many Income Protection Insurance policies limit the area of coverage to permanent residence in an area defined in the policy. The area may be the UK, the EU,  or Western Europe but may include the USA or other developed countries.

There are a number of restrictions that can affect a policyholder’s eligibility for income protection insurance

  • The policies do not pay out if the policyholder becomes unemployed for a reason other than illness or accident.
  • Most policies limit benefits for accidents or illness arising from self-inflicted events such as drug or alcohol abuse, criminal acts, intentional self-harm and pregnancy and may also include acts of war.
  • On change of occupation (or unemployment) of the policyholder the policy may become invalid, or the life office may require the premiums to be changed to reflect the new risk.
  • IPI policies do not provide health insurance, death benefits or critical illness cover, so health insurance and/or life assurance and/or critical illness cover may also be needed by the policyholder.
  • IPI policies are not suitable insurance against unemployment in general as benefits are only paid if the unemployment arises due to incapacity. An accident, sickness and unemployment insurance policy or Mortgage Payment Protection Insurance may be needed as an alternative or to complement the IPI policy.

Types of Income Protection Insurance

In addition to standard fixed-premium Income protection insurance policies there are a number of variations available:

  • Group Income Protection Insurance is provided by employers for their employees. This type of policy will expire if the employee ceases employment with the employer and a maximum payout period may apply.
  • Renewable Income Protection Insurance – renewable policies are like term life insurance in that they give the policyholder the right to renew the policy, possibly with an increase in cover, after a certain term (often 5 years). Renewal rates will be based on the prevailing premiums for a person of their age and occupation. Premiums will increase as the policyholder gets older.
  • Increasing Income Protection Insurance – the value of the benefit payable by a fixed-benefit policy is eroded over time by inflation so policies whose benefits increase are often more suitable. The benefits may increase at an indexed rate (such as the Retail Prices Index), a fixed percentage or by a percentage chosen by the policyholder every few years. For such increasing policies, premiums usually increase as well.
  • Unit-linked Income Protection Insurance – other IPI policies have no investment element and hence no surrender value, however a unit-linked policy has an investment element similar to unit-linked life assurance policies. Premiums will normally be more expensive than standard policies due to the investment element, and could be still more expensive if the return on the invested premiums is poor.

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