Guide to the background to protection planning
What advisers need to know about income protection to help clients build financial resilience
As advisers will know, most of their clients will experience some kind of income shock at some point in their life.
Income protection can often provide financial resilience when it is needed most.
But what do advisers need to know about income protection and how it interacts with state benefits when having the protection discussion with clients?
And what role can advisers play in smoothing the claims process?
Read on to find out more about why knowledge about state benefits is useful and how the income protection market might develop in the coming five to 10 years.
How to ensure clients are financially resilient
Say the words ‘income protection’ and clients may not understand what type of product that is.
But advisers have an important role to play in ensuring their clients have access to information about different types of protection and that they are not left vulnerable to the various life events that can impact an individual’s or family’s income.
So what are these income shocks and how can advisers use income protection to help clients financially withstand these events?
Rob Harvey, head of protection advice at Drewberry, says: “The big four life and income shocks clients are vulnerable to are illness, death, unemployment and redundancy.
"This is especially the case as the state cuts back on benefits, even as the prevalence of serious illnesses is on the rise.”
Mr Harvey adds: “Another issue is that, thanks to rising house prices, mortgage terms are getting longer and people are older when they get on the housing ladder, which means people have major financial commitments later into life. This can require more protection for longer.”
Given the weekly rate for statutory sick pay in the UK is £92.05 a week – available for up to 28 weeks, according to Gov.uk – taking out income protection can reduce the financial burden posed by various life events.
Income protection guarantees regular monthly payments if you are unable to work, typically assuming medical evidence supports this.
Advisers often neglect the more serious situations such as unemployment, long-term illness or even death.
Roy McLoughlin, associate director of Cavendish Ware, says: “There are the obvious [events] like births, marriages and moving house.
“However, advisers often neglect the more serious situations such as unemployment, long-term illness or even death.”
He continues: “For the self-employed and small business owner there is the added complication of fluctuation of earnings too.”
Jon Dean, head of retirement strategy at Altus Consulting, notes renting is why millennials - often dubbed ‘Generation Rent’ – may require income protection.
“Income needs may be impacted by rent or mortgage rate increases, or eviction, leading to having to rehouse to a more expensive area or property,” Mr Dean explains.
How income protection can help
Research by Zurich UK shows 13 per cent of people would have to sell their family home if they lost their income – with 92 per cent admitting they had no income protection in place.
Peter Hamilton, head of market management at Zurich, says: “As well as financial support, income protection also includes access to rehabilitation services that include things like counselling or physiotherapy that can be difficult to access via the NHS.
“Quicker engagement with rehabilitation and treatment can also mean a speedier recovery, helping customers back on their feet and back to work.”
While income protection policies are typically designed to cover an individual who is no longer able to work mainly due to illness, it can also cover unemployment and redundancy.
Experts are, however, divided on the extent to which they believe income protection plans will cover involuntary unemployment.
Redundancy cover is available within the market, but this is usually a separate insurance that can be taken out.
Mr Dean says: "Income protection protects against illness and accident but not usually for redundancy.
"It can provide a tax-free income of up to about two-thirds of the insured person’s gross income, for a period typically from one year up until the full term to retirement – usually with a waiting period before the first payment.”
Vincent O’Connor, senior business development manager at Royal London, says: “Redundancy cover is available within the market, but this is usually a separate insurance that can be taken out – not part of an income [protection plan] cover.”
But Paul Foody, chief operating officer of Inchora Group, points out: “Employment cover can also be added which will cover the individual in the event of involuntary redundancy by paying a monthly benefit for one or two years.”
So how can advisers clearly explain to clients the need to prepare for life-changing events that may leave them financially exposed and the role income protection can play?
Mr Foody says: “Tailored advice is key, taking into account individual circumstances to recommend the right protection, including savings, household outgoings, mortgages and other credit, cost of living, assets and ability to liquidate those assets if required – a partner’s income and many other factors can impact the advice provided.”
He notes the need for income protection fluctuates throughout an individual’s life and financial advisers’ recommendations should account for this.
Rod Jones, head of partnerships at ActiveQuote, says: “Advisers can ensure their clients are financially resilient by understanding what the customer's employer benefits are – for example, how much sick pay they receive (full pay or half pay) and how long they receive the payment, as well as what the terms of redundancy are.”
“This will help advisers to understand the financial needs of a client and the point that income protection would be needed,” he explains.
The need for advisers to first find out how much cover the client already gets through the workplace is voiced by several others.
Mr McLoughlin says during the factfinding process is when an adviser should find out whether a client has any other type of cover in place, adding "this will include what and if they are covered by their respective workplaces”.
“It is vital to ‘stress test’ certain situations and [judge] what is in place to deal with these,” he explains.
What do advisers need to know about state benefits?
Prior to discussing income protection (IP) with clients, it is worth advisers understanding how IP and state benefits interact.
Rob Harvey, head of protection advice at Drewberry, says: “Advisers need to know about state benefits because without this knowledge they can't educate clients on the limitations of them and therefore the need to self-insure.”
Generous and easy?
Why do advisers need to know about state benefits when it comes to the protection discussion?
Because income protection may result in reduced entitlement for certain benefits.
Jon Dean, head of strategy at Altus Consulting, says advisers need to be fully aware of how state benefits work because “benefits are inadequate to replace earned income for their clients, and secondly because protection benefits may result in lost entitlement to certain benefits”.
Mr Harvey notes: “There seems to be this myth that's often perpetuated by the media that state benefits are generous and it's 'easy' to survive on them, but in fact that is not the case.”
“Increasingly the level of support from the state is being cut back and it's become harder to claim benefits, especially since the introduction of hurdles such as work capability assessments,” he adds.
A number of experts point out that income protection reduces the amount of means-tested benefits available to people.
Mr Harvey notes: “All means-tested benefits are relevant to protection advisers, because these are the ones likely to be impacted by having protection in place.
“It's important, as advisers, to take a look at a client's circumstances holistically to know what they'll be in receipt of in the event of a claim,” he adds.
Like many others, you might think Universal Credit only applies to those out of work and on benefits, and isn’t relevant to your typical clients.
A means-tested benefit is a payment available to people who can prove their earnings income and capital are below specific thresholds.
In June 2018, the Department for Work and Pensions confirmed that if income protection benefits are intended and used to fund regular mortgage payments, and if paid directly to the lender, these will be disregarded from any means-testing assessment.
Universal credit has received plenty of criticism and some advisers may mistakenly believe they do not need to know the ins and outs of the new benefit system given the relative wealth of their average client.
Justin Harper, head of marketing at LV, says: “Like many others, you might think universal credit only applies to those out of work and on benefits, and isn’t relevant to your typical clients.
“However, the universal credit ‘super-benefit’ (replacing six existing benefits and credits) is set to reach working families too, particularly those who rent and have children.”
Mr Harper explains: “Individual income protection is hardest hit.
"Any income protection claim benefit is considered to be ‘unearned income’ and will reduce your client’s entitlement to universal credit pound for pound.”
He cites analysis from the New Policy Institute estimating one in 10 income protection claimants could have their universal credit entitlement completely “wiped out” and another four in 10 may see a degree of reduction.
“When a client is at their most vulnerable, this will come as an unwelcome and harsh surprise,” warns Mr Harper.
Universal credit is a payment made by the government to individuals to help with their living costs. It replaces six benefits and merges it into a single payment.
The six benefits are: income support, income-based jobseeker’s allowance, income-related employment and support allowance, housing benefit, child tax benefit and working tax credit.
While wealthier clients may have more in the way of savings or property to fall back on if they're ill... these often won't last indefinitely.
It has been a controversial policy since it was first announced in 2010 due to a spate of delays and the high cost of implementation.
Mr Harper adds: “With the average mortgage payment sitting [at] around £670 a month, that’s a sizable amount of money that might be excluded, or a hefty reduction to someone’s universal credit entitlement. “
Kathryn Knowles, managing director of Cura Financial Services, identifies recent changes to the Support for Mortgage Interest relief (SMI) as a key thing advisers must be aware of.
“Advisers also need to be aware if their clients have accessed the state SMI, as this is a loan and should be considered as part of the client’s liabilities,” she says.
SMI gives help to those who are in receipt of certain income-related benefits, such as the job seeker’s allowance and pensions credit. It is a form of help from the government to pay interest on a mortgage.
On April 6 2018, the government changed the rules so that SMI is now paid as a loan which must be repaid back to the government before an individual dies or sells his or her home.
Prior to this, SMI was paid as a benefit which did not have to be repaid to the government.
Vincent O’Connor, senior business development manager at Royal London, says: “Support for Mortgage Interest is a benefit which can pay the claimant’s mortgage interest.
"It’s important to know about this when talking to clients about protecting their mortgage.”
Knowledge of state benefits is useful to advisers even while dealing with wealthier clients.
Mr Harvey acknowledges: “While wealthier clients may have more in the way of savings or property to fall back on if they're ill, which can happen to anyone regardless of wealth, these often won't last indefinitely.
“Even wealthier clients may find themselves needing to rely on state benefits if a prolonged sickness saw them deplete their capital resources.”
Mr Dean suggests: “A wealthier client may still have a large mortgage and a family to support.
“As their fixed outgoings are likely to be much higher than average, state benefits will be even less adequate should that client lose their source of income.”
What do advisers' clients need to know about the claims process?
While the income protection (IP) market has seen positive growth in recent years, it is also one of the most undersold types of protection.
According to Emma Thomson, product strategist at British Friendly, too many UK consumers still do not have insurance or other provisions in place to support them through illness or injury.
She notes: “Both providers and distributors need to work together to promote IP, ensuring more people know about the risks of being off work, and solutions available.”
Processing a claim
Insurers have made a number of improvements to the claims process, such as taking details over the phone rather than via paper forms, says Ms Thomson.
Nevertheless, she suggests claimants need to provide as much detail about their illness or injury as they can early on, not at the end of their waiting period.
Rob Harvey, head of protection advice at Drewberry, agrees – the move from paper forms and posted evidence, to digital attachments, has made IP more common place, adding that the biggest insurers tend to employ large teams to process claims.
But one drawback of this is that with larger claims handling teams, advisers or clients might not always get a dedicated point of contact, he says.
Sometimes clients don't realise the extent of the financial evidence they'll need to make a claim and it's important that advisers explain this fully to clients.
Mr Harvey points out: “Smaller insurers are better geared up to offer this to clients to make the process as smooth as possible."
The gathering of medical information, he adds, can often turn into “a roadblock” when evidence for insurance claims is often treated as non-urgent NHS work.
Therefore, it is paramount advisers get this right, as the length of the claims process can significantly impact on the lives of people with severe illnesses.
Kathryn Knowles, managing director of Cura Financial Services, notes the claims process can differ between insurers.
She says: “Some insurers can approve claims within a few hours, trusting the client that they have told them everything relevant to their health and why they cannot work, while other insurers need to see a letter from the GP as evidence.”
This usually includes a medical certificate, proof of earnings and details of the bank account the claim is to be paid into.
Once the insurer has all of these details, only then can a claim be considered.
According to Mr Harvey, clients might also need to provide financial evidence, such as payslips, tax returns or audited company accounts, to prove they are entitled to the benefit.
Generally, processing delays are caused waiting for a GP or employer response.
He says: “Sometimes clients don't realise the extent of the financial evidence they'll need to make a claim and it's important that advisers explain this fully to clients.
“It's especially important advisers take care to insure only an amount that can be supported by the client's earnings in the event of a claim – up to 60 per cent of earnings for a personal policy.”
Craig Brown, director and general intermediary at Legal & General, explains: “For example, if employed, we will need their latest P60 form and payslip; if self-employed, the last three years of accounts.
“Generally, processing delays are caused waiting for a GP or employer response. Here is where advisers can help smooth out the process; ensuring the level of detail that’s required and encouraging the customer to get in contact as soon as possible.”
Smoothing the process
Making a claim at what is bound to be a difficult time can be nerve-wracking for clients, so anything advisers can do to alleviate the stress of the process is important.
Advisers must understand exactly what is covered under the policy and know what the deferred period is, according to Steve Bryan, director of distribution and marketing at The Exeter.
But first, Mr Bryan says they should ask whether the client meets the criteria to make a claim, and whether any exclusions have been placed on the policy.
He adds: “While this all may sound quite daunting, clients can be assured that they’re talking in confidence to expert claims assessors.”
Ms Knowles believes advisers can help clients by doing “all the chatting back and forth with the insurer”.
She says: “The adviser can also stay in communication with the client, so that if or when they do return to work, the adviser can make sure that their insurance needs are still being met by their policies”.
Justin Harper, head of marketing at LV, suggests advisers should take the time to make sure clients know how to access intervention support which can transform and accelerate a client’s recovery.
Mr Harper says: “Advisers should familiarise themselves with the claims process, for a number of reasons – don’t let your client miss out on early intervention support. Plus, there is the ‘duty of care’ advice opportunity to help your client adjust to income shocks and household finances – and their potential interaction with state benefits.
“There are [also] benefits for clients to notifying their insurer early, and not wait until the end of their waiting period.”
How will the IP market develop?
UK consumers are becoming increasingly cognisant of the benefits of having some form of insurance.
Combined with an evolving awareness of different policy options, this could see the income protection (IP) market grow significantly over the next five to 10 years.
Kathryn Knowles, managing director of Cura Financial Services, says there have been several examples where IP policies have proven their weight in gold, such as the Seven Families initiative by the Income Protection Task Force.
This was a charity-led campaign which, according to 7families.co.uk, aimed “to provide a tax-free income for one year to seven people who have lost their income because of a serious or long-term illness or disability”.
She says: “I believe that as the market grows and the public gain more confidence in the security of claims for IP, that the true worth of this insurance will start to shine.”
Diversity and flexibility
Ms Knowles says she would like to see IP policies become more inclusive, as there are still far too many people who want income protection that struggle to get it.
She explains: “I speak to many people with chronic health conditions that would be happy to have long-term IP with exclusions, and I cannot see why they shouldn't be able to have access to this.”
Conversely, she says the market is growing in the diversity of policies available to clients.
“There are so many different aspects to IP policies that you can effectively build the cover to specifically suit your client, whether that is due to their budget, health or job role,” she notes.
Steve Bryan, director of distribution and marketing at The Exeter, says there has also been an increase in short-term IP policies sold in recent years and predicts this will continue.
Mr Bryan explains: “These policies offer payments for a fixed period of time – often one, two or five years – making them more affordable than policies which pay until retirement age.
“There’s also a greater number of self-employed workers, and people employed on limited hours contracts, so IP as it currently stands will need to become more flexible.”
Importantly, he says increasing the uptake of IP requires insurers and advisers to create continued awareness of both its existence and its need.
Justin Harper, head of marketing at LV, says advances in underwriting engines – such as UnderwriteMe – have streamlined IP underwriting and made it a more intuitive journey.
He suggests: “The challenges here are interaction with employer sick pay schemes and state benefits and the risk of ‘over insurance’. However, this has been overcome to some extent with more outgoings-based options and ‘income’.
“We expect to see more of this as the world of work evolves – with one in six workers self- employed, and with a million plus so called ‘gig workers’.”
Not just a payout
Craig Brown, director and general intermediary at Legal & General, notes there are calls in some quarters for a hybrid critical illness and IP arrangement.
“However, we’re witnessing the introduction of more lump sum type benefits within IP – for events such as death, hospitalisation, fractures and, recently from LV, parent and child cover.
“Added value services and early intervention support are becoming the norm, demonstrating that IP is more than just a payout,” he adds.
Garry Webb, head of operations and independent financial adviser at Roxburgh Financial Management, predicts IP will increase in popularity over the next decade.
Mr Webb says: “Certainly, the inquiries we get are predominantly on IP. Consumers are becoming more aware of it.
“However, many still confuse full IP with other types of cover, such as accident, sickness and unemployment (ASU) insurance.
“More people are ringing up and asking for IP, but some are ringing up thinking IP is the same as ASU, and so it’s important advisers ask what exactly clients want covered.
“The biggest way to get the point across is with financial advisers and making sure they tell clients about it, so advisers being educated and knowing the differences is massively important.”
Mr Webb says there is always a possibility and scope for the market to see further consolidation, but that it is unlikely.
He acknowledges: “Aside from the acquisition of Friends Life by Aviva, the last I can remember was Exeter merging with Pioneer Friendly.
“Many providers are actively looking at their position in the market and where they can offer unique selling points to clients.”
He continues: “[But] market consolidations tend to lead to less choice for clients, and this was certainly the case when Aviva acquired Friends Life.
“Under Friends Life, we could provide airline pilots with ‘own occupation’ based IP which proved very popular. However, after the acquisition, the resulting plan didn’t allow this.”
Alan Lakey, founder of CI Expert, says while IP sales are a lot higher than eight or nine years ago, it is also not unreasonable to assume there could be some businesses out there that might be forced to pull out of the market.
Mr Lakey points out: “If you had said to me seven or so years ago that Friends Provident, Bupa and Axa would all join together to then be absorbed by the Aviva Group, I don't think I would have guessed that one."
"The danger, of course, is that as soon as you get only a few companies, then it weakens the need for advice. But if advisers move out of the market, then that in itself will reduce the number of people who buy.
“The reality is, claims are still sold rather than bought.”
House View: Beware Universal Credit and implications for your protection advice
It may come as a surprise to learn that Universal Credit is so far reaching and has implications for all types of protection insurance, not just income protection. Although welfare benefits are rolling back, they shouldn’t be ignored completely. Here’s why...
The rise of Universal Credit
Universal Credit is a subject of much criticism, confusion and negative press coverage. Like many others, you might think Universal Credit only applies to those out of work and on benefits, and isn’t relevant to your typical clients.
However, the Universal Credit ‘super-benefit’ (replacing six existing benefits and credits) is set to reach working families too, particularly those who rent and have children. However, it is when a life shock strikes – such as a serious illness, long-term sickness or death – that financial difficulties can quickly spiral.
This financial fragility is highlighted in the latest LV= Income Roulette Report. For example, only 27 per cent of people in their early 30s said they had more than the Money Advice Service (MAS) recommended level of savings (three month’s outgoings in accessible savings).
For the approximate 2.4m so-called ‘sandwich generation’ – those in their 40s and 50s who look after children and maybe older relatives – our research found that 57 per cent fell short of the MAS recommended amount. The financial resilience of UK households is woefully inadequate.
Universal Credit treats insurance policy payouts differently to the current legacy system.
So, while many people may not want to think about turning to the state for help, in the event of a life shock their circumstances might force them to do so.
That’s when Universal Credit might bite, even if they have taken out protection. In fact, due to Universal Credit rules, your client might find that their protection policy claim leaves them seriously out of pocket.
At LV= we believe this is wholly unfair and an unhelpful disincentive; people who do the right thing and take out protection insurance, risk being penalised for doing so. After persistent lobbying through the Building Resilient Households Group and others, we’re starting to see some recognition among policymakers and over recent months, clarifications from the Department for Work and Pensions (DWP) about how insurance payouts will be treated under Universal Credit.
Repercussions for individual income protection
Universal Credit treats insurance policy payouts differently to the current legacy system. Individual income protection (IP) is hardest hit. Any IP claim benefit is considered to be ‘unearned income’ and will reduce your client’s entitlement to Universal Credit pound for pound.
Analysis from the New Policy Institute in 2017, estimated that this interaction might result in one in 10 IP claimants having their Universal Credit entitlement completely wiped out, and another four in 10 seeing some degree of reduction. When a client is at their most vulnerable, this would come as an unwelcome and harsh surprise.
In July, DWP offered some clarity around mortgages, Universal Credit and IP.
Where IP benefits are ‘intended’ and ‘used’ to fund regular mortgage payments, they confirmed that these would be completely disregarded from any means-testing assessment. But, as it stands, no IP policy exists that meets the DWP ‘gold-standard’ definition.
So, uncertainty and need for interpretation remain - it would be down to the claimant’s individual DWP assessor to make that judgement call at the time. With the average mortgage payment sitting around £670 a month, that’s a sizable amount of money that might be excluded, or a hefty reduction to someone’s Universal Credit entitlement.
We’re also exploring how we might offer this facility to all existing IP policyholders at claim.
Some predicted the clarification might kick start development of new mortgage-friendly IP products; but we’ve yet to see that surface.
However, at LV= we have introduced the Pay My Mortgage facility as part of our recent IP changes. This enables the client to select at claim – based on their circumstances at that time – to have some/all their IP claim payout to be paid directly to their mortgage lender to cover their regular mortgage payment. We’re also exploring how we might offer this facility to all existing IP policyholders at claim. We believe this is a pragmatic solution and can offer greater comfort and certainty to clients and advisers alike.
Lump sum insurance payouts
In November, the DWP clarified how lump sum critical illness, terminal illness and life insurance payouts are treated under Universal Credit. How and when these payouts are spent could mean the amount falls in or out of any means-testing assessment, and could wipe out any Universal Credit eligibility altogether.
Good news. If the payout is used to repay a mortgage or debt (such as credit cards), the amount is disregarded from any assessment of household ‘capital’ under Universal Credit; this is much clearer than under the legacy benefits system.
However, if the claimant or their dependants don’t spend the payout immediately, or use it for something else – then that payout is included in their capital assessment. This could mean they’d be ineligible for any Universal Credit (if capital savings within the household is over £16,000, for example).
And, in the current world of partial/additional payments for Critical Illness (CI) (and children’s CI payouts too), where payouts are unlikely to be used to partly repay a mortgage, your most financially vulnerable clients could find themselves inadvertently ‘penalised’.
What does this mean for advisers?
From an adviser perspective, Universal Credit is an unwelcome distraction, but not much has really changed. Protection insurance remains a positive force for good, with high degrees of certainty and control (and life-changing amounts of money), compared to a client relying on meagre mercies of the state.
However, there are implications of making such decisions. As an adviser, there’s a duty of care to highlight and document them. It is worthwhile advisers familiarising themselves with the latest state benefit changes, particularly Universal Credit and its interaction with insurance.
We would suggest advisers might consider reviewing how they go about making any protection recommendation, particularly alongside a mortgage, to:
1. Discuss the ‘private vs state provision’ principle and document this in any recommendation.
2. Where a policy is intended to repay a mortgage, document it.
3. Indicate and document that their protection policy may have consequences for eligibility or amount available from the state, depending on their circumstances at claim and how they choose to use any claim payout.
4. Consider how the product may offer some additional protection, such as the LV= Pay My Mortgage facility.
Finally, while there are caveats and watch outs around the ever-changing complex subject of welfare benefits, there’s also opportunity too.
Universal Credit is topical; it’s often in the news and usually with an eye-catching horror headline. Advisers can turn this to their advantage, by talking to clients about what they think, what they might do…. and, with some valuable advice, how they can safeguard themselves and their loved ones with some well-planned protection.
Justin Harper is head of marketing at LV