While critical illness cover will largely pay a claim out in full, income protection falls short of the mark, leaving policyholders uncertain of what is coming to them, writes Roger Edwards
It is as predictable as the seasons, but ask anyone in the protection industry why income protection (IP) does not sell and the same answers just keep on coming. The product is too complicated and there is no common occupational database across the industry, meaning customers often get inaccurate quotations. There is also no standard approach as to whether state benefits or other payments should be taken into account in the income calculations. And, unlike critical illness cover, where the policy will pay out in full if the policyholder suffers one of a clearly defined list of illnesses, with IP there is no way of telling exactly what will be paid out until the claim is made.
Expectations
When consumers buy products and services, they like to know what they are going to get for their money. If it is a sofa, they can sit on it and measure how comfortable it is. If it is an item of clothing, they can measure the value, how they look in it, and what it says about their fashion sense. But, with IP, it is quite difficult to understand exactly what is being bought as the value of the eventual payout depends upon so many factors, some of which will not take place until much later.
So one could take out an IP policy to protect, say, 50% of a £40,000 salary. If that person becomes ill and cannot work at any time during the term then the plan will pay out. But, between now and then, what happens if the customer's salary reduces?
Well, if they claim then they may find it pays out less than what they thought they were paying for. What happens if state benefits change? Well, again, if the plan takes these into consideration then one may not get what they thought they were paying for.
This "unknown" element to IP is often compounded by the problem of over-insurance, caused either by too high an amount of cover being effected in the first place or, as mentioned previously, when the client's circumstances create the situation. Over-insurance will generally lead to a reduced amount being paid at claim stage.
This, perhaps, appears unfair and one can sympathise with the consumers' view that they should be entitled to a benefit, especially if they have paid for it. In the above example, if they have paid the premium for £20,000 worth of cover why should they not be entitled to receive that, even if their salary has reduced? The reason is, of course, the incentive to return to work.
The argument is that if a policy only provides cover for up to 50% of a client's salary, then while this benefit will go a long way towards helping them financially while they are ill, it will not replace their entire salary, and so the policyholder has an incentive to return to work and to restore their full earnings to the post-illness level. If the product replaced the client's total income then there would be no such incentive to return to work and they may be "better off" simply staying at home and living off the policy proceeds. Of course, many people would probably feel insulted to be categorised in this way - but the Department of Social Security knows to its cost the massive amounts of state benefits that are regularly paid to people who are never going to return to work and who have come to rely upon the payouts to support them.
But, while there may be a genuine reason why IP products will pay reduced benefits in these circumstances, the fact remains that the claimant is still going to receive less than what they have paid for and this is yet another negative that our industry has to deal with. It is therefore essential that advisers and providers work together to ensure that over-insurance does not take place in the first place. Unfortunately, the mechanism to achieve this complicates an already long underwriting process.
Gathering financial evidence at the outset will certainly confirm whether the applicant has applied for the right amount of cover. If the applicant is in PAYE employment, then this financial underwriting is relatively straightforward. If the applicant is self-employed then it may be more problematic - especially if the individual has only recently become self-employed - a period where earnings may be lower.
Another problem is that, in order to be tax efficient, some self-employed people may not pay themselves a very high salary - and they may take their income from the business in other ways. Again, this can reduce the amount of IP they are technically entitled to - or it could create over-insurance in the future if they make alterations to they way they remunerate themselves. Gathering the required three years report and accounts can be time consuming and, therefore, adds to the time it takes to underwrite the policy.
Underwriting
So over-insurance can be eliminated at the outset by financially underwriting the policy. The problem is that many years can pass between the policy start date and an eventual claim. So the whole financial underwriting process effectively happens again at claim stage and, once again, can cause delays while the company gathers the evidence. If there is over-insurance, which after such a period of time is very possible with self-employed customers, then the policy pay out will almost certainly be reduced.
Incentives to return to work not-withstanding, customers should be entitled to receive the benefit that they have been paying for. So, it is up to the industry to ensure that the products are structured in such a way as to make over-insurance difficult - or at least irrelevant.
A product with an automatic annual review of benefit related to salary would reduce the possibility of over-insurance becoming a problem. One could argue that it should be the ongoing responsibility of a good adviser to be doing this anyway - but an automatic review would certainly cut down on administration time.
Furthermore, if providers are promoting products that are designed specifically to target mortgage payments then there must be an argument to just pay the benefit regardless at claim stage, especially if the maximum income multiple is set at between 30% and 40% of salary at outset.
If the concern about over-insurance is the lack of incentive to return to work, then perhaps one answer would be to pay the benefit - regardless of amount - on the condition that the claimant undergoes compulsory rehabilitation at the same time. By working closely with the client, the provider can monitor their progress and amend the payment later if there is a concern over speed of recovery.
But, at least in this example, the client would get what they have paid for and would also be receiving valuable extra help to get them back on their feet.
And this is perhaps where the whole emphasis may eventually have to change. IP is currently marketed as an income replacement product - and this is why, with a heavy focus on the financial benefit, the problem of over-insurance can often come to the fore with its associated negativity.
Some IP products do come with rehabilitation services, but these are often in the background. If rehabilitation was the main reason for taking out the plan and the financial benefit was the secondary consideration, then maybe over-insurance could be tolerated for a period as long as the rehabilitation service did its job.
In terms of meeting customer's needs, the basic concept of IP is perfect, but the product does not sell for many reasons.
Both the Association of British Insurers Protection Committee and the IP Task Force are looking at ways of simplifying the product. The issue of over-insurance, how it is policed and how it is portrayed, are areas that need tackling along with the other current barriers to sales.
Roger Edwards is products director at Bright Grey
