Damage limitation

The trick these days would be to sell anything but a budget income protection plan. Budget plans, predominantly mortgage related, have boosted sales of income protection, which reached an all time high in 2000 with 180,000 new policies sold, representing a 3% year-on-year increase, according to GE Frankona. Budget plan sales increased by 19%.

IFAs were at the head of these sales, accounting for 42% against 30% of polices sold through bancassurers and 17% through direct sales forces. The average budget premium was £160 a year and the average benefit £4,683 a year

However, there is some discrepancy over the definition of a budget plan ' 'budget' can relate to ways of budgeting within more traditional income protection plans and those specifically designed to keep costs down.

The first step in advising on the best plan for a client is to assess the true net income they are eligible to cover and indeed if they need to cover all of that income. Does their employer pay sickness benefit and for how long? Do they have savings they could use for an interim period?

The traditional route

Within traditional income protection plans the most obvious ways of reducing premiums are through lengthening the deferred period and reducing the sum assured. For many people, however, largely due to their occupation or gender, such measures still leave them with high premiums, resulting in them either rejecting the idea of cover altogether or paying out large premiums for sums assured which offer insufficient cover.

Those in class three and class four occupations, for example ' manual workers and those in physical jobs ' will pay more for income protection, as will females under many plans due to the increased statistical risk of these groups making a claim.

Rosalind Pearson, research planning manager, personal finance at Swiss Life, says: 'An alternative for lower income groups looking for cheaper cover could be to look at products which allow the client to select an activities of daily working definition, rather than the own or any suited definitions which may be associated with their occupations.'

Clients should also look to any savings they have which, on top of any benefits they may get from their employer, could extend the period before they have to make a claim. Retirement age will also pay a part because if you plan to retire early your premiums will be cheaper, since the term of cover will be shorter.

Cheaper options

Optional exclusions could also be a way of reducing costs. Norwich Union Healthcare, for example, has a specific option for teachers who typically pay high premiums. 'If you are a teacher you can choose not to be covered for stress,' says Louise Zucchi, media relations manager at Norwich Union. 'It depends on a person's circumstances as to the proportion of saving this can result in, but it can make a significant difference.'

For some however, these options are still not enough and they will be looking for other budget options. Broadly, there are three types of budget plan: plans which are assigned to a particular debt, most commonly the mortgage loan; those providing income for a limited period; and those which restrict the sum assured.

One of the chief concerns over budget plans is that the individuals taking them out understand the implications of budgeting. Income protection has never been an easy sell for IFAs, largely due to the costs involved. It could be argued that with costs pared down under budget schemes the principle of the sale should be simpler, more acceptable perhaps, but the advice factor is greater to ensure clients are aware of the potential downside of reducing costs.

Budget plans sold under the banner of mortgage income protection are cheaper because the benefits payable on a claim are limited. Of course such plans can be used to settle any debt or outgoing the clients wishes to assign it to.

Dovetailing cover

These plans essentially compete with accident, sickness and unemployment (ASU) plans which typically cover mortgage payments for a maximum of one to two years.

'Some companies are also looking to use budget income protection to extend the initial term that ASU would pay out,' says Paul Casey, marketing analyst at GE Frankona. 'The claims and conditions would be the same, but the cover would take on for another two to three years after the typical 12 months covered by an ASU plan.'

The concern is that the mortgage is only part of the problem if an individual is unable to work.

'The danger is that despite this major expense out of the way, this is only part of an individual's living expenses,' says Mike Turner, product manager at Friends Provident. 'It has a parallel with the old days of mortgage endowments, the house might be paid for, but you still need income to live on. You need income protection beyond the mortgage.'

Budget plans which restrict the claims period to say three or five years will also be cheaper.

Pearson says: 'These are more suited to the business protection or keyperson market where there is a limited number of years required to keep the business going and replace the absent employee. But versions of this plan are sold to the individual for personal cover.'

As with mortgage or specific liability replacement plans however, such plans are of little comfort if benefit is needed for the long term.

'It is a fundamental weakness,' says Turner. 'You do not know how disability will strike, you may be one of the lucky ones who recover, or one of the unlucky ones who are unable to work again.'

Pearson agrees: 'While it is true to say that on average a claim will last five years, there are those who are not average and it is going to be difficult to explain to a long-term claimant that their income is going to stop after the payment term expires.'

Managing expectations

It is essential therefore that the terms are fully explained up front, as the spectres of pensions mis-selling and equity release peep over the adviser's shoulder.

The third recognised budget plan is where the income replacement ratio is lower, so premiums are also reduced. This means clients are still covered to their chosen retirement date, although clients should be aware that if their income increases and they need to increase the cover they are insuring for they will need to review their plan, which may mean additional underwriting. Plans such as that pioneered by Swiss Life offer a 50% replacement ratio with a 12.5% reduction in premiums.

'This is likely to appeal more to the IFA than the limited option which they see as too big a risk,' says Turner. 'They would rather have lower sums assured paid throughout life than pay less for something which will cease.'

The occupational classes rating criteria has always dogged the income protection market. Class one and two occupations, that is, fairly low-risk administrative and office-based jobs are simpler to cover. The problem is for those in higher risk, class three and four occupations.

Unum is one provider to have targeted and provided for the manual worker, although few other mainstream providers have followed the approach to take occupation out of the rating procedure. Friendly societies, however, have never made this distinction. June Williams, managing director of IFAs Clifton Associates, recommends Pioneer Friendly, Circencester and Tunbridge Wells.

'Friendly Societies do not differentiate between what a person does in employment,' she says. 'Other providers will always defer three months because of occupation. This is not good for manual workers which are higher risk ' certain occupations just do not get the best terms.'

David MacGregor, national sales manager at Pioneer Friendly Society, explains its approach: 'We do not follow traditional route of four occupational classes, everyone has the same rate, which keeps it simple. Neither do we load for gender, which can make it expensive ' up to 75% more for females in some cases.'

Premiums will, however, increase with age. Individuals may therefore want to review their income needs as they get older. As the mortgage loan decreases or is paid off, the children leave home and outgoings decrease, they can budget further by reducing cover, or changing their deferred period.

'Due to the way we have structured our rates we are popular for traditional class three and four occupations, especially male manual workers,' says MacGregor. 'We offer cover from day one ' if you have been unable to work for three days we will back pay to day one.'

Understanding the client

Cost is an obvious selection criteria for individuals taking out income protection. But the key role of the adviser is to look at the specific needs of each client, not just what they can afford but when they need cover to kick in. The self-employed for example, unless savings are in place, may well need cover from day one.

The consensus is while some form of cover is better than none, it must be appropriate. There is the danger clients will relax too much by having income protection, albeit on a limited basis, and be disappointed in the event of a claim.

'If you budget too much, income protection can be pointless to have,' says Zucchi. 'You have got to make it work for you. It is very much an insurance you need to keep your life going. There would come a point when we would say it is not advisable to reduce cover. It is a false economy.'