It is worth investing in a financial safety net

Published on Friday 2 July 2010 00:19

SCOTTISH families are being forced to re-evaluate their financial safety nets as government spending cuts herald a fresh period of uncertainty.

Strathclyde University's Fraser of Allander Institute this week forecast up to 126,000 Scottish job losses over the next five years as result of the emergency Budget, with swingeing cuts in the public sector hitting Scotland particularly hard.

And as finances become tighter, the prospect of redundancy or an illness that means not being able to work could spell financial catastrophe for many, with state aid including housing benefits and unemployment support being slashed.

Roger Edwards, proposition director at Edinburgh-based Bright Grey, said the notion that "the State will look after me" remains a popular misconception.

"Most people are just not aware that the level of state benefit is very low and will only serve to stop them from starving. Whether the inevitable cutbacks both in the amount of benefits available and the fact that they will be harder to claim will encourage more people to take out protection remains to be seen."

As Edwards suggests there are ways of making sure that being out of work doesn't have to trigger financial disaster. Here are some of the main options:

PAYMENT PROTECTION INSURANCE

Controversy has raged over PPI in recent years, but that has surrounded the misselling of the product by banks and other providers alongside the loans the insurance is supposed to protect. As a standalone product, however, PPI - also known as accident, sickness and unemployment (ASU) cover - has merit.

PPI pays out a monthly sum for 12 or 24 months in the event of losing your income because of redundancy or illness. It is most commonly bought to cover mortgage payments - in the form of MPPI - but it can also cover loans and credit card repayments.

PPI tends to be the cheapest cover available but is less comprehensive than the alternatives below and includes several exclusions. For example, pre-existing medical conditions are often excluded, while claims cannot be generally be made on policies less than three months old. Some policies don't pay out to those who are self-employed, aged 65 or over or out of work because of stress or back pain.

Providers of standalone PPI policies include British Insurance and Paymentcare. These are almost always more competitive than the policies offered by high street banks, but it's still vital to shop around for the best policy as costs can vary considerably. For instance, a 40-year-old wanting a policy paying 500 a month from day one will pay 20 a month with British Insurance and 34.60 with More Than.

INCOME PROTECTION

This pays out for longer than PPI and is significantly more comprehensive. Income protection (IP) provides the choice of guaranteed cover where the premiums and cover remain static for the full policy term, or reviewable cover, which is cheaper at the outset but revised every five years.

It typically pays out 50 to 65 per cent of income in the event of being unable to work due to accident, illness or disability. Like PPI it can be deferred, so the cover can start when sick pay ends. Unlike PPI, however, it pays out until retirement and covers any sickness or disability that has the potential to cause long-term inability to work, including stress and back pain. While IP is more expensive than standalone PPI, Edwards believes that it is significantly more cost-effective. "In reality most people could get cover for up to half their salary for about 40 a month. This might still seem expensive compared to 10 for life cover – but you are much more likely to claim on IP than you are on life insurance."

One oft-forgotten advantage of IP is that it can include unemployment cover, albeit as a bolt-on that must be requested. Edwards recommended including redundancy cover with IP to cover all eventualities, as opposed to buying a MPPI or PPI. "Then at least you get the one or two years worth of redundancy cover – plus the longer term sickness benefit from the IP."

CRITICAL ILLNESS

Critical illness (CI) insurance, typically bought with life insurance, pays a tax-free lump sum on diagnosis of a serious illness or in the event of disability.

Most claims relate to cancers, heart attacks and strokes, although medical advances mean people are being diagnosed earlier, are more likely to survive and so are more likely eventually to resume working. People with pre-existing medical conditions can find it difficult to secure affordable CI, but more insurers are now allowing people with certain conditions to have them excluded from their policies in return for lower premiums.

While CI covers serious illness – such as a cancer or heart attack – it doesn't pay out for the most common causes of being unable to work: back pain and stress or depression, unlike IP. But it doesn't have to be a choice between the two types of cover, claimed protection specialist Kevin Carr, of Kevin Carr Consulting.

"They can complement each other – a lump sum to pay off the debts and an income to pay the bills and maintain the standard of living. There's not much point in paying off the mortgage if you can't afford to live in the house. Life cover is the cheapest protection insurance, but it is cheap for a reason – it is the least likely to happen, whereas being unable to work due to illness, injury or unemployment is significantly more likely."

There's no way of making like-for-like cost comparisons between CI and IP because of the way the premiums and payouts are structured.

As a rough guide, however, the lowest CI premium for a 35-year-old non-smoking male taking out 100,000 over 25 years is 36.91 with Axa, according to broker LifeSearch. For the same person taking out 1,000 a month of IP over 25 years the best deal is 14.96 with Fortis.

Protection policies can be bought direct through insurers, from brokers or online through comparison websites, although the latter is not advisable as advice is recommended. Income protection (IP) provides the choice of guaranteed cover where the premiums and cover remain static for the full policy term, or reviewable cover, which is cheaper at the outset but revised every five years.

It typically pays out 50 to 65 per cent of income in the event of being unable to work due to accident, illness or disability. Like PPI it can be deferred, so the cover can start when sick pay ends. Unlike PPI, however, it pays out until retirement and covers any sickness or disability that has the potential to cause long-term inability to work, including stress and back pain. While IP is more expensive than standalone PPI, Edwards believes that it is significantly more cost-effective. "In reality most people could get cover for up to half their salary for about 40 a month. This might still seem expensive compared to 10 for life cover - but you are much more likely to claim on IP than you are on life insurance."

One oft-forgotten advantage of IP is that it can include unemployment cover, albeit as a bolt-on that must be requested. Edwards recommended including redundancy cover with IP to cover all eventualities, as opposed to buying a MPPI or PPI. "Then at least you get the one or two years worth of redundancy cover - plus the longer term sickness benefit from the IP."

CRITICAL ILLNESS

Critical illness (CI) insurance, typically bought with life insurance, pays a tax-free lump sum on diagnosis of a serious illness or in the event of disability.

Most claims relate to cancers, heart attacks and strokes, although medical advances mean people are being diagnosed earlier, are more likely to survive and so are more likely eventually to resume working. People with pre-existing medical conditions can find it difficult to secure affordable CI, but more insurers are now allowing people with certain conditions to have them excluded from their policies in return for lower premiums.

While CI covers serious illness - such as a cancer or heart attack - it doesn't pay out for the most common causes of being unable to work: back pain and stress or depression, unlike IP. But it doesn't have to be a choice between the two types of cover, claimed protection specialist Kevin Carr, of Kevin Carr Consulting.

"They can complement each other - a lump sum to pay off the debts and an income to pay the bills and maintain the standard of living. There's not much point in paying off the mortgage if you can't afford to live in the house. Life cover is the cheapest protection insurance, but it is cheap for a reason - it is the least likely to happen, whereas being unable to work due to illness, injury or unemployment is significantly more likely."

There's no way of making like-for-like cost comparisons between CI and IP because of the way the premiums and payouts are structured.

As a rough guide, however, the lowest CI premium for a 35-year-old non-smoking male taking out 100,000 over 25 years is 36.91 with Axa, according to broker LifeSearch. For the same person taking out 1,000 a month of IP over 25 years the best deal is 14.96 with Fortis.

Protection policies can be bought direct through insurers, from brokers or online through comparison websites, although the latter is not advisable as advice is recommended.