Cash clinic: Financial security provided in case serious illness strikes

Q I have been considering taking out some kind of insurance to cover me in the event of being unable to work because of illness. I'm in my early forties and although my family has no history of serious illnesses, I would like the peace of mind of knowing that my children are financially secure if I were to be diagnosed with something that prevented me from working. What form of protection should I consider?

AG Aberdeen

A The financial effects of being unable to work for a prolonged period can be catastrophic. An illness may render you incapable of carrying out your normal duties either for a period of time or indeed permanently. Living costs continue during absence from work of course, and indeed may be increased by the need for medical care. The employed may be offered some cover from their employer and can at least expect statutory sick pay for up to 28 weeks, however, this is likely to be significantly less than earnings. For the self-employed there is no such safety net.

Two forms of protection are commonly used in these circumstances – critical illness (CI) cover and income protection (also known as permanent health insurance).

A CI policy is designed to pay a tax-free lump sum on or shortly after the diagnosis of an insured event within a specific term. Benefits would be fully underwritten and the proposer's existing medical history would be taken into account in the cover offered. Cover varies from insurer to insurer and payment can depend on the severity of the illness. Heart attack, stroke, organ failure and diagnosis of cancer (normally excluding some less advanced cases) are normally included.

It is commonly used alongside life assurance and is useful security against long term debt. For instance, it would be a comfort to know that a mortgage had been redeemed following a heart attack, allowing the patient to recover without stress.

Income protection (IP), aims to pay a monthly amount to help replace income lost through long-term illness. Underwriting is carried out with personal circumstances and the risks associated with the job in question being considered. Payment is made until you return to work or until your normal retirement age if this is not possible. Benefits are normally limited to a maximum of between 50 and 65 per cent of pre-tax earnings to encourage a return to work and do not start until you have been unable to work for an agreed deferment period, typically between four weeks and two years. The longer the deferment period the lower the premium, reflecting the decreasing chance that benefits will be payable. If you can return to work but in a diminished capacity, the policy can be used to top up your reduced income.

Ideally both forms of cover should be considered, however, the cost implications and personal circumstances may mean that priority is given to one.

• HBJ Gateley Wareing financial services team. If you have a question you need answered, write to Jeff Salway, Personal Finance Editor, The Scotsman, 108 Holyrood Road, Edinburgh EH8 8AS or e-mail: [email protected]. This above is for general purposes only and is not tailored for individual use. It does not constitute legal, financial or investment advice on any particular matter and must not be treated as a substitute for specific advice. No action should be taken in reliance of the information given.

The Scotsman Publications Ltd and HBJ Gateley Wareing accept no liability on the basis of this article.