For those on low salaries, protecting the monthly income is crucial. Peter Madigan asks whether budget income protection is a viable option
It has become a well-worn cliché to describe income protection (IP) as a Cinderella product. Faltering sales and high premiums, especially in comparison to critical illness (CI), means the product has taken a back seat in the protection market.
However, providers have begun to realise that cost is a major issue for consumers and have introduced no-frills IP options to appeal to low-income clients. Although these budget IP schemes have been available for some time, the nature of these products has remained somewhat obscure to both clients and advisers. There are no hard and fast rules about what is included and each policy can vary greatly.
Inexpensive
Budget IP generally differs from the comprehensive option by proposing either a lower level of payout or a shorter benefit term in exchange for lower premiums. This vague definition does little to combat confusion and fails to address whether a budget plan offers good value in comparison to comprehensive cover.
"I am not sure what is meant by budget income protection," says Alan Lakey, partner at Highclere Financial Services. "It's quite a recent phenomenon, but the term budget is just a marketing phrase for cheap income protection."
Helen Collins, IFA marketing manager at Liverpool Victoria, describes budget IP as 'a lower-cost option with limited benefits'. These limited benefits normally manifest themselves most clearly in a shorter claims period, with the majority of policies only paying out for a maximum of two years for any one condition. In the event that a second condition unrelated to the first prevents the claimant from returning to work, they can claim again. Although this solution doesn't cater for the possibility of long-term incapacity, the savings can be quite substantial.
For example, a male accountant, 35 on his next birthday wants to take out a budget IP scheme. A non-smoker, he wants a policy offering a benefit of 50% of his £35,000 salary. With Liverpool Victoria's MIMI plan, a full IP scheme with a three-month deferment period would cost £26.27 a month. If he chose the budget option, the premium would be £10.78.
A saving of over 50% may seem impressive, but the client is paying half the cost for a budget plan offering a fraction of the potential cover available with full IP. A comprehensive plan could pay out for up to 40 years, while the budget option is limited to 24 months.
The budget option has been offered as a solution for low-income clients, arguably those who need to protect their income most. While better paid customers may have the option of covering themselves comprehensively, there are some financial benefits to be found for high-income customers in the no-frills offering, as Jason King, managing director at Life Policies Direct, points out.
"A master carpenter, who is very well-paid with a relatively low-risk job that is classified as a category three or four class occupation, because he has to work with his hands, can lower his premiums by taking a budget income protection option with a 12-month deferment period. He can then fill in the gap with mortgage payment protection insurance (MPPI). This is a relatively inexpensive option for a client that would otherwise pay over the odds for full income protection cover."
Lengthening deferment periods is certainly one option open to low-income clients. For example, if the male accountant was to extend the deferment period on his policy from three months to 12 months, then his premiums would drop even further: £7.27 for a budget plan and £16.36 for full cover.
Manageable
Although these figures may be manageable for a low income client, the problem of the long deferment period remains. For those on a low income, it can be difficult for clients to save to self-insure themselves during this period. Nor is it likely that they have the disposable income to invest in an additional MPPI policy to tide them over until the IP payments begin. Unless the client is able to survive on State benefits for a year, then the only option would be to shorten the deferment period, which in turn would raise the cost of their premiums. It appears the product designed with low income clients specifically in mind, could leave them in a Catch-22 situation.
Taking all these issues into account, the fundamental problem with budget IP remains the fact that the cover only lasts for two years. Rather than providing peace of mind in the event of long-term illness, these plans simply put off the inevitable reality that if the client is unable to return to work they may well be reliant on insufficient State benefits for the rest of their lives. Some advisers however, disagree with this analysis and see budget IP as a worthwhile investment.
All or nothing
"These plans can be a viable option as they buy breathing space," says King. "This gives clients time to readjust their finances and perhaps release the equity in their house and make themselves financially secure for when the claim period ends. This isn't a solution for everyone however, as there is a section of society that needs the cover most, but simply can't afford it."
Although some people are unable to access IP provision, intermediaries acknowledge that even for those that can afford cover, no-frills packages still fail to fulfil the basic mandate of the product.
"A budget income protection scheme is like a car with three wheels; it doesn't do the job it is meant to do. IFAs have a duty to advise their clients on the most appropriate products to meet their needs. I would not be comfortable recommending budget income protection to a client," says Lakey.
Change may be on the horizon however, as new products designed to plug the gap between full IP and the limited provision of the budget option have started to emerge. As part of its new menu-based offering, AXA Sun Life launched mortgage income protection, a policy that covers mortgage payments for the length of the mortgage term. By covering just the mortgage payments, the policy combines the benefit of an MPPI policy with the duration of a full IP product. This could be the type of solution that low income customers have been waiting for.
The basic mandate of an IP policy is to offer the client reassurance that in the event they are never able to work again, they will be assured some kind of income until they reach retirement age. Budget plans it seems, cannot propose to offer this service if that protection is capped at two years and leaves the client to their fate after the plan expires. Perhaps short-term IP would be a more appropriate and accurate title than budget IP.
Essentially IP is an all or nothing proposition; if you can't afford full protection then the majority of current no-frills options present low income clients with little incentive to invest their money. As new plans with more attractive propositions become available, customers may be more inclined to part with their cash as they perceive better value in new products.
Providing a client is clear about the limitations of a budget IP policy and is happy to accept the terms, then many customers may find budget IP the right product to meet their needs. "The most important thing is that there is effective communication between the adviser and the consumer," says Collins. "As long as there is careful planning on both sides and everyone is clear over what's covered, then budget income protection can be the ideal solution."
COVER notes
• Providers have begun to realise that cost is a major issue for consumers and have introduced no-frills IP options to appeal to low income clients.
• Budget IP generally differs from the comprehensive option by proposing either a lower level of payout or a shorter benefit term in exchange for lower premiums.
• The fundamental problem with budget IP remains the fact that the cover only lasts for two years.
