Income protection (IP) is increasingly being touted as the ideal form of mortgage protection because mortgage repayments are covered until your client resumes work, or their mort-gage is repaid. A large part of IP’s success has been down to aligning it with mortgage sales, but not every client can benefit from this type of policy.
The premium paid depends on the type of occupation held by the client, and those classified under a risky category may find premiums extortionately high, perhaps pricing them out of the market altogether. Occupations are usually graded from one to four, with four relating to policyholders in the most risky jobs.
Nick Homer, income protection marketing manager at Norwich Union Healthcare, explains: ‘Traditionally you have sedentary occupations (class one) and manual occupations (class four) which are traditionally higher risk. Two parts make up the loading of the premium ‘ the exposure to risk and the fact it takes less incapacity to stop a person working. People in sedentary occupations would not stop working if they broke their wrist, whereas someone in a manual occupation would not be able to work if they broke their finger,’ he says.
However, risk categories are not clear cut. Some occupations which were previously classed as low risk are creeping up the risk scale as conditions such as stress become increasingly prevalent in the workplace. As a result, risk categories are constantly under review.
‘Stress is becoming a major cause of claim and is far more typical in sedentary occupations. One of the best examples is teaching. Historically, teachers were classed as a safe, low-risk occupation in class one, but now they are in class three. There has been a lot of change in recent years to this profession and they are seen more as managers than teachers which is a stressful area,’ Homer says.
Checking the small print
However, Rosalind Pearson, research and planning manager at Swiss Life, says intermediaries need to look at the policy definitions offered by product providers as well as the occupational class.
With most IP policies, clients can choose the definition of disability upon which any claim will be based. These include own occupation, any occupation or activities of daily living (ADLs), or activities of daily work (ADWs). Own occupation pays out if your client is no longer able to do their own job, any occupation if they are unable to perform any job and ADL if they can not perform tasks such as dressing, washing, or using the toilet. An ADW definition, meanwhile, will only pay out when the policyholder can not perform certain functions associated with working ‘ such as sitting at a desk.
Pearson says: ‘Last year, Swiss Life removed the subjective any occupation definition and replaced it with an activities of daily working definition which is based on a more objective set of tests. This means we were able to cover a broader range of occupations at a reasonable price.’
The majority of policies will offer both an own occupation definition or an any occupation. However, those who find themselves in an occupation which is classed as risky would probably pay more for an own occupation definition, according to Roger Edwards, head of products at Scottish Life. ‘This is part of the advice process that advisers need to look at ‘ the costs,’ he says.
Despite the occupation clause excluding a minority of people from taking out IP policies, it should be considered by those that are eligible.
Unlike mortgage payment protection insurance (MPPI), IP provides long-term cover, which if needed, could span the remainder of the mortgage term.
Homer says: ‘IP is aimed at replacing part of an income which fundamentally supports everything you do. It pays a monthly benefit until you retire and people pay their mortgage monthly ‘ it is a perfect fit.’
While IP may look expensive, costs can be reduced by only covering the mortgage payment, instead of the whole salary. Edwards says: ‘Because you are not insuring such a large amount the premiums are cheaper and because you are only covering your mortgage you are less likely to have issues of over-insurance at the time of claim.’
Costs can also be reduced in other ways. If the policy is particularly flexible clients may be able to make savings on the back of interest rate cuts.
‘Interest rates have been falling and mortgage payments have been going down, so if you have a very flexible product you could change your cover each time interest rates go down and save yourself some premium. The only downside is that if interest rates rise again, so would your payments,’ Edwards says.
However, if a client’s occupation means they are unable to get own occupation IP at a reasonable price, there are ways of arranging lower priced cover.
Experts recommend taking out a policy with an activity of daily work (ADW) definition which can be less expensive than own-occupation IP, although making a claim will be harder as claimants will have to demonstrate that they cannot perform a series of functions.
Alternatively, costs can be controlled by dovetailing an MPPI plan with an IP policy that does not start paying benefits until the policyholder has been off work for a year.
Pearson says: ‘The MPPI covers the first year and the income protection kicks in at 52 weeks. This keeps the cost of IP down as the longer the deferred period the cheaper the plan. It also offers day one cover under the MPPI policy.
‘There are now many providers who offer cover for the mortgage payments only or what have been termed living expenses ‘ in other words, covering the main bills. These products tend to be cheaper because the amount insured is less than a ‘full’ income protection and consequently there is a greater financial incentive to return to work. Some of these products, sold under the banner of ‘budget’ plans, are also made cheaper by restricting the payment period to a maximum of, say, five years. But this is something to watch out for as who knows if they are the one person who is going to have a life-long claim.’
Selling the benefits
However, few borrowers are aware of the benefits of IP and there is a need for insurers and lenders to promote awareness of IP to persuade more consumers to take out this type of policy.
Homer says: ‘The Government does not provide much in terms of paying a mortgage if your client becomes either incapacitated or unemployed. There are three key barriers on why people do not take this product they desperately need ‘ they think the State will provide support, their employer will provide support, or they think they are invincible.’
The issue of a lack of education in the IP market arises time after time. Jerry Warner, marketing development manager at Standard Life, says: ‘More companies are selling IP as a form of mortgage protection and it has been the main area of growth within the IP market. However, the industry does need to provide more education.’
The lengthy underwriting process can deter some clients from taking out IP. This is necessary because it is a long-term contract which involves a long-term liability on the part of the insurer. However, Warner believes that the amount of underwriting can be reduced if the client is only insuring their mortgage payment and not their whole salary.
But additional underwriting will be required if a client moves house, an issue Warner believes should be made simpler. ‘More options need to be available so that if people move house, they are able to increase the cover without additional underwriting,’ he says.
But IFAs can play a role clarifying the underwriting process. Laura Shanks, product development manager at Scottish Equitable, adds: ‘It is important providers try and help advisers to manage clients’ expectations by ensuring clients know what they are taking out and understand what could happen to them if they were to claim.’
Looking towards the future, IP does appear to be a viable and worthy way of protecting a mortgage in the event of unforeseeable circumstances. The issue of occupation can arise, but only for a minority of applicants and when compared with alternative ways of mortgage protection, IP seems to hold its own.
Adele Burton is a staff writer