What is income protection for contractors?
Income protection for contractors, often called Executive Income Protection, is a type of insurance that pays out a monthly benefit in the event that you become too ill or injured to work. Similarly to traditional income protection insurance, it's designed to protect your outgoings, such as your mortgage, rent, utilities and groceries, during the time that you're unable to work.
Key facts about Contractor Income Protection
- You're able to cover up to 80% of your income, which includes your salary, dividend drawdown, pension and National Insurance contributions.
- You're able to cover your partner's dividend drawdown too, as long as they are non-profit making and wouldn't be able to create income for the business while you were unable to work.
- You can opt for a policy which will pay out after 4 weeks of injury or illness.
- You can protect your income up until your expected retirement age.
How Contractor Income Protection works
Contractor Income Protection covers up to 80% of your income if you're unable to work due to illness or injury. With this type of insurance, you can protect both your salary and dividend payments, alongside National Insurance and pension contributions. Uniquely, you can also protect your partner's dividend drawdown too, just so long as they're in a non-profit generating role within the business.
1. Setting up a policy
When it comes to setting up an income protection policy, a lot of thought and consideration should be given to ensure you have the right level of cover. It's why it always pays to speak to a specialist, like our partners at Sandbourne, as they'll be able to guide you through everything from configuring a policy to choosing the best insurer for your circumstances.
2. Making a claim
In the event that you're unable to work and need to make a claim, you can do so via your insurer's dedicated claims team. Their contact details alongside information about their specific claims process will be located in your policy documentation.
When you make a claim, your insurer will ask you to complete a claims form and provide evidence of your medical condition - a note from your GP will usually suffice.
3. Receiving a payout
As soon as your claim has been approved by your insurer and assuming your deferral period has passed, you'll start to receive a monthly payment in lieu of your wages. You'll continue to receive this income until one of the following happens:
- Your payment period expires
- You're well enough to return to work
- You reach retirement age
What does Contractor Income Protection Insurance cover?
Contractor Income Protection Insurance is designed to pay out in the event that you're unable to work due to illness or injury and there are typically very few limitations to that. While there tend to be very few exclusions on a policy, insurers will offer differing "definitions of incapacity", and it's therefore important to understand what this means and how it can affect your cover.
What's not covered by Contractor Income Protection?
Before we look at the various definitions of incapacity you'll encounter, let's first detail some of the few standard exclusions that insurers have in place that may limit claims:
- Drug or alcohol misuse
- Self-inflicted injuries
- Travel to a country with political instability, internal conflict or an active epidemic.
The only other significant factor to consider is pre-existing medical conditions, which we'll cover next.
Cover for pre-existing medical conditions
When you apply for a new policy, any medical conditions that you've experienced or had treatment for in the past five years will need to be declared. Each insurer will have its own view or policy on pre-existing medical conditions, but largely you can expect them to do one of three things:
- Cover the pre-existing medical condition on standard terms
- Offer to cover the condition for an increased premium
- Exclude the medical condition from the policy
How the definition of incapacity influences your cover
As we alluded to earlier in this section, insurers use three definitions of incapacity which determine how unwell you need to be in order to make a claim. Therefore, understanding this important part of the policy wording is vital. The three definitions you'll encounter are:
- Own Occupation
- Suited Occupation
- Any Occupation / Work Tasks
The best and easiest to claim under is "Own Occupation" with "Any Occupation / Work Tasks" being the most difficult.
An "own occupation" definition of incapacity means that your policy will pay out in the event that you're too unwell or injured to work in your own occupation. It is, without doubt, the most comprehensive and the easiest to make a claim under and therefore the one we tend to recommend to our customers.
The vast majority of clerical (office) workers will be able to get “Own Occupation” cover, regardless of the insurer, but for risky occupations and those which are very manual in nature, it can be difficult. There are some companies that offer “Own Occupation” cover for all but the riskiest occupations but their number is limited.
A Contractor Income Protection policy that uses the "Suited Occupation" definition of incapacity will typically provide less cover than one with the "Own Occupation" definition. With this definition, the insurer may expect you to return to work in an occupation that you have the skills, training, qualifications and experience for.
For example, you might be a skilled and experienced contractor working as an IT Director for a fast-growing firm but due to stress, you're unable to continue in that role. Where an “Own Occupation” income protection policy would likely cover you, the insurer may insist that you take a less stressful role at the same company or elsewhere under a “Suited Occupation” policy.
As you can see, in this example, the difference in definition has a significant impact on the insurer's restrictions.
Any Occupation / Work Tasks
Finally, the least favourable definition you might come across is "Any occupation or work task", which is by far the most restrictive, providing very little protection against all but the most serious illnesses and injuries.
Under this definition of incapacity, the insurer will only pay out if the policyholder is unable to complete a number of rudimentary tasks. These include things like walking, bending, seeing, hearing and climbing. Usually, if the individual can't do three or more of these tasks then the policy will pay out. As you can see, this definition is so restrictive that it undermines many of the benefits of income protection insurance and is therefore not usually recommended.
How much does Contractor Income Protection cost?
With there being so many aspects to each policy and individual circumstances varying so much, it's impossible to provide any guide pricing for Contractor Income Protection, but we can explain what core factors will impact the cost.
In this section we detail the options you'll have when setting up a policy, alongside factors outside of your control that will affect the cost of your policy.
Level of cover you need
Firstly, the level of cover you need will play a significant role in the ultimate cost of your policy. For example, if you're a high earner and have substantial commitments you can expect the cost of your policy to be relative. As with any type of insurance it always pays to speak to a broker and compare providers to make sure you're getting the best terms and prices.
Choice of premiums
When you set up your policy there will be several types of premium you can choose from, each with their pros and cons and associated cost implications.
Your first choice is whether your premium will be reviewable or guaranteed:
- Reviewable premiums - this type of premium allows the insurer to review the premium at regular intervals, usually every 5 years. While policies written with this choice are often cheaper from the outset, you have no control over what increases to the cost of the policy the insurer may make in future.
- Guaranteed premiums - this is the alternative to a reviewable premium and means that you know what your price will be in future (not that it is fixed - this is often confused with a fixed premium).
You second choice relating to your premium is whether it will be age-banded or fixed:
- Age-banded premiums - policies with this type of premium will increase over time as you get older. Unlike Reviewable premiums where you have no foresight or control over those increases, you will be told in your policy documentation exactly by how much your policy will increase each year, allowing you to be better prepared for the additional cost.
- Fixed premiums - these premiums will not change over time due to age, however they may still change if your premium is reviewable or index-linked.
Your final choice is whether or not you wish to index link your policy:
- Index Linking - if you decide to index link your plan to track with inflation, your price will increase over time as your benefit amount rises as it tracks with inflation.
For most people the best option is typically a “guaranteed”, “fixed premium” with “index linking” for inflation tracking. Although the most expensive initially, over the full duration of the plan this will usually work out cheaper in the long term than a reviewable or age-rated plan.
Policy payout length
The length of your policy payout period will, of course, impact the cost so careful thought should be given as to whether you need cover in the short-term or if you want something to cover you for much longer. Short-term policies will typically pay out for between 1-5 years per claim, whereas longer-term policies can cover you right up until retirement.
Your policy cease age
The policy cease age is how old you'll be when the policy ends, with most people setting this to be the date where they will no longer be working, i.e. their retirement date. Some providers will let you have cover that lasts right up to age 70, but these policies tend to attract premiums which are far higher than those ending at 65 or 60 years of age.
The first of the factors you don't have any control over, your age, will of course affect the cost of your policy. The older you are, the more likely you are to become unwell and therefore premiums will be higher for those individuals starting policies later in life.
Any health conditions you may have
As we previously mentioned, any health issues you've suffered from in the past five years need to be declared and depending on how the providers treat them, your premiums could be higher. That isn't always the case though, in most circumstances the insurer will simply exclude that condition rather than loading the policy.
Your smoker status
As we all know by now, smoking puts us at a much higher risk of various serious health issues and therefore, if you are a smoker you can expect insurers to increase your premiums accordingly.
Your occupation will play a significant role in the pricing of your policy and while office workers will generally enjoy lower premiums, those working in manual trades or in high-risk occupations can expect to pay more.
Definition of incapacity
Finally, as we've already outlined, the definition of incapacity that's used on your policy will also play a key part in its price.
As you can see, Contractor Income Protection is far from straightforward with there being many options and potential pitfalls. All contractors are different and we therefore strongly recommend that you speak to an expert about your requirements and circumstances before taking the plunge. Reading guides such as this can only provide you with a basic understanding of the topic, but an independent financial adviser will be able to go much further into detail and ensure you get the right policy at the right price.
If you'd like to speak to an income protection expert please call 01202 714178 or request a quote here to get started.