Income Protection Insurance

What are the different types of income protection insurance?

There are two different types of income protection cover that can pay a regular monthly income directly to either:

• an individual to cover sick pay entitlement (for personal income protection or employer provided income protection)
• a senior employee and/or their employer to cover a senior employee’s salary, and/or lost profits, and/or the cost of employing a replacement employee (executive income protection)

What is personal income protection?

Personal income protection is insurance that you or any employee can independently choose to arrange and pay for, or that can be arranged and paid for by an employer (known as ‘employer provided income protection’).

Personal income protection can replace up to 50-70% of an employee’s loss of income resulting from an accident, long-term sickness or serious injury.

Policies usually pay out after six months (28 weeks) of absence when statutory sick pay (SSP) stops being paid - often referred to as a ‘deferred’ or ‘waiting’ period.

Personal income protection only pays a monthly income to an employee should they suffer an injury or illness that prevents them from working; it does not pay an income to a business.

For a business to be the insurance beneficiary, you will need to instead take out ‘executive income protection’.

What is employer provided income protection?

An employer can arrange and pay for personal income protection (also known as group income protection) as part of their ‘employees’ benefits package’.

Group income protection can cover up to 80% of an employee’s gross earnings up to a maximum of £425,000 and cover for less than £150,000 doesn’t require medical underwriting.

Similar to having employee life insurance as a benefit, providing income protection insurance to your employees can help attract and retain the most talented staff.

Employer-provided group income protection insurance is usually a single policy that covers all of a company’s employees and can make the management of long-term sickness easier and help a business hold on to their principal, top-performing employees.

When an employer provides this insurance, they can typically choose how long an employee is absent for before insurance payments kick in and how long the policy will pay out for (the term of the policy).

This type of policy can be fully paid for by an employer or an employee, or partly paid for by both.

What is executive income protection?

Executive income protection is the most comprehensive income protection insurance that is arranged, paid for and owned by a business, for the benefit of a business and/or its senior employees.

Should the insured employee suffer an accident, illness or injury that prevents them from working, executive income protection can cover:

• the income of the absent employee by way of sick pay or
• the cost of replacing the absence employee or
• both the income and cost of replacement
• self-employed director(s) or senior employee(s) aged between 16 and 69 years
• high earners with a salary up to £300,000 per annum
• up to 80% of an employee’s salary up to £300k (to compensate for tax deductions)
• dividends (including dividends paid to a spouse or partner that do not count as P11D)
• an employer’s pension and national insurance contributions

Executive income protection cover can provide a higher level of cover and support than a personal income protection plan which typically has a maximum payment limit of 70% and £200,000.

This type of income protection policy offers more flexibility as insurance payouts are made directly to the policy-holding business and it’s up to the business owner(s) or directors to decide how to use the insurance proceeds.

If a company decides to use the insurance proceeds for the absent employee’s income, the proceeds will be paid via Pay As You Earn (PAYE).

Alternatively and in addition to paying the absent employee’s salary, the business can use the insurance proceeds to replace any lost profits suffered by a company due to the absence of a key member of staff, or to cover the costs of temporarily employing a replacement employee.

Some businesses choose to provide executive income protection to their employees for a limited time, usually until an employee reaches a certain age (say, 50-70 years old), or it can be limited to a period of time of between two to five years of cover.

As cover can widely vary between insurers, it’s important that you seek professional advice and guidance when choosing this type of policy.

Note: At the end of some time-limited policies, the insured can receive a lump sum payout up to 4 x an employee’s yearly pay.

Who needs income protection?

An individual or a business may need income protection if:

• they are a senior employee with significant financial commitments who could not survive financially, long-term, should they be unable to work
• they are a business with an employee, whose long-term absence could have a catastrophic impact on their company’s finances and future and who would urgently need replacing

How does an income protection policy work?

An income protection policy works by paying a monthly income to an employee or its business, should the insured person/employee have an accident or be too badly injured or ill to work.

In the event of long-term absence, this type of protective insurance can cover either the sick pay of an employee or, in the case of executive income protection, lost profits and/or the salary cost of a temporary replacement.

The level of cover you choose to have can be calculated by:

• multiplying the insured’s salary by, say, x 2, 3, 4 or more
• taking a percentage of your business profits solely generated by the insured
• using the amount required to repay a loan that usually relies on the income of the insured for its repayments

Premiums can be affected by the insured’s age, job, income, health, the payment start and end date, and are usually paid by direct debit, by the insured or their employer, depending on the policy type.

Upon a claim being made, a percentage of the insured’s salary will be paid:

• directly to the insured (personal policy)
• directly to the business (group or executive income protection policies)

for either a set period of time or until the insured reaches a certain age.

What are the key benefits of income protection?

Personal income protection insurance or group income protection insurance benefits your employee (the insured) by covering the cost of providing sick pay to them in the event they are too poorly or injured to work, long-term.

Executive income protection benefits a business and usually its senior employees (i.e. directors) as the monthly compensatory payment is paid directly to the company to spend as they wish and it is more tax-efficient than personal income protection as the premiums are tax deductible. This type of insurance can also include wellbeing and/or rehabilitation support.