What are your protection needs?

As we’ve all learned in 2020, life can throw some very unexpected curve balls. That’s why it’s important to incorporate some protection measures into your financial planning, to ensure that circumstances outside your control do not derail everything you have worked for.

When financial experts talk about protection, they are usually talking about different types of insurance that will pay out if you become ill, can’t work for any reason, or to protect your family if you die unexpectedly. Because every family’s circumstances are different, the types of protection they will need will also vary, but here is an explanation of what is available.

Protection fits into the following areas: mortgage and loan protection, personal protection, family protection and business protection.

Life insurance

This type of insurance, as the name suggest, pays out money to your partner and/or children if you die.

It falls under the categories of family protection and mortgage & loan protection.

Some life insurance provides a regular monthly income for the family, while other types of policies provide a lump sum.

Some policies are tied to specific debts, such as your mortgage, and will only pay out if you die during a specific time. This is called term assurance. Other policies, known as whole-of-life-cover, will pay out at any time. Premiums for whole-of-life insurance are generally higher than for term assurance.

If you buy a term assurance policy, this can be set so that the amount that is paid out decreases or increases over time (for example as a mortgage payment decreases or the cost of having children in education rises) or so that it remains the same. If it stays the same it is known as level term assurance.

The cost of life insurance depends on many factors, including your health, your occupation and your family background. Two other important factors are the sum assured and the term of the policy.

These types of polices can be set up on a single life basis or a joint life basis. This can be joint life first death, which means that the policy will be paid out on the first death or, in the case of a whole of life policy set up for inheritance tax purposes, joint life second death. This policy will pay upon the second death.

A financial adviser could help you to pick the right policy for you and also discuss having the policy written in to trust for the family, which can help with administration and costs in the event of a claim.

Income protection insurance

If you are worried about how your family would cope financially if you were unable to work due to illness or disability, income protection insurance is another form of protection that is available. It is a form of personal protection designed to provide a regular income if you become ill or injured.

Any pay-out is usually based on a percentage of your earnings and pays out tax free.

You can choose different types of income protection insurance, including some that kick in after an employer stops paying sick pay (known as stepped income protection insurance), and some that are index linked, so that they rise in line with inflation. There are also short-term versions of these policies, which may be a cheaper option, allowing you to cover yourself for a certain amount of time (usually 12 or 24 months).

Different policies will also have different definitions of what it means to be unable to work, so it is worth making sure you understand the specific policy conditions to ensure that the policy you buy fits your needs. Again, an expert will be able to help you pick the best insurance for your specific circumstances.

The premiums for this type of contract are usually based on occupation, the amount of benefit, age, health and the deferred period (this is the waiting time before the benefit begins to pay, usually a choice of 1, 3, 6 or 12 months). The longer the deferred period, the more cost effective the premium. Self-employed people may well be able to apply for a 1-week deferred period.

Critical illness cover

Critical illness cover is a type of personal protection that pays out a lump sum if you are diagnosed with a critical illness that is named in your insurance policy. In some cases it will pay the same amount no matter the severity of your condition and in others the payment will be severity based.

Typical illnesses that are covered include heart attack and strokes, as well as some cancers, while some policies give you the opportunity to name specific illnesses.

There is an option of adding critical illness to a life insurance policy at outset. This means the policy would pay out on the first event, either death or the diagnosis of a specified critical illness.

Business protection

Business protection provides cover in the case of a key person within a business becoming critically ill or dying. There are three main types available: key person insurance, shareholder protection and loan insurance. Key person insurance protects the business if a person named in the policy, who is key to the operations or profitability of the business, becomes ill or passes away. Shareholder insurance provides protection in the case of a business owner or partner dying or becoming critically ill, and the agreement specifies what happens to the shares if the person dies. Finally, business loan protection ensures that loans taken out by the business are repaid if a key person or shareholder dies.

Personal indemnity insurance

Indemnity insurance is a form of business protection for those operating as a small business or as an entrepreneur. It covers legal costs and expenses which may arise from clients making any claims against you, such as for defamation or breach of copyright.

Some clients will require you to have this cover in place, while it can also provide peace of mind that any claims against you won’t have to be funded from your personal finances.

Do I need protection?

Not everyone needs a protection policy, although everyone should consider whether they do. It will depend on all sorts of other issues, including whether you are the only earner in a family and the amount of mortgage and other debts outstanding.

Before you buy a new policy, it is also important to check whether you are already protected. For example, your company may offer a ‘death-in-service’ payment that could reduce the need for life insurance. Some policies also overlap and provide cover over and above your needs. It is therefore important to consider your entire position, to avoid payment for cover you do not require.

Talking with a financial adviser can help you to decide what is right for you and to get the policy that best fits your circumstances.