Each year around one million of the UK’s 30m strong workforce find themselves unable to work due to serious illness or injury, with a quarter of these forced to leave employment altogether. But, while this represents a significant risk, take-up of income protection insurance (IP) remains low.
Figures from the Association of British Insurers (ABI) suggest there are 1.2m people with individual IP policies in place, with a further 2m covered through their workplace. This leaves many reliant on the state if they are unable to work, often with dire consequences.
This is shown in research commissioned by the ABI from independent think-tank the Centre for Economic and Social Inclusion. It found that, although the state would provide a decent replacement income for households with low earnings, there was little or no support for those with moderate or higher earnings.
As a result, if the main breadwinner was unable to work due to illness or injury, 10.8m households, equivalent to more than 60 per cent of working families, would see their income fall by more than a third. Of these, 6.6m would see it reduced by more than 50 per cent.
The forecast for the state is no less bleak. While the government’s welfare reform is chipping away at the benefits bill, the need for state support is growing. As well as the health issues associated with an ageing workforce, the ABI report shows an increase in the incidence of a number of conditions that lead to long-term absence. These include mental illness, depression and progressive conditions such as cancer and multiple sclerosis.
Benefit clarity
Increasing take-up of IP could ensure that households have a financial safety net while also reducing the burden on the state. But the ABI found there were a number of barriers preventing this.
One particularly concerning obstacle is the fact that the complexities of the state welfare system mean it is very difficult to understand how much you would be entitled to if you were unable to work.
Entitlement is based on a number of variables including whether the home is rented or owned; whether there is a second income; how many children there are in the household; and whether there are any savings. “People just do not know what they would get and the government has made little effort to explain it,” says Helen White, head of protection at the ABI. “It is very difficult to plan for something if you do not actually know what you need.”
As well as being blindfolded when it comes to understanding how much benefit the state might provide, the way IP and benefits interact can serve as a further disincentive. For every £1 of unearned income – which includes benefit paid under an individual IP policy – you lose £1 of welfare support. On a group IP policy, the benefit is treated as earned income, reducing welfare support by 65p for every £1 of group IP benefit received.
To resolve these issues, the ABI would like to see more joined up support from the state and private insurance. Central to this, there would need to be clearer information about what the state would provide if someone was unable to work. Although this would be challenging due to the number of variables, the government has recently launched annual tax statements detailing how an individual’s tax is split across areas such as welfare, health and education. Extending this into an individual’s benefit entitlement should therefore be feasible.
Tax breaks
As well as providing more information, the ABI would also like to see the removal of the disincentives currently in place around IP. While this could be achieved to some extent by standardising and reducing the benefit clawback when someone claims on their IP policy, the possibility of a tax break to encourage take-up is another option.
This is an area Zurich explored earlier this year in its report, ‘Income Protection – working together to improve take-up’.
It found that, even at the relatively low penetration rate it currently has, group IP represents a saving of around £165m to the taxpayer. This breaks down as £85m in lower welfare payments and £80m from higher income tax and National Insurance contributions.
In addition, it found that the use of rehabilitation in helping employees return to work generated a further saving of £20m a year for taxpayers, £5m for employees and £15m for their employers.
Pushing take-up to the levels seen in the US, where 35 per cent of employees have group IP, compared with 9 per cent in the UK, would increase the annual savings to the taxpayer to around £0.75bn as well as providing additional benefits through rehabilitation.
Gary Shaughnessy, chief executive, UK Life at Zurich, says that putting the right incentive in place could deliver this sales boost. “A temporary tax incentive rather than something baked into future would create the impetus to take out cover,” he explains. “This government support would signal that IP is a good thing while the short-lived tax advantage would help to overcome some of the inertia.”
Distribution decision
After the introduction of automatic enrolment for pensions, it is probably not surprising that the workplace is regarded as a key distribution channel for both individual and group IP products. But rather than replicate the pensions system, the ABI is proposing a model it calls ‘time-based collective insurance’.
This would require employers to put insurance in place to provide full income replacement for up to a year. Employees would be able to extend this cover up to a set time period, for instance five years, after which the state would step in, potentially paying benefits at a higher rate than it does now.
While there is debate over the ability of employers to take on a further cost, Paul Avis, marketing director at Canada Life Group Insurance, believes that some element of compulsion is essential. “If you do not have compulsion you will not see a significant increase in take-up,” he says. “This type of arrangement is in place in other countries where it has led to major benefits for employers, employees and the state.”
As an example, in the Netherlands, as well as providing sick pay for at least two years at a rate of 70 per cent of earnings, employers must also ensure that employees attend effective rehabilitation programmes to help them return to work. This has helped to reduce the numbers going onto state benefits by up to 15 per cent.
Short-term measures
Whether or not the idea will gain traction with the government, with a general election scheduled for 2015, it remains a long-term goal. But, to guarantee the best possible reception, the protection industry is ensuring the benefits of IP are clear-cut.
An awareness campaign is part of this with a number of different initiatives helping to raise the profile of IP. These include the Income Protection Task Force’s Seven Families campaign but also the ABI’s work with the Money Advice Service to increase the information and tools it provides to its users.
Insurers are also stepping up their activities. For example, Johnny Timpson, financial protection specialist and planning manager at Scottish Widows, says that the industry needs to help customers understand the value of their benefits. “We send out an annual protection statement to our customers but we could also learn from the US where insurers have developed not-for-profit organisations such as Life Happens to raise awareness. We have to educate consumers to win their trust.”
And, with government, employers and individuals set to gain from a more integrated approach to providing disability benefits, starting the debate now is an important first step.
