Protection planning for the self-employed

As a result, their financial resilience is likely to be low - which means if they were to suffer an illness or have an accident that renders them unable to continue working, their savings will soon dry up.

In May, Scottish Widows research showed 21 per cent of Britons admitting they could not survive financially if they lost their income due to a long-term illness. 

A further study, carried out by Royal London, came up with these figures: 

• If illness struck, nearly half (43 per cent) felt they could manage for a year if they were unable to work due to serious illness or injury.
• Some 55 per cent said they would manage for six months.
• Some 71 per cent said they would manage for three months.

However, the reality was, given their actual levels of savings, only two people in five could survive financially for more than six months if they were unable to work.

This shows how poor is the average person's financial resilience. The message hits home further when it comes to the likelihood of a worker being off sick through long-term illness or accident. 

The figure, below, taken from Royal London's State of the Protection Report, using figures from Pacific Re, highlights the reality of how precarious people's financial situation is - especially when it comes to someone who is the main or the only employee in their own business.

Source: Royal London/Pacific Re

Income protection 

Adam Higgs, head of research, adviser services, for F&TRC, says it is important to protect the income first and foremost.

He explains: "As with all clients, protecting income should be the first objective. Unlike many employed people, the self-employed do not benefit from a company sick pay scheme.

"As such, they are reliant on savings and the state from day one if they are unable to work due to ill health or injury.

"Income protection (IP) policies have vastly improved for self-employed people offering shorter deferred periods, more benefits to help people get back to work and even policies with benefit amounts based on essential expenditure rather than income."

For Mr Higgs, the key to recommending income protection for the self-employed is getting the benefit amount right, and getting the timing right as to when this kicks in. 

He adds: "This means that an accurate understanding of the client’s expenditure and the savings they have in place are critical."

If you’re looking for income protection, it is notoriously difficult for the self-employed to prove if they can’t go to work and there’s a lot of exemptions on the policies. Jamie Smith-Thompson

Ian Smart, product architect at Royal London says: “Our research shows that small business owners recognise the importance of insuring the equipment that helps them earn an income but they often overlook the importance of insuring themselves. 

"It can sometimes be difficult for the self-employed to prove their earnings to apply for a loan, mortgage or insurance. 

"We recognised this was a barrier to sales so recently made some changes specifically for the self-employed. We now allow them to cover a proportion of the fixed overheads they have for the day to day operation of their business, as well as replacing the income they take from the profit generated by the business."

Mr Smart says the benefits of having a form of income protection need to be explained fully to the self-employed, as it is not just a "nice to have".

He adds: "Without this additional cover allowing them to continue to pay the business bills as well as maintain a decent level of income, they may be forced to wind up their business and so when they recover they may not have a job to go back to. These changes make the level of benefit and support they get whilst ill more relevant to them.

"If you are self-employed, income protection should be seen as a necessity not something that is nice to have, breaking down the barriers to closing sales will help advisers to get their clients the protection they need.”

And those barriers need to be broken down across the industry, says Jamie Smith-Thompson, managing director of Portafina, an advice firm specialising in the self-employed market.

He explains: "If you’re looking for income protection, it is notoriously difficult for the self-employed to prove if they can’t go to work and there’s a lot of exemptions on the policies.

"The best thing to do would be to check the exemptions on these policies and the likelihood of them paying out should you need it - although the cost of such policies may also rule it out as an option."

While the cost might be a potential barrier, for Tom Conner, director at Drewberry, IP is a no-brainer.

"First and foremost, we'd recommend an IP policy. A tiny proportion of self-employed people have IP, yet without sick pay there's very little to stand between a self-employed individual and the breadline.

"There are lots of benefits to working for yourself, but unfortunately a lack of employer-provided sick pay is not one of them. IP is there to pay a proportion of an individual's earnings each month if they can't work due to accident or sickness until they can return to work."

Set your business up properly from day one Martin Stewart

According to Mr Conner, Drewberry often arranges IP for the self-employed with short deferral periods, i.e. less than a month or even as little as one day.

This is to compensate for the fact that many clients who work for themselves do not have sick pay or much in the way of savings to fall back on should they be unable to work.

He admits "although this can increase the cost of cover, it prevents someone from ending up in dire straits should they fall ill, even for a relatively short time".

Health and life insurance

Specifically, getting health insurance is "one of the best things you can do if you’re self-employed", according to Mr Smith-Thompson. 

Whether this is a form of PMI or critical illness cover (CIC), he says this is a huge benefit "as it means you won’t be waiting in an NHS queue if there’s something preventing you from working".

Mr Conner says that, after IP, if there’s any budget left, Drewberry might get an individual to consider life insurance to protect their loved ones should the worst happen.

He states: "This can also help meet any outstanding debts, such as a mortgage, making sure the family is financially taken care of without that person around.

"It’s also important to remember that many business loans taken out by a sole trader are personally guaranteed, so if they were to pass away it could fall on their family to make repayment, which can make a nightmare situation far worse."

It is important to remember that many adult critical illness policies also make some automatic provision, usually up to £25,000, for children's illnesses, with some exemptions - for example, illnesses diagnosed in utero will not be claimable against on the parent's policy.

Yet according to Scottish Widows research, only 9 per cent of Britons have a critical illness policy - with more people likely to insure their mobile phones, at 12 per cent, than to insure their own lives.

Relevant life and key person cover

According to Martin Stewart, director of London Money, tax planning and financial planning go hand in hand here.

He explains: "Again, using the analogy of their business being a financial planning tool then limited company owners need to be looking at Relevant Life policies as a very efficient way to get cover without incurring a personal financial commitment.

"The state benefits for all people are derisory so ensuring there is a budget at outset for things like income replacement, life cover, critical illness cover, etc, is paramount."

Relevant life policies

Relevant Life policies allow firms to offer a death-in-service benefit to employees, including salaried directors. It is set up by the company and pays out a tax-free, lump sum on the death, or on the diagnosis of a terminal illness, of the person insured.

The proceeds go directly to the employee's family or financial dependants. The following checklist, available from life and pension provider LV=, outlines the pros and cons of relevant life policies.

Key person insurance

Key person insurance (KPI) is cover that will provide a financial safety net for a business if a key member of staff - such as the biggest money-earner or a senior director - dies or is diagnosed with a serious illness (if critical illness cover is also selected).

The claim is paid directly to the company or partners, which allows the firm some 'breathing space' to help keep the business trading as normally as possible. Again, LV= provides a helpful overview of KPI, as shown below.

Do it right, early

Mr Stewart's mantra is "Set your business up properly from day one", adding: "There is no state safety net should something unfortunate happen to your health.

"If you are in partnership with someone else, then key man insurance (often called key person insurance) is something that needs to be looked at."

"Likewise, if you are a limited company with other shareholders, have you had a discussion about what would happen to the other should something unfortunate happen to you?"

Mr Stewart pressed the point home: "These are the grown-up discussions that need to be had before you even think about opening the doors for business."

simoney.kyriakou@ft.com