ProtectionSep 25 2018

How protection payments affect benefits

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How protection payments affect benefits

Clarification from the Department for Work and Pensions (DWP) that it will exclude mortgage-related protection payouts in state benefit assessments is great news for the insurance industry. But while this should lead to an increased take-up of income protection (IP), insurers will need to ensure product design meets the DWP’s conditions.

The interaction between protection payouts and state support has long caused frustration for insurers and advisers. As state benefits are clawed back pound for pound when IP is in place, this can create a disincentive to take out cover.

Need for protection

Although the Building Resilient Households Group has campaigned for protection to be excluded from benefits calculations for a few years, the issue came to a head when changes to state support were introduced in April 2018. These transformed support for mortgage interest from a benefit payment to a loan. 

This loan can be taken out to cover the interest on up to £200,000 of an outstanding mortgage, and is repayable with interest, currently at a rate of 1.7 per cent.

Ron Wheatcroft, technical manager at Swiss Re, says this is a totally different proposition from a claimant’s perspective. “Taking out a loan to cover mortgage interest will lead to an individual’s debts spiralling, making it even more important to take out protection,” he explains. 

“Having clarification from the DWP that any income from an insurance policy taken out to cover mortgage interest will be totally disregarded is a step in the right direction.”

This clarification should help to increase sales of IP. Although some advisers include IP in mortgage advice, the change in state benefits, coupled with the reassurance of the disregard, will make it a much more compelling proposition. 

It is also positive that it puts IP on an equal footing with mortgage payment protection insurance (MPPI), which has always had an exclusion from benefits means-testing. 

“IP can offer much better protection than MPPI,” says Johnny Timpson, financial protection specialist at Scottish Widows Protect. “It is underwritten at outset rather than at claim and can provide cover for a much longer term.”

Conditions attached

In spite of these positives, the DWP also attached a couple of conditions that may require further attention. One of these is that an individual’s insurance payout will be taken into account if they apply for a support for mortgage interest loan. While important to note, in practice, this is unlikely to affect many people as having protection to cover mortgage payments would usually negate the need to take out a loan.

The other condition may prove to be more taxing. This states that any income from a protection policy “where it is specifically intended and used to cover mortgage repayments” will be disregarded. Where the individual has choice over how this income is spent, the DWP will judge how much is intended for mortgage payments and should therefore be disregarded.

While this works perfectly well with MPPI that is assigned to the lender to cover the loan, it creates uncertainty for IP as the benefit is paid directly to the policyholder.

Addressing this may require changes to product design, enabling an individual to split their benefit so the mortgage element goes directly to the lender. This may be relatively straightforward to implement. Many of the IP insurers also offer MPPI, where assigning benefit to the lender is common practice, so the mechanics for this should already be in place.

Peter Hamilton, head of market management at Zurich, agrees. “We do need clarification on what evidence the DWP will require to disregard the mortgage element of the IP benefit, and I would argue for something as simple as showing a mortgage statement. Paying it directly to the lender would not require any material changes, but it is easier to pay the full benefit to the customer.” 

Practical issues

Keeping the policyholder as the sole benefit recipient also addresses a number of practical problems. Mortgage interest payments can fluctuate in line with interest rate changes or as the capital is repaid on a repayment loan. And with remortgaging much more common, the lender could potentially change too.

This is less of an issue with a short-term MPPI product, which can be linked to the lender in the event of a remortgage or adjusted as rates change, but David Hollingworth, associate director of communications at L&C Mortgages, says these factors could cause substantial issues for IP: “Will the borrower need to update the insurer every time they remortgage? It would mean the adviser could add more value ensuring protection is up to date, but it would create much more administration.”

Demonstrating the benefit is intended to cover mortgage interest could be supported in other ways, too. For example, Mr Timpson says that using an appropriate product name could add weight to the argument. 

“If an insurer is offering an IP product that covers the mortgage, give it a name that reflects this,” he says. “Being clear about what the product is intended for will help consumers, but will also make it easier for the DWP to recognise the intent.”

As well as ensuring future products offer the necessary proof of intent, existing IP clients may also need help to enable them to benefit from the disregard. This is particularly the case for those who are already claiming, who may require supporting evidence such as the initial report from the adviser or a statement from the insurer to demonstrate the product was taken out to cover mortgage interest.

Next steps

Having this disregard for mortgage payments is a significant step forward for the protection industry, but the Building Resilient Households Group is campaigning for further changes from the DWP. In particular, it would like to see the disregard being extended to rent payments.

With the number of people renting their homes on the up, there is likely to be huge demand for this. Although the benefits system covers rent, this support often falls short of the amount charged in the private rented sector.

This move also supports government housing policy. Under the shared ownership Help to Buy scheme, the homeowner pays a combination of mortgage and rent. 

“Having a disregard for protection taken out to cover rent would improve the financial resilience of these first-time buyers,” adds Mr Timpson. “It would also address the disconnect between the government’s welfare and housing policies.” 

Negotiations are already well under way to secure this disregard, but putting it in place may take time. While the disregard for mortgage interest was a matter of clarifying the wording to include IP alongside MPPI, extending it to rent would require an amendment to the 2012 Welfare Reform Act.

There are also calls to exclude protection income that covers other living expenses such as utility bills, council tax and childcare from benefits means-testing. 

Mr Hamilton says this is positive: “The more we can remove unnecessary, counter-intuitive and counter-productive disincentives to individuals making their own provision, the better. The changes to mortgage interest support in April simply reinforce the fact that state benefits are likely to continue to be eroded.”

Creating a system where individuals are better off if they take out protection is also in keeping with the government’s push for self-provision. Mr Hamilton adds: “Disincentives have already been removed around pensions to make sure people are not disadvantaged for making their own provision. The more the government can encourage self-provision, the better.”

Excluding mortgage-related protection payouts from state benefit assessments is a great first step for the insurance industry. With negotiations under way to ensure self-provision dovetails more neatly with state benefits, it should improve the fortunes of the IP market.

 

BIG NUMBERS

1m

Number of people in the UK that suffer a prolonged absence from work due to sickness each year (Chartered Insurance Institute, Building Resilient Households Group) 

34%

Proportion of adults who would not be able to recover quickly from an unexpected financial shock or loss of income (Zurich, ‘Cost of resilience’) 

10%

Percentage of people covered by insurance that would cover their income if they were unable to work (Chartered Insurance Institute, ‘Building resilient households’) 

2.8%

Increase in sales of individual IP between 2016 and 2017 (Swiss Re, ‘Term & health watch 2018’)

121,084

Number of new individual IP policies sold in 2017 (Swiss Re, ‘Term & health watch 2018’)