The relative merits of income protection and critical illness are often debated by financial advisers but opinions are frequently based on gut feel and what they recommend most, rather than cold, hard facts.
The comparison below is based on information rather than opinions and is designed to help you decide which type of cover fits your circumstances better.
To avoid any confusion, it is worth explaining exactly what each type of cover does.
What is Critical Illness Cover?
A critical illness policy pays out a lump-sum, when the policy holder suffers a critical illness specified on the policy conditions list. Once the claim has been paid, the policy ceases to exist.
The policy is not linked to income levels and the cover amount is frequently linked to the policy-holders mortgage amount, though the level of cover can be based on many other factors, as for life insurance. The most common reasons for claims are cancer, heart attack and stroke.
Many buyers of critical illness wrongly believe that it will pay out if they are ill and cannot work!
What is income protection cover?
An income protection policy pays out a regular monthly or weekly income (after the chosen deferred period) if you are unable to work due to accident or illness. The policy continues to the end of the term, regardless of claim length or number of claims.
The policy is directly linked to income and can cover up to 70% of pre-tax earnings, though this payment is not taxed, so it is equivalent to 88% of take-home pay, based on average UK earnings of £27,600.
The most common reasons for claims are mental disorders, followed by joint and muscle problems e.g. a bad back but it pays out for any condition that stops you from working.
The table below summarises the level of cover for each policy
|Condition||Critical Illness||Income Protection|
|Stress & Anxiety||No||Yes|
Claims statistics from LV, who offer both critical illness and income protection policies, show that 50% of the claims for income protection are for mental disorders and muscular / skeletal problems, for which critical illness cover will not pay out. Thought provoking, when you consider that one of the most common reasons for people claiming disability benefits, is due to mental illness, followed by back injuries.
This is backed up by Which?, the consumer protection group, which has stated that around half of the people unable to work for more than 6 months due to illness or accident, would trigger a pay-out from critical illness insurance(1).
It’s rather difficult to compare different types of cover in isolation, so a great alternative is to look at them in a practical situation and see how they perform:
Married couple, two children, Mr Smith works full time on £30,000, Mrs Smith works part time on £5,000, total net income £2539.
Mortgage of £90,000 over 14 yrs
Total monthly outgoings = £2389 with savings of £150 per month
Mr Smith has a serious medical condition and is unable to work for 8 years, a typical duration for an income protection claim.
Solution A – Mr X has critical illness for the mortgage amount of £90,000
If the medical condition is not covered…………………….disaster!
If the medical condition is covered…………..
£90,000 cash lump sum received from critical illness policy.
Mortgage is not paid off as money needed to pay monthly bills. (This is normal)
Monthly earned income plus child benefit now £566 + £336 in disability benefits (middle level claim for care and lower for mobility component) = £902.
Total outgoings £2389 / month, deficit £2389 - £902 = £1487 / month or £17,844 per year.
The £90,000 critical illness payment would cover costs for 5.04 years and then Mr & Mrs would have to survive on £902 / month and any other benefits they might get. Mr Smith now has no illness cover to protect his mortgage.
If they cancelled ‘luxuries’ like Sky / Virgin TV, had no holidays etc, maybe they could make the money last a few extra years.
If the period of illness was much longer, the situation would be much worse.
Solution B – Mr Smith has income protection for £1,500 per month, index linked. (60% of his salary)
He can’t work, so his policy pays out £1500 each month.
Monthly earned income plus child benefit now £566 + £336 in disability benefits (middle level claim for care and lower for mobility component) plus the income protection payment of £1500= £2402.
Total outgoings £2389 / month, surplus £2402 - £2389 = £13 / month.
Money would be tight but the bills could be paid for the full period where Mr Smith is not earning and he would be still fully insured against illness for the future.
It is likely that Mr Smith would return to work earlier with income protection as typically, insurers pay for rehabilitation benefit to speed up the return to work, which is in their interest and Mr Smith.
If the period of illness was much longer than 8 years, even to retirement age, the cover should still be sufficient to cover all outgoings, including the mortgage.
If the condition that caused the work absence should come back, then then a new claim could be started and Mr Smith would still receive monthly payments.
The comprehensive nature of income protection cover, versus critical illness, is illustrated by looking at a claims breakdown for each policy type from LV
Don’t take our word for it, see what consumer group Which? say………………..
“Find out how income protection works, and why it's the one protection product every working UK adult should consider buying.” – Which?