Money: A crutch for the self-employed

David Burrows reports on policies that protect your earnings if you can't work because of illness or injury

ALMOST everyone has dreamt of being their own boss. But if you are serious about it, you need to be realistic about the cost involved in going it alone. We all know you need a good accountant. But one point many people overlook is that you will depend on being fit to earn a living. Insurance to protect your finances if you are sick or injured is vital.

It is worth looking into these plans even if you are not self-employed. State incapacity benefit is between pounds 64.70 and pounds 111 per week depending on circumstance. Moreover it is hard to qualify for this benefit. As a consequence more and more people are looking to safeguard their earnings.

Income protection (see box below) will pay out a percentage (usually half) of your usual monthly salary in the event that you are unable to work through illness or injury. Unfortunately for the self-employed, who arguably need it more than anyone, they will find it both hard and expensive to obtain cover.

The main problem is that you need to produce a long history of earnings before cover is granted. And many self-employed workers are in high-risk occupations, such as the building trade, and are turned away.

Income protection has been accused, in many cases quite rightly, of being expensive. It may be worth consulting an independent financial adviser who will be able to pick a policy to suit your needs; if you do the research yourself, you may go for the cheapest scheme without spotting potential snags. It is possible that a scheme with lower premiums is less costly because it includes clauses that, in effect, reduce the number of payouts.

For example, a policy may stipulate that you must be unfit to carry out "any occupation" rather than just your "own occupation" before it will pay you. So a self-employed graphic designer would have to prove that he or she could not work, for example, as a telephone operator in order to qualify for a payment.

Alternatively, the policy may pay out under an "own occupation" definition for the first six or 12 months and then change to "any occupation". Ensure you buy an "own occupation" deal.

There is also the problem that there may be a large gap between the earnings that the self-employed declare to the Inland Revenue and the amount they take home. It is perfectly legitimate: the self-employed attempt to offset as much of their income as possible against tax, so a real earnings figure may be closer to pounds 1,000 a month rather than the pounds 700 they have declared.

However, if they make a claim under their income protection policy, they will receive a payment relating to the pounds 700 declaration. Even with insurance, they may struggle to make ends meet if they are unable to work for any length of time.

Some insurers assess claims by only taking the previous year's income into account. This can be disastrous if the previous year was unusually bad. If you are well established in your business, look for a policy which will base average earnings on a number of years' income.

If you don't have a long earnings record, one way to get around this is to buy critical illness cover as it is not income based. You would receive a cash lump sum if you had a heart attack, stroke or any other sudden and life-threatening illness named on the policy. Unlike income protection, you would receive nothing for stress-related illness or chronic back disorders.

The products are not the same but they do at least cover some of the same ground - namely that if you are unfit to work, there is cash to help you through.

One insurer, UNUM, has introduced Essential Ability Cover which goes against current trends and does not require details of occupation or an earnings history. Instead, claimants are given a set of tests (11 physical and one psychiatric) to determine if they are fit for work.

If claimants satisfy any three of these physical tests, or the one mental health test, they will qualify for monthly income replacement payment. Other insurers will probably follow UNUM down this path in an effort to open up the self-employed markets.

Some insurers, such as Royal & SunAlliance, are offering "integrated deferred benefits", a scheme tailored for the self-employed. It works by giving a low payout for the first six months and then an increase as the absence from work gets longer. The premiums are often less than for a standard plan.

Any good financial adviser will look at the individual and offer tailored advice. For example, if a client is in his late 50s, is a self-employed joiner, and is looking to retire but is concerned that he may not be able to afford to do so for a number of years, it may be a good bet to take out critical illness cover. Income protection could be hard to obtain because he is in a higher-risk profession.

Private medical insurance (PMI) can protect income in its own way. With PMI you are, in effect, buying into a private-sector waiting list which will be shorter than that on the NHS. You keep lost income and absence from work to a minimum by receiving prompt treatment.

q Contacts: Independent Financial Advice Promotion, 0117 971 1177 (for the numbers of three advisers in your area); Institute of Financial Planning (for fee-based advisers), 0117 930 4434.

q David Burrows is deputy editor of `Planned Savings' magazine.

Health insurance plans

There are two main types of health insurance scheme that pay out if you become sick, plus private medical insurance (PMI) which pays private hospital bills.

Income replacement insurance (sometimes called permanent health insurance - PHI). This pays you an income if you can't work due to illness or injuries that are not life-threatening - for example, stress-related illness and broken limbs. On average, 50 to 60 per cent of earnings are paid after a pre-arranged deferral period, which can be anything from four weeks to a year. The payments continue until the claimant is able to return to work or reaches retirement age.

Critical illness cover provides insurance against life-threatening illnesses such as a heart attack, stroke, cancer or multiple sclerosis. Payment comes in the form of a lump sum but varies according to the sum assured and the condition you are claiming against, so it could be anything from pounds 20,000 to pounds 200,000 plus.

Private medical insurance. Insurance to pay for medical treatment carried out in the private sector. The likelihood is that the waiting time will be much shorter, so you can get back to work more quickly. There are budget plans that limit the treatments you are covered for, and it may be that you have no cover for outpatient treatment. The more expensive plans will offer full refunds for treatment and will include all the added extras such as a private room, food and TV/video.

Policies can cost anything from pounds 35 a month for a budget family plan, which will offer few full refunds and give little choice on where you are treated, to pounds 340 a month for a comprehensive family plan providing full refunds for all treatments and all the extras.