Your money: Danger! Pitfalls in health policies

Insurance: in the sixth part of our series, we look at how to protect income in case of illness

Benjamin Disraeli's jibe that there are "lies, damn lies and statistics" seems to have been taken as a recommendation for statistics by many financial advertisers, as well as politicians.

Certainly, the depressing odds of someone suffering a serious illness or disability before they retire has been exploited by the health insurance industry. While the firms would not admit it, fear can be a great sales tool.

Selling policies by pointing out to people the nature of the risks they cover is, of course, a reasonable thing to do. But a report by the Office of Fair Trading this year criticised the questionable use of statistics in potentially misleading adverts for income- replacement policies.

The report highlighted, for example, a claim that "working men aged 20- 65 are over seven times more likely to become incapacitated and be off work for more than six months than to die during those ages".

This is based on accurate figures for social security claims for long- term illness. But around half those claimants were unemployed before they became ill and so would not qualify under most income replacement policies. What is more, at least half of the rest probably had at least adequate cover from their employer.

As well as dubious sales tactics, the OFT were also critical the fact that "the combination of medical matters and insurance makes [health insurance policies] doubly difficult to understand and almost impossible to compare".

This is not an isolated complaint. Indeed, the complexity of income-replacement policies has been blamed by some commentators for the fact that this type of insurance has failed to take off. It is also a factor in the claims problems that have dogged policyholders, with an astonishing estimated one-quarter of all claims being rejected.

This is a pity because income-replacement and critical illness insurance might be vitally important, particularly if you are self-employed or are one of the growing band of people working on short-term contracts. The welfare safety net now has gaping holes in it.

If you are too ill to do your own job you may still not qualify for long- term incapacity benefit - a tough medical test introduced last year is designed to assess whether you are fit to do any job. Even if you are deemed eligible for the benefit, it will not get you too far financially: the current level is just pounds 61.15 a week before tax.

Deciding between complex, often expensive, insurance on the one hand and inadequate state protection on the other, may seem to be something of a Hobson's choice.

But there are some pointers to make the decision easier:

Who needs this insurance?

Income-replacement insurance is well-nigh essential for most people who are self-employed or working on short-term contracts. If you are in full- time employment "check carefully what your employer offers. This not only helps decide if you need insurance but, if so, what level of cover is appropriate" advises Penny O'Nions, an independent health insurance adviser.

Critical illness insurance is again most important if you have no protection to fall back on from your employer. It is also often used to cover specific debts, such as your mortgage, with the critical illness cover sold as an add-on to your life insurance cover.

This makes it much more affordable, but be careful, these combined policies will only pay out once. If, for example, you suffer a stroke, and then spend the money paid out under the policy, your spouse and children will not get a second payment if you subsequently die.

What does it cost?

Premiums vary hugely, as the table indicates. There can be a two-fold or even three-fold difference in the cost of roughly similar cover for the same person. The premiums quoted by any given insurer will also vary depending on your occupation, age and gender. For example, women pay on average half as much again as men for income-replacement insurance.

When looking at quotes check that you are comparing like with like. While some of the variation in premiums is down to inadequate competition, some is due to variations in cover. There are, for example, budget income- replacement policies that will pay out only for five years or so after you first become ill - the standard policies will pay out until retirement.

What is more, some income-replacement policies guarantee that the premiums will not be increased in future; in other cases, the premiums are renewable (that is, almost certain to go up after five years, if that).

What are the main pitfalls?

Health insurance policies tend to be riddled with exclusions and it pays to check the small print before you sign. Check whether the policy provides cover for you if illness prevents you from doing your own occupation or just any occupation.

With income-replacement policies, check how long you have to wait after you fall ill before the benefit is paid (known as the deferred period) and whether you are covered if you become unemployed immediately before you claim.

How much cover do I need?

A typical income-replacement policy will cover half whatever your pre- tax income is before you fall ill, although some insurers use more complex formulae to work out the cover.

With critical illness, the amount of cover needed is harder to define. A lot depends on your financial circumstances, such as whether you have young children, as well as your budget. "In practice, the main rule is usually `what can you afford?' " says John Joseph, an independent adviser who specialises in critical illness cover.

Where do I get advice?

Health insurance is so complex that it pays to get good advice. "The competence of the adviser is paramount," believes Mr Joseph. But not all advisers are happy to deal with health insurance. As Ms O'Nions puts it: "They are terrified to sell something that's got so many twiddly bits." The adviser should be happy to explain things in detail and put together an insurance package that suits your budget.

Jean Eaglesham works for `Investors Chronicle'.