Payment protection insurance, or PPI as it is commonly known, is an important tool for anyone who is in the process of applying for any type of credit agreement, whether it be a straightforward loan, credit card or a mortgage.
What is payment protection insurance?
As the name suggests, PPI, or MPPI (mortgage payment protection insurance) in the case of mortgages, is a policy which runs alongside a loan or mortgage for the purpose of protecting the monthly loan repayments in the event of the policyholder suffering from one of a number of eventualities. These usually include accident, sickness and unemployment or redundancy, although policies can be tailored to suit an individuals personal needs and may only include one or two of the above conditions. For example, a self-employed person would have no need for unemployment cover, as it is not possible for them to be made redundant.
How does payment protection insurance work?
In the event of the policyholder suffering from either, accident, sickness, or being made redundant from work, the policy benefits would commence and payments would be made directly to the loan or mortgage company each month to cover the level of repayments on the loan. These benefits are only paid for a limited period of time, usually just one year, although some polices will provide benefits for up to two years. The payments will stop either when the policy payment term has expired, or when the policyholder returns to work. In the case of unemployment or redundancy cover, the policyholder must be in receipt of Jobseekers allowance in order to qualify for benefit payments. In the case of mortgage payment protection insurance, the level of benefit payable can include, the monthly mortgage payments, any life assurance policy premiums connected to the mortgage and, in the case of interest only mortgages, the monthly cost of any repayment vehicle, such as an endowment policy or ISA.
What are the benefits and drawbacks?
The main benefit of payment protection insurance is to provide peace of mind in the event of a claim. If the policyholder were to suffer from any of the conditions covered within the policy, very often their monthly income would stop and without this, they would be unable to maintain the monthly repayments on their loans, which would inevitably lead to the loan falling into arrears and the individual getting a poor credit rating in the future. PPI allows the individual to focus on getting better and getting back to work, without having to worry about their finances.
There are, of course, several drawbacks to PPI, as one would expect from any insurance policy. Premiums need to be maintained in order to keep the cover in force and these could be relatively expensive depending on the level of cover taken. Secondly, the cover only pays benefit for a limited period, usually one year. If someone were ill for a period beyond this time, then benefits would cease regardless of whether or not the policyholder was back in work. There is also often a waiting period before benefits are paid out. This could be one or two months and is normally an option when the plan is first taken out, in exchange for a reduced monthly premium. As we have previously mentioned, to qualify for unemployment or redundancy benefits, the policyholder must be in receipt of Jobseekers allowance. This benefit could take several weeks to be granted to the claimant and during this period, no benefits would be paid under the PPI policy. Indeed, it could well be the case that the claimant does not receive Jobseekers allowance at all, in which case, an individual may have being paying monthly premiums on their PPI plan for unemployment cover, but not receive any benefit payments when they are needed.
What alternative covers exist?
There are several types of cover available in the marketplace which can be used to protect loan payments other than PPI, although these all provide different benefits.
Life insurance is often taken out alongside a loan (particularly a mortgage). This can be set up on either a single or a joint life basis and would pay out on the death of the life assured, or on a first death basis in the case of a joint life policy. This payment could be in the form of a single lump sum equivalent to the balance outstanding on the loan, in the case of term insurance, or as regular monthly payments, in the case of family income benefit.
Critical illness cover can also be taken out, either as a freestanding policy, or as part of a combined policy which also includes life assurance. Critical illness cover is designed to pay out on the diagnosis of one of a number of serious illnesses (which would be listed in the policy conditions), either as a lump sum or monthly benefit, as described above. As with life assurance, critical illness cover can be taken on a single or joint life basis.
Permanent health insurance (PHI) is designed to provide a regular monthly income, free of tax, up to a maximum level of 50% of the policyholders' gross income, in the event of the policyholder being unable to work through accident or sickness. This cover could be on an own occupation or suited occupation basis, or on an activities of daily living basis, depending on the occupation concerned. The main differences between PHI and PPI are that in the case of PHI, the benefits payable are based on the individuals' level of income rather than the loan repayments and these benefits are payable up to retirement age (or return to work if sooner), instead of just one year as is the case with PPI.
