2nd February 2021

What is meant by financial protection?

Financial protection means taking out an insurance policy so that if an unexpected life event occurs (like illness or death), the financial consequences are taken care of. The financial consequences of illness or death vary from person to person:

Liz is 19 and works at a gym. She earns £1,500 a month. Her monthly expenses, which include rent, are £900. If Liz were unable to work due to illness, financial protection insurance could cover her monthly expenses, meaning Liz could focus on getting better rather than worrying about money.

Sam and Jo
Sam and Jo are a couple in their mid-twenties. Sam works and earns £30,000 a year. Jo stays at home looking after their new baby. The couple have a mortgage of £175,000. Their monthly expenses are £1,800. £800 of this is mortgage repayments. If Sam were to die, financial protection insurance could provide Jo with the money she would need to pay off the mortgage and enough money to live off. While the policy cannot bring Sam back, it can make Jo’s life a little easier at what would be a difficult time.

Some people may have family and friends who can help them out. Others may have savings. The Government provides some help for some people and an individual’s employer may also provide assistance.

However, none of these are reliable, long-term solutions to the financial problems that Liz and Jo might face. This is where financial protection insurance comes in.

How does financial protection insurance work?

Insurance works a bit like the National Lottery. With the National Lottery, lots of people pay in a small amount of money each week. The money is pooled together into a prize fund. If your number comes up, you receive a share of the prize fund.

Insurance operates on the same principle. Lots of people pay a small amount of money each month. The insurance company pools the money together into a fund. If a customer experiences an unexpected life event, they or their loved ones tell the insurer who then pays them a share of the fund.

What types of financial protection insurance are there?

You may have heard of life assurance. This type of insurance policy pays out a lump sum if someone dies. This could be useful for Jo in the event of Sam’s death. Part of the lump sum could be used to pay off the mortgage, the rest could be put into a savings account and Jo could use the money to pay the household bills.

A less well known type of protection product is income protection. This is what Liz might need. An income protection plan will pay out a monthly income if someone becomes ill and is unable to go to work.

There are other types of insurance too. Most people have home insurance, which protects their home, and car insurance, which covers the cost of damage to their vehicle – or someone else’s – if it is involved in a collision. When you go on holiday, it’s a good idea to have travel insurance, to cover any medical treatment or lost luggage. There is also insurance available to cover your possessions, like your mobile or your bike. Schools and companies also need insurance for their people, property and activities.

How much financial protection insurance is needed?

As we said earlier, the financial consequences of illness or death vary from person to person. Therefore the amount of financial protection insurance needed varies too.

Cast your mind back to Liz, how much income protection insurance do you think she needs?

  • Liz earns £1,500 a month, but her total monthly expenditure is only £900
  • This suggests she might need a plan that pays out £900 a month

Life assurance is a bit more complex. For example:

  • Jo might want a lump sum of £175,000 to pay off the mortgage so that she no longer has to make a mortgage repayment each month
  • Jo’s monthly expenses would then fall to £1,000, i.e. £12,000 a year

How much does financial protection insurance cost?

£391,000 sounds like it would cost a great deal, but financial protection insurance is generally a lot cheaper than people think. Jo could buy this level of cover for around £11 a month.

How do I know if I need financial protection insurance?

Generally speaking, the need for financial protection insurance arises when someone starts to rely on the money they earn from employment to pay their own bills or the bills of others.

You might sail through life without major illness and live to a ripe old age. You might face prolonged periods of illness or an earlier than anticipated death. Unexpected life events are a bit like the lottery too – you never know whether your number will come up.

Financial protection insurance, therefore, is all about providing people with the peace of mind that should an unexpected life event happen to them, the one thing they won’t have to worry about is finding the money to pay their monthly bills and to look after their loved ones.

With thanks to our partners over at the NMBA for content.