What is Income Protection Insurance?

Income protection insurance (also called permanent health insurance or PHI) pays a regular income to the policyholder if they are unable to work due to illness or injury. For employers, a group income protection policy ensures employees continue to receive a proportion of their salary during long-term absence, protecting both the individual and the business.

Unlike statutory sick pay (SSP), which pays a flat £116.75 per week for up to 28 weeks, income protection replaces a meaningful percentage of the employee’s actual earnings and can continue paying until the employee recovers, reaches retirement age, or the policy term ends.

How Income Protection Works

1. The employer (or individual) takes out a policy with an insurer
2. A waiting period (deferred period) must pass before payments begin – typically 4, 13, or 26 weeks
3. If the employee cannot work due to illness or injury beyond the waiting period, the policy pays out
4. The benefit is a percentage of pre-incapacity earnings, typically 50-70% of salary
5. Payments continue until the employee returns to work, reaches retirement age, or the policy term ends

Waiting Period Options

The waiting period should align with the employer’s contractual sick pay arrangements. If the company pays full salary for 13 weeks, a 13-week deferred period avoids paying for insurance that duplicates existing cover.

Individual vs Group Income Protection

For Directors and Sole Traders

Company directors who are employees of their own limited company can be covered under a group scheme (even a small one). Sole traders must take out an individual policy, but the premiums are not tax-deductible as a business expense (because the benefit is tax-free when received).

For directors of limited companies, the employer-paid group policy is the more tax-efficient route because the premium is a Corporation Tax deduction while the benefit, though taxable as income when paid, replaces salary that would have been taxable anyway.

What is Covered?

Income protection covers the inability to work due to:

• Physical illness – cancer, heart disease, musculoskeletal conditions, neurological conditions
• Physical injury – accidents, back injuries, fractures
• Mental health conditions – depression, anxiety, stress-related illness (most policies now include mental health, though some limit the duration of mental health claims to 2 years)

Definition of Incapacity

Policies use different definitions, which matter enormously:

Own occupation is the gold standard. A surgeon who injures their hand cannot operate but might be able to do administrative work – an “own occupation” policy pays out; an “any occupation” policy might not.

Cost

Group income protection premiums depend on:

Indicative Premiums

For a typical UK office-based workforce with a 13-week waiting period and 75% of salary benefit:

A company with a £400,000 payroll might pay £4,000 to £8,000 per year for group income protection.

Tax Treatment

Group Policies (Employer-Paid)

The net effect is that the employee receives the benefit but pays income tax and NIC on it, just as they would on normal salary. This means the effective replacement rate is lower than the headline percentage:

Individual Policies

Premiums paid by an individual are not tax-deductible (they come from post-tax income). In return, benefits received are completely tax-free. This makes individual policies attractive for higher-rate taxpayers.

Income Protection vs Other Absence Benefits

Income protection fills the gap between the end of employer sick pay and the employee’s return to work (or retirement). Without it, an employee who develops a long-term condition faces a dramatic drop in income.

Rehabilitation and Return-to-Work Support

Modern income protection policies do far more than just pay claims. Most group policies include:

• Rehabilitation support – the insurer provides access to physiotherapy, counselling, and occupational health to help the employee return to work faster
• Early intervention – some insurers engage as soon as an employee reports a health issue, before the waiting period even starts
• Phased return – the policy may support a gradual return to work, paying a partial benefit while the employee works reduced hours
• Vocational rehabilitation – retraining or workplace modifications to help the employee return in a different capacity

These services benefit the employer by reducing absence duration and benefit the insurer by reducing claim costs. Employees benefit from professional support they might not otherwise access.

Setting Up Group Income Protection

Key Decisions

Integration with Sick Pay

Design the policy so that income protection payments start when contractual sick pay ends:

This avoids gaps in income and avoids paying for insurance that duplicates existing arrangements.

Accounting Treatment

Premiums

Record premiums as a staff cost in the profit and loss account:

Claims

When an employee is on claim, the insurer pays the benefit to the employer, who then passes it through payroll to the employee (deducting PAYE and NIC):

The net cost to the employer during a claim period is the employer NIC on the benefit payments, plus any difference between the benefit level and contractual sick pay during any overlap period.

Related Protection Benefits

Income protection forms part of a broader employee protection strategy:

• Group life insurance – lump sum if an employee dies
• Private medical insurance – access to private healthcare
• Key person insurance – protects the business from the financial impact of losing a critical individual
• Employers’ liability insurance – covers the employer’s legal liability for workplace injury or illness
• Workplace pension – retirement savings

Together, these benefits provide employees with financial security across the main risks: illness, incapacity, death, and retirement.