While insurers report greater demand for financial protection products, purchasers should beware of small print exclusions, writes Caroline Madden

WITH SO much doom and gloom in the air and the "R" word being bandied about with increasing alacrity, many people are considering worst-case scenarios and wondering how they would cope if they lost their job, or whether they can afford to fall ill.

According to some life insurance companies, the economic downturn is prompting consumers to sign up for products that provide a degree of financial protection, such as critical illness cover (also known as serious illness cover) and income protection insurance.

Bank of Ireland Life says that in recent months it has experienced a significant pick-up in sales of life insurance and critical illness cover (which pays out a lump sum on diagnosis of one of the illnesses specified in the policy). Meanwhile Friends First says that income protection insurance - which provides a replacement income if you're unable to work due to sickness or disability - is one of the product lines that it is seeing the most interest in.

But is this necessarily the best time to be splashing out on expensive insurance products when everyone else is tightening their belts? Apparently many consumers think not. In contrast to the upbeat line from the life insurance industry, LA Brokers chief executive John Geraghty has noticed that people are cutting their outgoings where possible. "People are tending to look at their finances and see ways they can actually save money," he observes.

"People who may have been paying for critical illness policies . . . are now shopping around and taking out cheaper forms of cover," Geraghty says. "They're going for the more basic levels of cover such as life assurance just to cut their outgoings.

"Probably in the boom, they had the luxury of being able to afford to pay for a greater scope of cover," he continues. But in these straitened economic times, people are now cutting back on "luxury" insurance products. "Serious illness would be a luxury product compared to, say, mortgage protection, which is a bog-standard legal requirement."

Of course, serious illness cover can be a godsend if you fall ill and have no other cover in place, but only if your interpretation of what constitutes a "serious" illness matches the exact definition in your policy.

"Sometimes people get a nasty surprise," says Michael Kemp, chief executive of the Irish Insurance Federation (IIF). "Having bought the cover, they then realise that the particular condition they've got . . . is not actually included. There have been problems with certain conditions being tightly defined and people thinking they're getting broader coverage than they are," he says.

For example, most of us would assume that being diagnosed with cancer is about as serious as it gets, but if the disease is caught early, before it has invaded the surrounding tissue, the chances are you won't be able to make a claim under a serious illness policy.

"Most serious illness policies will not cover you for many of the most common illnesses that prevent people from working," warns the Irish Financial Services Regulatory Authority. These include stress-related illnesses, back injuries and diabetes. And even if a policy covers heart attacks, it might well exclude a related condition such as angina.

"So, even if you develop an illness that is serious enough to prevent you from working and earning an income, your policy might not pay out any benefit," the financial regulator says. It's essential to check not only which illnesses are covered by your policy before signing the dotted line, but also how these illnesses are defined.

It's also advisable to shop around before choosing a provider. Although serious illness cover has become more expensive over the last three or four years, savings can still be made. For example, quotes for a serious illness policy for 40-year-old non-smoking male over a 20- year term, with a €250,000 lump sum benefit, range from €31.74 to €58.79 monthly.

Kemp advises people not to be swayed by price alone. The level of cover and service provided should also be factored in.

Once you've taken out a serious illness policy, it's tempting to tick it off your to-do list and forget all about it. However, it's important to review your situation on an ongoing basis to make sure that the product still matches your circumstances. For example, as people approach retirement, they may well decide that the need for serious illness protection is no longer as pressing, perhaps because their children have flown they nest and they no longer have dependants. It could make more sense at that stage of life to divert the money away from insurance policies and towards a better retirement.

For consumers who are still at a financially precarious life stage, income protection insurance is another alternative worth considering. Not only are premiums for this type of product generally cheaper than for serious illness policies, but they also qualify for tax relief at the individual's highest rate, up to a limit of 10 per cent of their yearly income.

Sometimes called permanent health insurance, income protection provides you with an alternative income if you're unable to work because of sickness or disability, until you are able to return to work or you reach retirement age. The maximum benefit is usually 75 per cent of your salary, less any other payments you're entitled to when out of work, such as social welfare entitlements and sick pay. The first benefit payment is made once a set period of either 13, 26 or 52 weeks - known as a "deferred period" - is over.

As with serious illness cover, the need for income protection insurance depends entirely on your personal circumstances. If you are self-employed, for example, your income could stop immediately if you become seriously ill, as you wouldn't be entitled to social welfare disability benefits or sick pay from an employer. In those circumstances, this type of policy could provide an invaluable financial safety net.

If, on the other hand, you work in the public sector you may be entitled to full pay for six months and half-pay for a further six months. You could also be eligible for State benefits, and an ill-health retirement pension, which means that you take early retirement with a pension if you become permanently unable to do your job. In such situations, you would have to weigh up whether it's worth paying for extra protection.

If taking out income protection insurance, consumers should take care to select the appropriate level of income required, and review this every few years. Otherwise they could find that they are under- or over-insured. For example, if an individual is earning €25,000 at the time they become sick, their replacement salary will be based on this amount, even if they have insured themselves for €50,000.

It's also important to understand exactly what is, and isn't, covered under the policy. "Some income protection policies cover you only if you become severely disabled and are not able to carry out any job," warns the financial regulator. "This type of policy provides very little protection. You would need to become severely and permanently disabled before you could claim any benefit."

The Financial Services Ombudsman receives many complaints in relation to income protection products. In his 2007 annual report, the ombudsman elaborated on a particularly shocking complaint brought by a consumer who lost his sight and was unable to work.

When the complainant made a claim on his income protection policy, his unnamed insurer refused to pay out on the basis that he did not meet the blindness test set out in the insurer's policy conditions. This was despite the fact that he was registered as blind with the National Council for the Blind in Ireland. Not surprisingly the ombudsman upheld the complaint and the insurance company was obliged to pay arrears and ongoing benefits.

Apart from all of these pros, cons and pitfalls, consumers must also realise that neither critical illness protection nor income protection insurance will protect them if they are made redundant. So if you haven't done so yet, it's time to start building up a sizeable nest egg to tide you over in case your worst case scenario becomes a reality.