Written by Tom Salmon, Senior Claims Assessor at Pacific Life Re
When assessing an Income Protection claim, the first task is to establish the insured’s earnings during the 12-month period immediately prior to the Date of First Absence (DFA). For example, if your last working day was 1st January 2025, the claims assessor will calculate earnings for the period of 1st January to 31st December 2024. This will be considered the Pre-Disability Income (PDI).
For Employed Individuals, verifying earnings is relatively straightforward. Essential documents needed include:
- P60s and Payslips: Typically, the 2024 P60 and the December 2024 payslip will suffice for the example given.
- Employer Questionnaires: Additional information, such as sick pay arrangements, might be gathered via questionnaires. These documents and processes help confirm the salary and any benefits an employee receives, ensuring a clear and accurate PDI calculation.
For Self-Employed Individuals and Company Directors, the process can be more complex. In these cases:
- Financial Evidence: The most recent accounts or tax return prior to the DFA – in this example the 2024 accounts and tax return will be used. These figures form the basis of the PDI. However, when the 2025 accounts and tax return are available, this figure may be recalculated to better reflect the earnings in the 12 months immediately before the DFA. For company directors taking dividends, dividend vouchers may also be requested.
- Managing Expectations: It is important to communicate that once the up to date financial evidence is received, there may be adjustments resulting in an underpayment or overpayment of benefit which will need to be addressed.
Financial evidence in the event of a claim
The following table shows what financial evidence is generally required in the event of a claim:
| Employment status | Financial evidence usually needed for a claim |
| Employed | Most recent P60 and payslips prior to date first absent |
| Self-employed | Latest tax return and trading accounts prior to date first absent. Dependent on when the trading year ends, the following year’s accounts and tax return may also be needed to accurately calculate income in the 12 months prior to date first absent. |
| Company Directors | Latest tax return and trading accounts prior to date first absent. Dependent on when the trading year ends, the following year’s accounts and tax return may also be needed to accurately calculate income in the 12 months prior to date first absent. Dividend vouchers may also be required. |
Handling Dividends for Company Directors
Dividends can be misunderstood when it comes to calculating IP entitlement for a company director. The insured might pay themselves a dividend of £50,000 during a tax year. However, it needs to be established that that £50,000 payment is justified against the performance of the company in that twelve month period. If the net profit for tax purposes was only £20,000 then the £50,000 dividend wouldn’t be used to calculate benefit. It indicates that that dividend (or at least £30,000 of it) is being paid to the insured from retained profit. We need to remember that we only consider earnings for the twelve month period prior to the DFA. Different insurers have different philosophies when this happens but generally most would limit the dividend income within the PDI to the £20,000.
Alternative Earnings Periods
In certain circumstances – such as when the insured suffers from a degenerative or prolonged illness that reduces their earnings capability over time – it may be considered reasonable to calculate an average of earnings over the previous three years or even consider an alternative PDI period altogether. This flexibility ensures that the benefit payable truly reflects the insured’s financial loss.
Calculating the Limitation of Benefit
After determining the PDI, the next step is to apply the insurer’s replacement ratio percentage. This is known as the Limitation of Benefit calculation:
Example Calculation:
- PDI = £50,000
- Replacement ratio (e.g., 65%) = £50,000 × 65% = £32,500
From this maximum benefit figure, any applicable deductions are subtracted:
- Sick-pay (for employed)
- Continuing net profit (for self-employed)
- Directors’ remuneration or dividends (for company directors)
- Other Income Protection payments
- Pensions paid due to ill health early retirement
If there are no such deductions, the insured receives the lower of either:
- The calculated Maximum Benefit (in this example, £32,500), or
- The Sum Assured stated in the policy.
As always, check the terms and conditions of each insurer as what they include as earnings and deduct as continuing income may differ slightly.
To bring this story to life, Vicky Churcher, Executive Director at the IPTF, invited Tom Salmon, Senior Claims Assessor at Pacific Life Re, to share his perspective. Watch the full video below:
