Income protection insurance - also known as permanent health insurance - is designed to replace part of your lost earnings if you are unable to work because of illness or disability.

Depending on how much cover you chose to buy, income protection insurance provides a tax-free monthly payment of between 50 and 60% of your usual earnings. The monthly payment continues until you go back to work or you reach retirement age, although budget policies usually limit the payout to five years.

Income protection insurance is generally considered to be a must-have for the self-employed who would not have enough to live on if unable to work because of ill health or accident. If you are an employee, whether you need this sort of insurance depends on what your employer would provide in the way of sick pay and/or retirement benefits if you were too ill to carry on working.

What is covered

Income protection insurance pays out when you become ill or suffer an accident and, as a result, you are left unable to work.

But how "unable to work" is defined varies from policy to policy and can be any of the following:

· An inability to do your own job

· An inability to do your own or a similar job for which you are qualified

· An inability to do any kind of paid work

A policy which pays out simply if you cannot do your own job is clearly better than one which pays out only if you are unable to do any sort of paid work and as a result, this is the most expensive type of cover.

For a limited period, some policies also make a "partial" or "rehabilitation" payment if you are able to return to your old job but in a reduced capacity - part-time, for example.

Some policies also make a 'proportionate' payment which tops up earnings if you go back to work full-time but take a lower-paid job.

What is not covered

No policy will pay out while you continue to receive your full salary. Most policies will not pay out until you have been off work without pay for a "deferred period" of at least four weeks. You can choose a longer deferred period – of up to 52 weeks - which reduces the cost of insurance. If your employer offers sick pay for a set period, it may be wise to choose a deferred period of the same length.

To make sure that you don't profit from the insurance, all policies put a limit on the amount you can claim. Typically, the amount paid by the policy plus money from any other insurance that pays out when you are ill plus any sick pay or state benefits must not come to more than three quarters of your before-tax earnings over the past 12 months.

Policies do not cover you if you are unable to work as a result of:

· Health problems you had before taking the policy out – called "pre-existing medical conditions"

· Taking part in dangerous sports or other activities which you failed to disclose when applying for the policy

· Self-inflicted injury

· Alcohol or drug abuse

· Pregnancy or childbirth

Buying income protection insurance

What you pay for income protection insurance depends on your age, sex, state of health and the kind of work you do. Women tend to face higher premiums as do people in jobs where there is high risk of physical injury.

When you buy income-protection insurance, you will need to decide:

· How much you want the policy to pay out;

· How long you want cover to last

· How long you are prepared to wait before payment is made

· Whether you want to build in increases to the cover - to keep up with inflation, for example

Because policies vary - and insurers differ in their attitude to the risks posed by different jobs - it is worth buying through an independent adviser or a broker who specialises in protection insurance.

An adviser will be able to trawl through all policies on the market and should be able to find the one offering the best cover for your particular circumstances.

Making a claim

Your policy document will tell you when you should tell your insurer that you are ill and are likely to claim. If you are still ill once the deferred period has ended, you should start to receive payment once you have completed your claim form and the insurer has checked things out with your doctor (if necessary).

While you are receiving payments under the policy, you will usually have to provide monthly medical certificates from your doctor as ongoing proof of your ill health.