Unemployment cover could help soften the blow of losing your job by giving you much-needed income while you search for another.

Thousands of people have lost their jobs since the downturn turned into a recession. The number of unemployed hit an 11-year high of 1.92 million as 2009 began and is expected to increase further in the coming year – prompting many of us to look for ways to protect against the consequences of suddenly finding ourselves out of work.

So, could taking out unemployment cover provide a financial cushion to fall back on? These specialist policies, which usually pay out for up to 12 months after you have been made (involuntarily) redundant, have surged in popularity recently.

Although few statistics exist to help gauge either the number of policies sold or claims made, industry observers insist there has been a dramatic increase in this area of insurance, and they expect the trend to continue over the coming months.

Matt Morris, spokesperson for broker LifeSearch, says: “Unemployment cover has become a highly sought-after form of protection over the past six to eight months.”

According to research from the Post Office, most of us would need nearly £300 a week to support ourselves if we lost our job. Yet 40% of us have less than one month’s salary set aside and more than 70% have no unemployment cover. In addition, 75% of us are unaware of what we would be.

What are the options?

There are various ways to buy cover and each type of policy comes with its own list of conditions. Similar policies from rival providers often differ in their list of exclusions: the period before a claim can be made could differ, or the length of time they will continue to make payments.

You can choose from three different types of cover: standalone unemployment cover; as part of a payment protection insurance package (usually sold alongside loans and mortgages); or as an add-on to an income protection plan.

1. Standalone unemployment cover

If cost is a concern or you neither need nor want sickness cover, then standalone unemployment cover could be the best option. Andy Gadd, head of research at Lighthouse Group, says: “The premiums are likely to be lower if you’re buying unemployment protection on its own rather than as part of a protection package.”

The price will be about £17 a month for cover worth £500 a month. This will usually be paid out for up to 12 months, with the first payment arriving 30, 60 or 180 days after you make a claim – the longer the waiting period, the cheaper your monthly premium will be.

However, Emma Walker, head of protection at comparison website moneysupermarket.com, warns that only a dwindling number of insurance companies, such as British Insurance and the Post Office, still offer such policies. “If you only want unemployment cover, you need to buy it now as it might not be around for much longer,” she says.

2. Payment protection insurance

In most cases, unemployment cover is part of a package known as PPI, which also guards against the effects of accident and sickness on your income. Such policies will cover your mortgage repayments and loans. As with standalone cover, most people are eligible to apply – age, gender and health are not important factors.

Premiums vary between companies, but expect to pay between £10 and £50 a month for cover worth £500 a month. Policies usually kick in one month after your income ceases and payments will continue for a set period, usually one year, sometimes two.

The idea of the policy is to provide short-term assistance, but you need to be aware of the limitations and exclusions. In many cases, you will need to have been continuously employed on a permanent contract by the same company for at least a year to qualify under the unemployment element of the policy.

You should also be aware that a policy won’t pay out in the first three months after you sign up. So, unless you’ve been with your current employer for at least nine months, there’s no point applying for this type of cover.

Mortgage payment protection and short-term income protection work in the same way. As with PPI, these often come with health warnings and for good reason: they are notoriously full of exclusions. 

A staggering 10,652 new complaints about PPI were lodged with the Financial Ombudsman Service in the year ending 31 March 2008 – up from 1,832 the previous year. A significant number of these concerned the way these policies operate. Sharon Brately, chartered financial planner at fairinvestment.co.uk, says: “Bad practice has been rife in the PPI market for years.”

3. Income protection

Another way you can purchase unemployment cover is as a bolt-on addition when you buy an income protection policy.

Income protection insurance is designed to replace your income if you’re unable to work for more than a specified period because of illness, accident or, in some cases, unemployment. As with standalone cover, there’s usually a deferment period before the payment kicks in – again, the longer you agree to wait, the lower your premiums.

A 30-year-old who wants £800-a-month cover could expect to pay anything from £6 a month for the most basic cover to £21 for the bolt-on unemployment cover. Once payments start, they continue for up to 12 months. On top of that, income protection will also pay out for conditions not covered under critical illness plans, such as back pain and stress.

On the negative side, however, the application for an income protection policy is usually more complex than it is for standalone unemployment insurance or PPI because of the increased level of cover on offer.

What’s best for you?

The sort of policy that is most suitable for you depends on your personal circumstances – for example, whether you have any policies or how much protection is offered by your employer.

“You may work for a company that offers a great redundancy package, but it’s still worth considering the worst-case scenario,” advises Walker. “Look at how much you need and how long you could last before receiving the first of your payments, as policies are generally cheaper the longer you agree to wait before claiming.”

If, for example, you have critical illness or income protection cover, it’s worth seeing if you can add unemployment cover for a nominal charge. Failing that, your insurer may be able to offer you a more inclusive policy.

Next, you need to decide how much cover you require. To give yourself an idea, work out how much you would need to sustain your standard of living each month and then simply multiply that number by 12 to estimate your annual requirement. However, you won’t be able to insure your total income as an upper limit of 50% of your gross income – or £2,000 a month – usually applies. The benefits will be paid out tax-free.

When buying a policy, it’s advisable to shop around. If you’re buying the cover alongside income protection, it also pays to buy it sooner rather than later because the premiums will increase as you age.

Also, once you’ve bought a policy you can’t just forget about it. You need to revisit your original decision at least once a year to ensure the cover is still sufficient for your needs, particularly if your circumstances have changed. Many policies have reviewable rates, which mean the cost of the premium is not guaranteed to remain the same.

Once you’ve chosen a policy, there are other things you need to consider. When you’re discussing a policy with a provider be honest. Don’t hide the fact that your company has talked about cutbacks, for example. It could make you ineligible for a payout.

Also, ask to see a detailed guide to the cover offered and key features document, setting out the policy’s benefits and exclusions. You should study the exclusion and limitation clauses in detail to ensure you’ll actually be eligible to claim.

Peter Chadborn, principal at IFA CBK Colchester, warns that some policies can be misleading and expensive as well as failing to pay out when expected. “There will be lots of caveats so you really need to read the small print carefully before buying the cover or you might find the policy worthless when it comes to claiming.”

Regardless of whether or not you decide to take out unemployment cover, there are some simple measures you can take to safeguard against financial difficulties if you lose your job. “

You should put aside the equivalent of three months’ salary to protect your family should you face redundancy,” recommends Geoff Penrice, a financial adviser at Bates Investment Services. “This will help buy you some time in which to find an alternative source of income.”

A cash ISA or a straightforward savings account would be an ideal place. Just make sure you can get your hands on it quickly and easily if and when you need it.