You've struck out and set up your own business

You've struck out and set up your own business - but can you afford to insure yourself in case things go wrong? Part two in a series on insurance for different stages of life

When you are moving from a staff job to self-employment, you need to think about how to cope with sickness or an accident that leaves you unable to work. Yet this is also the time when you are most likely to be short of cash. You will lose the sick pay, maternity leave and death in service benefits that came with employment, plus you will not have access to a workplace pension scheme. You will need to think about a stakeholder pension to replace it.

MikeRothman, a senior financial consultant with Best Advice, based in Sutton, Surrey, takes a holistic approach. 'There are four considerations: what can you afford; what existing arrangements do you have; do you have any dependents or liabilities and what is your attitude to risk?

'The cover you need depends on the size of your mortgage and whether you have taken out any loans to build up the business. For example, you might have a new car loan to replace the company car that your employer provided.

'If you have a family or dependents it is important to make arrangements to ensure debts could be paid if something happened to you as the main breadwinner."

He recommends life cover as a top priority for anyone with a family. If you can afford it, he also suggests income replacement (also know as permanent health insurance, or PHI) which would pay out if you were unable to work because of illness or injury. 'You would need some cash in an emergency fund because PHI policies tend to have a three- to six-month exclusion period before the payments start. Once you have taken out PHI, however, the insurer has to honour the contract if you wish to continue it until you stop work.'

Income protection is expensive - it costs around £500 a year to cover income of £10,000 a year until you are 65. It is cheaper if you defer payment for more than three months, as the table above right shows. But don't be tempted to cut corners by opting for 'any occupation'. This means the policy would not pay out unless you were unfit for any job. You want cover for when you are unable to do your own job, known as 'own occupation'.

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The cost of 'own occupation' cover is more expensive the older you are, and women pay more because they are more likely to make a claim.

Roderic Rennison, financial planning director of financial adviser Charcol, which is part of Bradford & Bingley, also advises making income protection a priority. 'You are not likely to need life cover in your twenties and thirties but you may well need help if you are unable to work. Income protection should be factored in as part of your business plan.'

Graeme Warner, a director of health intermediary Manson Warner Healthcare, believes PHI is too expensive for most people. 'It only kicks in when you have already had a considerable time off work. Likewise, critical illness cover, which pays a lump sum if you had a heart attack or stroke or if you developed cancer, is very costly.'

Critical illness cover can easily cost £50 a month. Warner says private medical insurance would be a better option because it would help you get back to work as quickly as possible. You can opt for any level of cover, from full in- and outpatient down to restricted plans that have a limited choice of hospitals. The table above left shows the premiums for a single person in their thirties. Then there is the question of whether you are at risk of being sued in your new business. Peter Smith of the London-based independent financial adviser Inter-Alliance suggests professional insurance can be more important than healthcare and life insurance.

'In some professions you need indemnity cover before you start working. If you are a scaffolder, builder or IT contractor you need to ensure that you can't be sued by the people you are going to work for, or that if you injure someone you have the right cover in place.'

After professional indemnity, he favours sickness and accident cover, which is relatively cheap and straightforward, or income replacement if you can afford it.

'Sickness and accident cover pays out if you can't work, but it's only a short-term fix,' he says. 'Income replacement will pay out until retirement age at 65, if necessary. But obviously the latter is a much more expensive option.' A man aged 35 earning £35,000 would have to pay between £16 and £37 a month for a PHI policy to protect his income until 65. Alternatively, £20,000 worth of accidental death cover would cost around £24 a year with Norwich Union.

Self-employed people also have to fund their own pension. The new stakeholder pension guarantees that charges and terms will be good value - although it does not guarantee performance.

Roderic Rennison of Charcol says you should start your pension only after sorting out life insurance and income protection. Even then, it may not be the best option if you are looking to buy a house. 'Sort out the deposit for your home before arranging a pension. It is better to set a budget and decide how much you can afford to save than to try to fund everything all at once.'

So your priorities will depend on how many other people depend on your income and what kind of debts you would need to pay off if you were unable to work. Above is a checklist to help you with priorities.

Are you sitting comfortably?

1. Have you got an emergency fund? Six months' earnings tucked away in a deposit account will tide you over if you need cash quickly or if you are sick.

2. Do you have dependants? If so, consider life cover, which would provide a lump sum to pay off debts and the mortgage if you died. If you are single you can do without it.

3. How would you cope if you were unable to work? Sickness and accident policies will provide short-term help; more expensive income-replacement policies will cover you for the rest of your working life.

4. Is there a risk of you being sued? Check whether you need indemnity cover - your trade union may provide a dedicated policy.

5. Could you cope with being on an NHS waiting list or do you want private cover? The issue is both one of cost and of principle - some people object to the concept of private medical insurance while others find the premiums too high.