Life Insurance Explained

We all think it will never happen to us but sadly statistics show that one child in every 20 loses a parent before they finish their full time education. Term life insurance also known as life assurance is remarkably cheap and costs as little as £5* a month. This ensures that a lump sum is paid to your dependents on your death.

Overall, we do not contemplate our own death.

Market research highlights that a third of adults do not have any life insurance. So, we overlook arranging life insurance.

Have you ever contemplated what will become of your family should you die? If you are the main earner, your family may have great difficulty in paying bills and retaining its standard of living should you die. Therefore, it is vital for you to understand the different kinds of available cover.

Here we explain the types of cover and the correct policy for you and your family, at a price that is right for you.

Many of us may think that life insurance pays out when we die. However, it is not that straightforward. There are huge differences between the kinds of cover and the size of the premiums.

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What does term assurance mean?

Term assurance is the simplest kind of life insurance, normally also the cheapest. Essentially, should you die within the policy term it pays out a lump sum agreed when you take out the cover.

How can I decide what length my life insurance policy should be?

You need to carefully contemplate the financial needs of your loved ones prior to agreeing on a term. The majority of individuals wish their policy to be active whilst they have dependents. Hence, say you have children aged 8 and 6, you may wish for the policy to run until the youngest child has left University, so around 16 years. Those who have no children can select their mortgage term, or the length of time up to the spouse reaching retirement.

What level of cover will I need?

The majority of policies specify minimum and maximum payout limits. However, there is a lot of flexibility therein. It is always sensible to agree a payout adequate enough to clear debts and provide for your family.

This of course is dependent on your individual circumstances. Should you have three youngsters at private school, a huge mortgage and a second home, you are going to need a larger payout than another person who has just one child at University and no mortgage debt. Most advisors recommend a payout that is ten times your income. Of note is that the larger the payout, the higher the premium.

Also remember death in service benefit from your employer. Numerous companies pay a lump sum equivalent to four times your annual salary should you die whilst employed.

You should frequently review your policy as your circumstances may change. You may say have more children, get on a larger mortgage, or get divorced, all of which impacts on possible payout and relevant premiums.

What is the cost of life insurance cost?

Insurers consider the length of the term and the size of the payout when setting premiums. Moreover, they consider various factors, such as, age, gender, state of health and the job you do.

Men normally pay out 30 per cent more than women as the longevity of men is less than that of women. As of December 2012, insurers will no longer be able to set premiums according to gender, due to new European Court of Justice Rules. This could mean 20 per cent higher premiums for women. Whereas, men could experience a decrease of 5 per cent in their premiums.

Anyone who is poorly can anticipate to be impacted by a higher premium, such as, older people and those in risky occupations. Therefore, a 24 year old teacher in great health is going to get cheaper cover than a 50 year old miner who smokes 20 day.

Smoking has a huge impact on life insurance policy costs. It pays to give up smoking; you are only recognised as a non smoker when you have gone an entire year without smoking. Should you have quit smoking, you need to inform your insurance company, or change to another policy as you could save money on premiums.

Do not lie with regard to your health or any medical condition. If you have lied about any relevant details when making an application for life insurance, you may find that the policy does not pay out.

Check whether or not life insurance premiums are reviewable or guaranteed. Reviewable premiums are guaranteed only for the first five or ten years, when the insurance company reassesses the cost. Life insurance gets more costly as you get older, therefore, you may find that reviewable premiums are highly expensive later on in life.

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How do I select the correct kind of life insurance cover?

There are many kinds of term assurance. With a level term life insurance policy, the payout stays the same throughout the term. Therefore, should you take out cover for £200,000 on day one, the policy pays out £200,000 in the event of your death or at any time within the term.

The payout on decreasing term assurance becomes smaller until it finally reaches zero at the end of the policy term. You usually get decreasing term assurance to cover a dwindling debt, like a capital repayment mortgage. Alternatively, you can purchase mortgage term assurance, which works similarly and is set up to coincide with your mortgage term.

You can get cover with a payout that increases with time, as protection against inflation. Should you purchase level term assurance, inflation eats into the policy's buying power. Hence, certain individuals choose increasing term assurance in order that the payout increases each year, normally by a set amount like 5%. Increasing term assurance is normally more expensive than a level policy. It is vital to check the details as any increases can cease at the age of 65.

Renewable term assurance is usually taken out for a short period of time, with the option to renew at the end of the term without a health check. Should you purchase a renewable policy, you can be certain that you are not going to be refused cover on health grounds. Premiums can still increase as you get older on this policy.

Alternatively, you can select convertible term assurance, which permits you to convert your term policy into a whole life insurance policy; hence, the insurer pays out upon your death, whenever that is. The insurer does not undertake a health questionnaire at conversion; however, premiums can still go up. Convertible policies are more costly than standard level term assurance.

Should you prefer your policy to pay out a regular income on your death, as opposed to a lump sum, you can opt for family income benefit. Say if you opted for a 20 year policy and died after 16 years, the policy does not pay out a lump sum on your death. However, it pays a monthly income to your family for the remaining four years of the term.

Do my spouse and I need to take out separate life insurance policies?

You may take out individual term assurance policies or you may take out a policy in joint names, which pays out on the first death. However, bear in mind that the payout is the same, whoever passes away first.

It is worthwhile to check quotes for single life term assurance as it is not always more expensive to take out two single policies as opposed to one joint contract. Moreover, you may wish to arrange varied payouts to reflect your differing earnings.

Are there any other types of life insurance?

The majority of insurance companies provide whole life insurance cover in order that a pay out is guaranteed when you die. So, there is no set term. The premiums for whole life insurance policies are usually higher than those for term assurance as the policy will have to pay out.

Whole of life insurance policies are different to and more complex than term assurance. Your premiums are usually invested in a fund and the investment fund performance affects the future value of the pay out.

The insurer can often review the policy to work out whether or not it is on track to pay out for future claims, accounting for factors like age and mortality rates. The insurer can then request the policyholder to increase the premiums, or to accept a lower pay out on death and retain the same level of premiums.

There are three main kinds of whole life insurance policy:

• Maximum cover;
• Balanced cover; and
• Guaranteed.

Should you opt for maximum cover, the majority of the premium pays for the life insurance protection and a minimal amount is invested, so the initial premiums are low. The policy is reviewed frequently, so the cost increases or the level of cover drops as you get older.

Balanced cover, known as standard cover, involves more of the premium being invested in the fund, which is then used for subsidising the cost of cover as you get older. If the fund performs as per forecast, there ought to be no need to increase the premiums.

Should you no longer need the cover, you are able to cash in the policy. The so-called surrender value may be minimal in the early years and could well amount to less than the sum of your contributions.

A guaranteed whole life insurance policy has a fixed premium for life. At no time is there an investment element or any cash-in value. The benefit of guaranteed cover is that your premiums do not increase and you are not depending on any investment performance. However, it is usually more expensive than the other two choices.

Certain insurance policies offer endowment whole of life insurance policies, which combine life insurance with saving for the future within an endowment policy. There are two types: with profits and unit-linked. However, both can prove expensive and there is guarantee as to the amount of future pay outs.

Life insurance policy types

Life insurance is crucial in order that your loved ones are provided for after your die. There are numerous policy options, with “no size fitting all.” The right life insurance policy for you depends on your own specific circumstances. You need to understand the various policies before you select the best policy for you.

There are two kinds of cover: term life insurance or term assurance and whole of life insurance. Term assurance pays out a lump sum should you die in the selected period, being the least costly and most popular choice, Whereas, whole of life offers the most extensive protection levels given that it covers you for the entirety of your life. Hence, it is more costly.

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Whole of life insurance

A whole of life insurance policy is aimed at providing a level of life assurance which can last your entire lifetime. This kind of cover guarantees a lump sum payment when the policyholder dies given the payments are made continuously from the beginning of the policy.

The lump sum can be paid out at any time, not within a fixed period, as is the case with term assurance. The policy proceeds are usually given to the policy holder’s family or beneficiaries of their estate.

The premium you have pay is divided to buy life cover and amass an investment reserve. The concept behind this is that the investment growth in the early years subsidises the higher cost of life insurance as people get older, thus providing insurance for the entirety of your life, given than you pay the premiums. This ought to mean that there is a “surrender value” should the policy is cancelled.

Usually these policies insure for large sums, normally to cover future inheritance tax bills. This, along with the fact that a claim is inevitable, means these policies can have higher premiums than term life insurance.

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Policies that are reviewable

Premiums sold on what is called “maximum cover” and are guaranteed not to go up for the first 10 years. Policies can be “reviewable” or “non-reviewable.”

With non-reviewable policies the premiums paid can be fixed from the start date and remain the same until the end of the policy. A reviewable policy involves premiums being reviewed on a ten year basis and may increase, often significantly to make sure that the policy remains on track and is going to pay out the expected lump sum.

Is a life insurance policy pay out taxable?

Should a life insurance policy pay out, the money goes to your estate. Hence, its liable to inheritance tax (IHT), paid at 40% on estates worth more than £325,000. However, should you write the life policy 'in trust', it is going to fall outside your estate and your family does not have to be concerned about an IHT tax bill on the pay out. Moreover, they will obtain the money more quickly as it does not have to go through the legal process of probate.

There should be no costs for writing the policy in trust and your insurer is going to have the relevant paperwork.

Can I purchase any add-ons?

You can normally add critical illness cover to a life policy. Critical illness insurance forks out a lump sum on the diagnosis of a condition, say cancer or a heart attack, from a set list. Certain insurers put on critical illness cover for free. However, read the small print with care as the policies come with multiple exclusions.

Certain insurers offer to waiver premium, so that your premiums will get paid if you can no longer work due to illness or injury. There is normally a fee for waiver of premium and, once more, it is crucial to read the small print. It may take several weeks, for example, for the benefit to kick in. There could also be a strict definition of incapacity.

What is pension term assurance?

Pension term assurance is like term assurance. However, the policyholder qualifies for tax relief on the premiums, as per pension contributions. You are no longer able to purchase pension term assurance as the government has abolished this kind of cover. Nonetheless, policies in force prior to July 31 2007 are still able to take advantage of the tax benefits. Should you have pension term assurance you need to carefully think prior to making any changes as you may lose any benefits of tax relief.