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How does life insurance work?

Understand the different kinds of life insurance and how they work

Rachel Ditchburn
Written by  Rachel Ditchburn
7 min read
Updated: 26 Feb 2024

Getting life insurance is a big decision, so our guide explains everything you need to know about the different types of insurance and how they work

The basics of life insurance

There are several different types of life insurance policies – but they all work in a similar way. When you take out life insurance, you’ll pay a small amount every month to your insurer. These payments are known as premiums. If you die while your insurance is still active, your life insurance will pay out to your family. This payment is called the ‘lump sum,’ and you can choose how big you want the lump sum to be – but a larger lump sum means higher premiums. Some types of life insurance will also pay out while you’re alive, if you develop certain critical illnesses covered by the policy.

Term life insurance

Term life insurance is a policy that's active for a predetermined period or 'term.' If you pass away during this time, your family receives a payout. Let's break down the different types of term insurance:

Level term

With level term life insurance, the payout your family will receive remains unchanged throughout the term. This consistency in premiums and payout makes level term insurance an excellent choice for those looking to lock in rates for long-term financial planning.

Decreasing term

Decreasing term insurance, also known as mortgage life insurance, is designed to cover specific debts that diminish over time, like a mortgage. As the debt decreases, so does the payout, making it a cost-effective option for debt protection.

Increasing term

With increasing term insurance, the amount your family receives goes up every year. It’s usually tied to a measure of inflation, such as the government’s Retail Price Index. However, your premiums will also go up at the same time. This means that even if you buy increasing term insurance with the same monthly premiums as a level term policy, it’ll still be more expensive in the long run.

Term insurance is often a more affordable life insurance policy for younger people, as the risk to the insurer is lower. However, premiums can be influenced by lifestyle choices and health status.

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Whole of life insurance

Whole of life insurance offers a guarantee that your loved ones will receive a payout, as there's no set term. This type of insurance is more expensive due to its certain payout.

Standard cover

Standard whole of life cover comes with fixed premiums, and getting this insurance earlier in life can lead to more affordable rates.

Maximum cover

Maximum cover includes an investment component and may adjust premiums based on health reassessments. While it can offer benefits if investments perform well, there's also a risk of increased premiums due to poor market performance.

Over 50s life insurance

Most over 50s life insurance policies have a waiting period of one year before the full lump sum is payable upon death. If death occurs within the first year, only the premiums paid are returned to the family.

Death in service

Death in service is an employer-provided benefit that pays out a multiple of your salary if you die while employed, regardless of the cause of death.

Critical vs. terminal illness cover

Critical illness cover and terminal illness cover are add-ons to life insurance that pay out during your lifetime under specific circumstances. Critical illness cover assists with costs associated with severe health issues, while terminal illness cover provides a lump sum if you're diagnosed with a life-shortening illness.

Choosing the right life insurance

Selecting the right life insurance depends on your personal needs and the financial support your family requires. Term life insurance is suitable for income support, while decreasing term life insurance is ideal for covering mortgages. It's vital to weigh the cost of insurance against the level of cover needed to ensure your family's security.

Finding the best life insurance deals

Life insurance is about protecting your family's future. Once you've decided on the type of insurance, you can use MoneySuperMarket to compare life insurance quotes and find deals that match your needs. Sort through options by cost or cover level and connect with the provider to secure your policy.

You can read more in our guide on what is life insurance.

Life insurance is a promise of security for your loved ones in the face of life's uncertainties. By understanding the different policies and choosing the right one, you can ensure that your family is financially protected, no matter what the future holds.

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