When you buy life insurance you secure peace of mind. You know your family would be financially protected if you were to die unexpectedly and prematurely or, indeed, whenever your death occurred.
There are different kinds of policy from which to choose, with different durations and potential benefits, so it is crucial to choose the right one for your needs and preferences.
The right one for you will depend on your individual circumstances, such as how long you’d like the protection to last for, how much money you want the policy to pay out in the event of claim, and how much you can afford to pay in premiums. So it’s worth doing plenty of research before picking a policy.
‘Term’ and ‘whole-of-life’ options
There are two main types of life cover: term insurance, and whole-of-life assurance.
There are different kinds of policy from which to choose, with different durations and potential benefits
Term insurance is the most popular kind of cover. It pays out a lump sum or a monthly income if you die within a set period of time. If you don’t die, then the policy simply lapses and you get nothing back.
Whole-of-life assurance, as the name suggests, offers protection for your lifetime until your eventual death, whenever it occurs, and therefore premiums are much higher.
(In case you’re wondering, term insurance is so-called because you are insuring against something that might happen; whole-of-life assurance has that name because you are assured a pay-out at some point.)
Types of term insurance
There are several types of term insurance, so it’s important to understand which is likely to suit you best.
Level term insurance
Level term insurance pays out a fixed lump sum if you die during the policy term. This lump sum doesn’t change over time, so you know exactly what any dependents will be left with in the event that you die.
Increasing term insurance
Many people want to take out life insurance which will factor in the rising cost of living, and therefore opt for increasing term insurance. This type of life insurance policy is designed to combat the erosion of our money’s purchasing power each year due to inflation, so that the sum insured maintains its real value throughout the term.
The sum insured either increases by a fixed amount each year, or rises in line with the Retail Prices Index (RPI) measure of inflation.
However, as the sum insured rises over time, premiums will also increase, so if you are considering this kind of policy, you must be prepared to pay more as time goes by (see also index-linked term insurance).
Decreasing term insurance
If you are looking for life insurance to cover a debt that will gradually reduce over time, such as a repayment mortgage, then decreasing term insurance is worth considering.
With this kind of cover, any pay-out also reduces over time, which means the premiums are lower than for level term insurance.
Convertible term insurance
As its name suggests, convertible term insurance enables policyholders to convert their policy into a whole-of-life policy if they want to. The insurer is obliged to convert the policy regardless of any changes to the policyholder’s health.
However, remember that changing your cover so that it lasts for your lifetime rather than a set term will mean an increase in premiums.
Renewable term insurance
With renewable term insurance, policyholders have the option to renew their life cover when the policy term finishes without the need for a health review.
Joint life insurance
If you are married or have joint financial commitments with a partner or relative, you may want to consider a joint life policy rather than two single policies. However, although this will mean premiums may be cheaper than if you have two separate plans, remember that joint life insurance is normally written on a “first death” basis.
This means that there is only one pay-out when one of the policyholders dies, at which point the policy ends. If the remaining partner wishes to remain insured, they will then have to look for another policy when they may be much older and premiums will be considerably higher.
Opting for two separate policies means that the surviving person will still have cover in place even if the other person dies. This has the advantage that any future dependents will be financially protected, and the surviving policyholder won’t have to look for new cover. It also means that, in the event a relationship breaks down, there won’t have to be any negotiations over what happens to the policies, as each plan is separate from the other.
Index-linked term life insurance
If you want to be certain that any life insurance pay-out will keep pace with the cost of living, you may want to consider index-linked term life insurance. Premiums for this kind of policy rise in line with the Retail Prices Index measure of inflation, to ensure that the sum insured maintains its real value throughout the insurance term (see also “increasing term insurance”).
Family income benefit
A family income benefit policy will pay out a monthly income of an agreed amount each month from the date of the claim to the end of the policy term. As the insurer would, in total, pay out less than with a level term insurance plan, the premiums are lower. But this type of policy would not enable you to clear a capital debt such as a mortgage.
As the name suggests, a whole of life insurance policy provides cover for your entire lifetime. It guarantees a lump sum payment at whatever age the policyholder dies, provided premiums have been paid continuously from the start of the policy.
The proceeds of the policy will usually go to the policyholder’s family or beneficiaries of their estate.
The premium you pay is split to purchase life cover and build up an investment reserve. The idea is that the investment growth in the early years subsidises the higher cost of life insurance as people age – thereby providing insurance for the whole of your life, as long as you pay the premiums.
However, it is important to bear in mind that if the investments perform poorly, the premiums might have to increase so that you still maintain the same level of cover.
This kind of policy is often taken out to cover future inheritance tax bills. Inheritance tax is payable at 40% on the value of your estate over £325,000 (for the tax year 2014/15), which includes your property and all other assets. Premiums are high because a claim is inevitable.
Most whole-of-life policies guarantee that your premiums won’t change for the first 10 years. However, if you have opted for a “reviewable policy”, your cover can be renewed after the 10-year period finishes, and premiums could rise substantially to ensure the policy will be able to pay out the expected lump sum.
When working out whether the premiums need to rise, the provider will look at the way in which the underlying investments have performed up to that date, as well as taking into consideration the customer’s circumstances, such as their health and life expectancy.
If a policyholder is unable or unwilling to increase the amount they pay for cover, they can either cash in the policy, or accept the policy will provide a smaller sum than they had anticipated at the outset. Remember that if you are considering a whole-of-life policy, there is a risk that you will pay more into the policy than you will end up getting out of it.
Only “non-reviewable” policies have fixed premiums which will not change over time, but these premiums are likely to be more expensive, at least initially, than the premiums you will pay for reviewable cover.
Whole of life insurance comes in various forms:
Non-profit whole-of-life policies
Non-profit whole-of-life policies are similar to term insurance policies, in that there is no investment element, and premiums are fixed. Policyholders receive a cash lump sum on death, which is also fixed.
With-profit whole-of-life policies
A with-profit whole-of-life policy includes an investment element, so that the pay-out on death is the sum assured, plus any investment profits allocated to the policy.
With-profits plans aim to smooth out the peaks and troughs of stock market volatility by retaining investment returns built up in good years so that payments can be topped up in bad years. Bonuses are intended to be added yearly to the basic sum assured - with a possible final bonus being paid at the end of the term.
However, in many cases they have performed poorly, and as a result this kind of policy is much less popular than it used to be.
Low cost whole-of-life policies
This is essentially a with-profits plan, which on death will pay out either the guaranteed death benefit, or the value of the policy, whichever is highest.
Unit-linked whole-of-life policies
This kind of life insurance incorporates an investment element where the monthly premiums go towards purchasing units in a selected fund. The policy grows in value as the number of units held increases.
However, if investment growth is poor, premiums will increase.
Over 50s plans typically promise a relatively small pay-out, and are generally designed to cover funeral costs. Premiums are usually guaranteed for life, and pay-outs are usually small (between £500 and £2,000).
However, those buying these policies can find they end up paying far more than the policy will ever pay out when they die, especially if they live a relatively long time.
An endowment policy is effectively an investment scheme with life insurance attached. This type of plan used to be popular with interest-only mortgage holders who used them to build up savings with which they could repay their mortgage capital.
However, many of these schemes have under-performed, so they are much less popular than they used to be.
Policies can be either with-profits, where bonuses are added to the policy, and once added are guaranteed, or unit-linked, where premiums are invested in investment funds whose value can move up and down, with no guarantees attached.
Choose the right policy for you
When buying life cover, always compare a wide range of different quotes to ensure you find the best possible deal to suit your needs.
Remember, however, that you shouldn’t base your decision to buy cover on price alone. It’s also important to check the level of cover and to understand whether or not your premiums could rise in future.