How does it work?

The purpose of life insurance – also referred to as ‘life assurance’ – is to pay out a lump sum, a series of smaller sums, or even a monthly income, to an assigned beneficiary if you die. This is usually within a given timeframe, for example 25 years.

Life assurance is especially appropriate for people with dependants, as it means they will be provided for if you are no longer around to earn money to pay the mortgage and put food on the table. The amount your policy pays out – known as the ‘sum assured’ – is down to the individual and their circumstances. For example, the size of your outstanding mortgage and the age of your children are both important factors. It is this sum assured, the type of policy you take and other personal criteria, on which the cost of your life insurance premium is calculated.

On what is my premium calculated?

Depressingly, your premium will be calculated on the likelihood of your dying within the policy term. The more likely this event, the greater chance – or the sooner, depending on your type of policy – the insurer will have to pay out, and therefore the higher your premium will be. The following are the main factors that will determine your premium:

• Your age: The older you are, the nearer you are to death in the eyes of the insurer.
  Your gender: Statistically, life expectancy of women is greater than that of men so, like-for-like, premiums for females are lower.
• Your health: The real dangers of smoking can become most evident in insurance premiums – smokers will pay considerably more.
• The type of policy you opt for: Policies differ in price according to the level of cover they offer.

What types of deals are out there?

Life insurance can predominantly be divided in to two kinds – policies that offer protection only, and those that are also linked to investments, such as an endowment or ‘whole of life’ policies.

Term insurance

Life insurance that offers protection-only is known as ‘term insurance’. This is the most straightforward variety, although there are several different kinds available. Term insurance is a basically a temporary policy that will pay out if you die within a given timeframe. The period of this timeframe is up to you, but it needs to coincide with your outstanding liabilities such as your mortgage, childcare costs and school fees – that’s why 25 years is typical. If you survive to the end of this chosen time period, the policy will never pay out. Because of this, term insurance is the cheapest type of policy.

Different kinds of term policy

Once you have decided that term insurance is right for you, you will need to decide what kind to opt for. There are several ways that this type of policy can be taken – and they relate to the actual amount of money that will be paid out if you die.

Decreasing term life insurance

Decreasing term life insurance is when the sum assured – what is paid out when you die – is relative to the amount outstanding on your mortgage. So, as your debt to the mortgage lender decreases, so does the amount paid out by the insurer on your death. In this case, at the end of your mortgage term – say 25 years - the benefit would be zero and the policy valueless.

Although the benefit gradually reduces, the premium you pay for decreasing term life insurance stays the same over the chosen term. That is why it is the cheapest version of term insurance. Decreasing term cover suits people whose primary concern is just paying off the mortgage when they die. The type of policy sits best with a standard repayment mortgage that – providing you don’t remortgage – can be mapped out exactly in terms of what is owed over the years.

If you do not die within the chosen term, the policy will not pay out. Nor will it pay out if you fail to keep on paying the premiums, or if the details on your application are not accurate.

Level term insurance

This is when the sum assured is fixed for the term. For example, if the sum assured was £200,000 – regardless of your changing financial situation over the course of the term – £200,000 will always be the sum paid out if you die. Level term cover suits people with interest-only mortgages that do not reduce over the years, or flexible mortgages that may have fallen behind the payment schedule at any given time.

The premiums for level term cover are considerably higher than for decreasing term. If you do not die within the chosen term, the policy will not pay out. Nor will it pay out if you fail to keep paying the premiums, or if the details on your application are not accurate.

Increasing term insurance

This is the opposite to decreasing term insurance, as the benefit actually increases with each year of the insurance term – typically by five or 10 per cent. However, you are not permitted to increase the sum assured once you have hit 65 and beyond. Although increasing term is more expensive than term insurance it does mitigate the effect of inflation. If you do not die within the chosen term, the policy will not pay out. Nor will it pay out if you fail to keep paying the premiums, or if the details on your application are not accurate.

Convertible term insurance

When your life policy is nearing its end you can choose to make it permanent under what is known as ‘convertible term’ insurance. You can do this by converting the policy to an endowment, increasing term or whole of life product. The benefit is that – regardless of whether your health has deteriorated, and despite the fact that you are older – the insurer cannot refuse to extend the cover. However, you will not be able to increase the sum assured and the premiums you pay can rise – but only as a result of age and sex, not of health. You must also be sure to convert the policy before the original policy expires. In return for these options and flexibility, convertible term insurance is priced considerably higher than level term. The insurance will not pay out if you fail to keep paying the premiums, or if the details on your application are not accurate.

Family income benefit

This type of policy is aimed at families that are looking to sustain a regular income after the death of one or other bread-winner. The income will be tax-free and paid until the end of the relevant term. Policies are usually written on a joint basis, so that as soon as one partner dies the income kicks in immediately. On taking the policy, you can choose to keep your income regular or, for a higher cost, arrange to have the income increase, giving the effect of typical ‘would-be pay rises’ over the course of the term.

Investment-linked life insurance

This category of life insurance refers to endowments or ‘whole of life’ policies. Many pension plans also count as investment-linked life insurance.

Whole of life

As its name promises, this type of policy will pay out whenever you die. Given the fact that this event is inevitable, the cost of a whole of life policy is relatively high. This is also because, when you reach a certain age – typically between 70 and 80 – you no longer have to pay the premiums, although the benefit is still paid in the event of your death.

Premiums for a whole of life policy are invested, often into unit trusts. Some of these are regularly encashed to pay for the guaranteed part of your life cover, whilst others are invested in the long term to build up a sum that is paid out on your death. However, depending on the type of policy, you can sometimes choose to cash this in during your lifetime. 

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