Life insurance policies come in various shapes and sizes. It's important to understand the different kinds available, so that you can make an informed decision about which will suit your circumstances best.
Life insurance policy types
- Whole of Life: A Whole of Life policy will pay out on death whenever this occurs. Typically this can mean the policy is expensive (potentially several times what you would pay for fixed term) simply because the insurers know that they will have to pay out at some point. Often Whole of Life is sold to include a degree of investment-the philosophy being that the savings/investment portion would provide a subsidy in later life - however it also can hide the true insurance cost of this pricey option. However, there are some non-profit whole life policies on the market, as well as what is known as 'low cost' whole life policies; these have a guaranteed level of cover so that the amount payable on death is greater than the basic sum plus bonuses. A good reason to take out a Whole of Life insurance policy is for estate planning (to meet and cover any inheritance tax obligations). However, if all you want to do is cover your family against an unexpected, untimely death then this would not be the best solution for you-instead look at fixed term.
- Fixed Term: A fixed term policy is often the simplest, most basic and cheapest form of life cover. You decide how long you want the term to be - say 5, 10 or 15 years - and if you were to die during the course of the term then the policy would pay out. If you are still alive at the end, however, there is no payout.
- Endowment: If you are looking to include a form of savings with your life insurance policy then an Endowment policy may be the answer. However, you should be cautious of putting all of your eggs in one basket by mixing your insurance and your investments together. This is a topic of much debate and, whilst it is still practised in the UK, it is a definite no-no in the US. Typically the endowment is taken out with a decreasing term (see below) but the endowment investment is designed to make up the difference (and if you've got it right - surpass it). Unfortunately, you are left in the hands of the investment markets for the outcome of this, though.
- Convertible: A convertible policy is simply a level term policy with the option to revert to whole life or endowment insurance.
- Decreasing: Usually a decreasing policy is chosen if you want it to run alongside a repayment mortgage. If you are purchasing your policy because you have just bought your first home or are about to move home and have a repayment mortgage then this is the type of policy you should consider. Some mortgage providers won't even release funds unless you are covered for the mortgage debt by life insurance. If you happen to die at the outset of the policy then the payout is higher than if the policy pays out towards the end (roughly in line with your mortgage as long as interest rates aren't higher than 10%). A decreasing term policy tends to have lower premiums but it will also depend upon many other factors (see the 'How much will it cost?' section).
- Level: A 'level term' policy pays out the same amount of money whether you die at the beginning, middle or end. The sum assured is guaranteed and remains unchanged throughout the term. These policies are often recommended for people with interest-only mortgages.
- The Option to Increase: Whichever type of policy you decide on, you can usually protect it against inflation by a various number of 'increasing' methods. Of course, the exact options available will be dependent upon the specific policy but some will increase it by a specific percentage each year, some will allow it to follow the RPI (Retail Price Index), and some will allow it to be increased at each renewal.
Optional Extras and Additional Policy Features
- Critical Illness: Often life insurance can be bought with critical illness cover as an additional extra. The payout is usually in the form of a lump sum upon diagnosis of the illness and not to be confused with the payment of treatment for the actual illness (as this would be covered by health insurance). Conditions the insurers cover against will be anywhere between 10 and 154 differing illnesses so do check the policy if you are looking to cover against a specific potential illness. With critical illness cover, more than anything, you need to ensure you have fully and truthfully disclosed your medical and general history. Also, be aware that insurers can be extremely explicit as to the actual illness definition before they are willing to payout. Some policies will also offer an option where you can buy-back your life cover to the original amount if you make a claim for the critical illness.
- Total Permanent Disability: If you are taking out critical illness cover with your life cover then a vast number of insurers also write this in to your policy at no extra cost (or included within the critical illness cost).
- Child Cover: As above, this is often included automatically if you take out life insurance with critical illness cover - check the policy specifics if it is something that interests you.
- Premium Insurance: As a rule, if you stop paying your life insurance premiums, your policy is cancelled. Therefore, most insurers offer protection from unemployment, accident and sickness so the premium will continue to be paid. This is known as a combined product (i.e. you are actually buying two types of insurance), and whilst it's a very useful piece of cover to have, you may end up paying a disproportionately higher fee for it. A better suggestion may be to look at income protection which will cover all your monthly outgoings as opposed to just the one.
- Helplines: A few insurers offer their own helpline to give 24-hour care/support services.
- Free Accidental Death Cover: Often, if your life insurance policy is taken out to cover a mortgage or alterations to your home, free accidental death cover is given whilst your application is being processed by the insurance company.
- Insurance with Investments: Some insurance companies tie life insurance in to investment plans (or vice versa) - these are not typically known in the industry as good value. General advice would be to keep your insurance policies and your investments separate or at the very least take further advice from an independent financial advisor on the subject. If you do proceed, then make sure you have compared the return on this against the return you may get by investing separately elsewhere.
- Joint Policy Replacement Cover: This comes under many titles, but in a nutshell it allows the non-claiming partner to buy-back or start a new plan that is not subject to the earlier claim. There are a variety of ways that the insurance companies offer this option; one allows you to buy further critical illness cover back after a claim on critical illness. Remember though: the more you cover yourself, the higher your premium will be.
Types of Premium
Always check the type of premium that you are going to be paying. There tends to be three kinds:
- Current Costed: Your premiums will be reviewed each year and will go up or down accordingly.
- Reviewable: Your premiums will be reassessed every few years and will be adjusted as necessary. In the short term, these premiums work out cheaper; however, over time they are likely to be increased and may well surpass the total cost of a guaranteed premium. If you are on a restricted budget initially then these may be your answer.
- Guaranteed: Throughout the duration of your policy the premium that you pay will continue unchanged. Initially, these premiums may be more expensive but will often work out as better value for money in the long term. Be careful though - some guaranteed premiums are only guaranteed for the first five/ten years of your policy and then change to the reviewable type.
What kind of payout?
The deciding factor when choosing a policy that pays out a lump-sum or an annual income is usually based on the initial requirement for the insurance policy: Is the policy there to allow your loved ones to pay off large debts/liabilities? Or is it there to ensure that your loved ones can maintain their day-to-day lifestyle without your support? If it's the former, then a lump sum payout would be your solution and an annual income for the latter.
However, there are other details that need to be factored in; when choosing an annual income you should also consider the following:
- Would it be more beneficial for my loved ones to receive a lump sum to invest and then take an annual income from the investment?
- If I were to die ten years in to a fifteen year policy-would a five year annual/monthly income be enough?
- Would it be a good idea to link my payout to an index (such as the Retail Price Index) so it can stay in line with inflation? If you do decide to link your premiums/payout to an index - check to see whether it is linked automatically or whether you have to annually opt-in.
Who does it go to?
You can agree for your policy award to be passed on to your nearest and dearest - usually your spouse, partner, children or other family members. If you plan to take out a joint policy with your partner/spouse, check to see whether the payout occurs on the first death and whether you need to name a separate beneficiary upon the death of the second policyholder. Spouses can take out 'Life-of-Another' policies on each other - since they are assumed to have an automatic insurable interest in each other. If you want a 'Life-of-Another' policy in any other case then you will need to prove an insurable interest in the person whose life you are insuring.
To compare life insurance policies from leading UK providers please click here.
Author: KYM Editor
knowyourmoney - company information
Comment on this article...