Types of life insurance
Generally there are two reasons people take out the protection of life insurance:
• Paying off loans and debts such as your mortgage
• For family protection, where it leaves money for your family to live on after you’ve died
Here are the main types you might want to think about….
This is in a way the simplest and most basic type of life insurance. You should the amount and term (period) and pay normally a monthly or annual premium. If you die within the term, the policy pays out the contractual amount to your beneficiaries. If you don’t die during the term, the policy pays out nothing and that’s it on this part.
You could chose a level term where the amount of cover (and premium) stays the same throughout say to cover a fixed loan, family protection or interest only mortgage, or a decreasing-term life where the amount of cover decreases at a specified rate, for example to cover a repayment mortgage or a decreasing debt schedule. Premiums for decreasing term should be cheaper.
Family income benefit
Here an income is paid to your beneficiaries during the period of term agreed.
But note, if let’s say (by way of an example) you agree a £1,000 per month income over a 25 year term and die with only 3 years remaining your beneficiaries only receive the income for those 3 outstanding years remaining.
Whole-of-life policies are ongoing policies that pay when you die. This type of policy is more expensive. The premium you pay is split to buy the life cover amount and build up an investment reserve. The idea being that the investment growth in the early years cross-subsidises the higher cost of life insurance as you get older, as long as you pay the premiums.
BUT – if the investments perform badly, your premiums might need to increase to maintain the same level of cover. It is possible that there will be a cash-in value if you decide to cancel the policy.
This kind of policy is often taken out to cover future inheritance tax bills.
As often is the case, there’s even more additions and options you might want to think about!
You could opt for a “reviewable policy”, where your cover can be renewed after the 10-year period finishes with the high probability that premiums could rise substantially. The areas that will decide this are how the underlying investments have performed up to that date, as well your health and life expectancy recalculation at that point.
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.