A Guide to Different Types of Life Insurance

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What You Need to Know

  1. Whilst ‘term’ life insurance policies are cheaper than ‘whole of life’ policies, they only cover you for a set period. Renewing them can become difficult and expensive as you get older, or if your health worsens.
  2. Decreasing term policies tend to be the cheapest and can be especially attractive if your main financial concerns are your mortgage or your children.
  3. ’Whole of life’ insurance policies tend to be more expensive, but come with the peace of mind that you will always be covered.
  4. Though joint policies are popular amongst couples, getting two separate policies normally leads to a lot more cover and isn’t much more expensive.
  5. Be very aware of exclusions that may apply to your policy. It has been estimated than one in ten life insurance policies do not pay out due to being invalidated, normally because of ‘withheld medical information.’
  6. When shopping around for a policy, be sure to compare the ‘keyfacts’ document, which, under FSA regulations, the insurer is obliged to provide you with.
  7. Arranging for your life insurance payment to go into a trust can help your beneficiaries side step inheritance tax and get their money quicker.

What Is Life Insurance?

Life insurance is a policy whereby a lump sum is paid out in the event of the policyholder's death. This enables the policyholder to ensure that their loved ones and dependents are protected against any financial difficulties that may occur after they’ve gone.

Whilst this is the idea behind all life insurance policies, not all policies work in the same way. As such, it pays to read up on the different products available so as to work out which one is right for you before obtaining a life insurance quote.

Different Types of Life Insurance

Here are the key aspects of the various types of insurance available;

Term Insurance

This is the most popular and, generally speaking, the simplest and cheapest type of life insurance available.

A ‘term’ policy will cover you for a set period, typically, 15 or 20 years. Should the policyholder die within this time frame, then a lump sun will be paid out. Once you reach the end of that period you can either renew your insurance, switch to another insurer or, if you wish, go without any cover.

Within the bracket of ‘term’ based life insurance there, are a number of different policy styles to choose from;

    1. Level Term

These policies are paid for in regular instalments, with the premiums fixed at a set rate. A full payout can be expected at any point during the term. The amount of the payout is worth, like the premiums, stays the same throughout the term.

Having fixed premiums for a long period can prove prudent, as life insurance tends to become more expensive the older you get, especially once you pass middle age.

Having said this, you will (hopefully) have to renew your policy at some point. This can be expensive once you pass middle age and, if you develop an illness during your term, you may find, once it is over, that you can’t get covered again as you no longer meet the underwriters criteria.

Luckily, there are plans specially designed to avoid people being left in such a situation. Though these policies can be pricier, they are usually very accepting. Some even provide no medical life insurance, whilst others are geared towards catering for higher risk areas, such as over 50s life insurance.

However, the renewability of the policy is still one of the key things you should check before taking out such an option.

 

  • Increasing Term Insurance

 

With these policies the premium increases year on year for the duration of the term, the advantage being that the cover also increases, providing guaranteed insurance with no medical.

This makes this policy type popular amongst those who feel that as they get older, they will want a guaranteed higher level of coverage, rather than keeping their cover fixed, as with a level term policy.

 

  • Decreasing Term Insurance

 

This is generally the cheapest form of term life insurance. This is because the premiums stay fixed throughout the term, whilst the level of cover decreases.

This type of insurance is an attractive option if your main reason for taking out life insurance is to provide financial protection for your children or your mortgage repayments.

In both cases the money required to meet those costs will decrease over time, as your children become more independent and the amount left on your mortgage is gradually reduced. Similar policies include those labelled as ‘Mortgage Protection Life Insurance’ policies.

As well as these forms of ‘term’ life insurance, there also policies that can go on indefinitely;

Whole of Life Insurance

This form of assurance allows a policyholder to carry on making payments for as long as they like. Quite simply, so long as you have kept up with your contributions, a lump sum will be paid out in the event of your death.

Generally, these policies are more expensive than ‘term’ based alternatives, with the premium either staying roughly the same or increasing at a pre-determined rate.

Their major advantage is that they never need to be renewed. This can save you from big price hikes once you get passed middle age and also eliminates the risk of you being left with no life insurance options available.

For example, if you only had ‘term’ insurance and developed a serious medical condition, after your term ran out you may find it hard to get more insurance, as you may no longer meet insurers underwriting requirements. With ‘whole of life’ life insurance policies, you don’t need to worry.

The other benefit of ‘whole of life’ life assurance is that you know that, unless some form of exclusion applies, a pay out is guaranteed. With a ‘term’ based policy there is a good chance you will survive the term. In these cases you won’t usually see any of your money back.

Indeed, there are ‘whole of life policies’ that actually build up a cash value over time. In some cases you will even be able to cash this in, invest it or even borrow against it, which can provide you with some more financial flexibility.

Waiver of Premium

This is a feature of some insurance policies that you may want to think about including. It works almost like a form of payment protection, but relating solely to your life insurance premium.

With this feature you pay an increased premium and, in return, the insurer will waive your premium (pay it for you) should you lose your income, due to ill health or a disability.

This may be worth considering, as missing payments can invalidate your policy, which would be very costly. At the same time, you need to be sure you understand the terms and conditions. In most cases you will be covered for a limited period and only for a limited number of conditions.

Pension Term Assurance

As well as the two standard types outlined above, there are also a range of more specific life insurance types to consider. Pension Term Assurance, for instance, uses the rules associated with pension schemes when it comes to determining contributions rates and frequencies.

However, despite the name, these policies still pay out on your death rather than providing you with an income upon your retirement.

Critical Illness Insurance

It's also possible to get covered against critical illness, with insurers usually covering a wide range of serious conditions.

These policies work much in the same way as standard life insurance products, with policyholders entitled to a lump sum payout should they be diagnosed with any of the critical illnesses listed on the contract.

Within these policy types, there are a number of variables. For instance, a contract may require an insurer to provide the holder with a fixed income should they need to take time off work, while it may also be the case that the holder is required to survive for a minimum number of days after a critical illness is diagnosed before any money is owed.

In many cases, who can add critical illness insurance cover to your life insurance policy.

Joint Policies

It is possible to take out joint life insurance policies and this is an option popular with many married couples. In most cases, though, experts would recommend getting two separate policies, as they tend not to be too much more expensive, but provide double the coverage.

This is because, almost all joint policies are ‘first claim’, meaning they only cover the first person to die (or become critically ill, if this eventuality is also covered.) Therefore, if both parties died together, only one person receives a pay out. Similarly, if one person becomes critically ill, the other is left without cover.

This is made worse by the fact that, with many policies, only the surviving partner is allowed to claim. In this case, if you were killed as a result of a criminal act by your partner there would be no pay out, as only they can claim and it is illegal for them to profit from the crime.

Common Exclusions

Losing a loved one is always tragic, but finding out that their life insurance has been invalidated can cause a huge amount of further distress.

The insurance industry as a whole, like any other business, is geared towards making money and it is no secret that insurance companies will take full advantage of any situation which allows them to increase profits by avoiding a pay out. It has been estimated that in this country, about 10% of life insurance policies do not pay out.

The policy may be invalidated if you engage in certain activities, such as dangerous sports, or if you had some sort of medical condition that pre-dates your policy and was not made clear at the time.

By far the most common cause of exclusion is incorrect medical information. You need to make sure that you are completely accurate with the information you supply and that you update it regularly to avoid giving your insurer the option to decline payment.

For example, Sarah Webb was killed by a driver going down a main road the wrong way at 90mph. Though she had life insurance cover, her insurer refused to pay out on the basis that when she took out the policy she had written on a from that she was a non smoker, but on a later medical form, when she had taken up smoking again, she indicated she was a smoker.

As this example illustrates, even if the cause of death is unrelated, insurance companies are very good at combing your medical records to find any incomplete or conflicting information they can.

Policies of all kinds can also become in valid if you do not keep up with the required payments.

FSA Keyfacts Documents

Under FSA (Financial Services Authority) regulations all insurers need to provide potential customers with a ‘keyfacts’ document. This should outline in a clear manner all of the ‘need to know’ information attached to your policy. It is vital you examine this document, as well as the small print of your contract, before taking out a policy.

‘Keyfact’ documents are also very handy when you are shopping around for insurance, as they present all the most important information about policies in any easily comparable way.

Trusts

Many experts strongly recommend that write your life insurance into a trust. The advantages of this are numerous.

For one thing, it could help sidestep inheritance tax, as the money will go straight into the trust. This means it will not count as part of your estate and, therefore will not be included when inheritance tax is calculated.

Secondly, the payout is likely to reach your loved ones much quicker, as the often lengthy legal process of probate (which asses the legal right of an executor to distribute money left to them) does not apply to funds left in a trust.

Trusts also allow you greater control over your money, as you can determine who will benefit by how much and when, even leaving a trustee to manage it for you before it passes into the recipients hands.

Further Reading

 

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