Defaqto

How much should I insure for?

As a rule of thumb, financial advisers recommend that you insure a sum equal to 10 times your annual salary. So if you earn £50,000 a year, you might want to consider insuring your life for £500,000.

While this might not be realistic if you are on a tight budget, if you have some insurance already (as described above), you will only need to top up your existing cover and term assurance is extremely cheap for non smokers in normal health.

Term insurance

Term insurance will pay either a lump sum or an income, if you die during the term of the policy which can be anything from five to 40 years.

Policies can be arranged to cover just one person or, in many cases, spouses or partners. But you need to remember that if you die outside the term of the policy, there is no payout.

The level of life inurance you buy will depend on your individual circumstances, but generally speaking it should be enough to pay off major debts, such as your mortgage.

Different types of term insurance

There are four main types of term insurance:

Level term

The amount of cover remains the same throughout the term of the policy and these policies are normally used to cover an interest-only mortgage or to provide family protection.

Decreasing term

The sum insured reduces each year, decreasing to nil at the end of the term. The cover can fall by a fixed amount each year, or in line with a repayment mortgage to match the reducing debt.

Family income benefit

This type of policy is ideally suited to provide your family with a replacement income, if you die during the term of the policy.  A regular income is paid to your dependants for the remainder of the policy’s term.

This can be a useful way of providing a  partner or spouse with a monthly income to pay for essential outgoings, such as council tax, utility bills, child care and so on. If you pay school fees, you may wish to factor this cost in as well.

The income can be paid monthly, quarterly or yearly. Some policies provide an income which increases each year at a fixed rate, such as 3 or 5 per cent.

Gifts inter vivos policies

These policies are designed to cover the potential inheritance tax liability that can arise if you bequeath assets or gifts to someone from your estate while you are alive.

Such a gift is called a Potentially Exempt Transfer, or PET. If you die within seven years of making the gift, there may be a liability for inheritance tax (IHT). A Gift Inter Vivos policy lasts for seven years, so a seven year, decreasing term assurance policy should cover the potential IHT liability.

Alternatively, you could take out a 7 year decreasing term assurance policy to cover a potential IHT bill.

Whole of life

This is more expensive than term assurance because it will pay out whenever you die. Whole of life can be useful if you have dependants, such as a wife and children, whom you wish to protect, irrespective of when you die.

Premiums are typically reviewed at 5 or 10 yearly intervals and may well increase. Despite their expense, whole of life policies can be useful in certain circumstances and are often used as part of inheritance tax planning so that your beneficiaries can receive a lump sum to pay a potential IHT bill.

The important thing to remember when buying life assurance is that cheapest is not necessarily best. It is more important that you buy cover which is appropriate to your needs.

What options are available?

Some term insurance polices offer other options at extra cost which can provide added protection for you and your family.

Inflation protection

If you do not arrange for your cover to rise in line with inflation,the cover will be eroded over time. Many term insurance and family income benefit policies include the option for your cover to increase automatically in line with inflation each year, which may result in higher premiums.

Waiver of premium

Some policies include ‘waiver of premium’ as an optional extra. This  will ensure that your premiums are paid if you are unable to work due to long term sickness or disability.

Conversion options

A small number of policies allow you to convert your policy into a different type of life policy, without the need for you to provide fresh evidence of your state of health.

Insurability options

Marriage, birth of a child, divorce and moving home may bring with them additional expense, in which event, you can take out a top-up policy.

Policies that include 'insurability options' allow you to increase cover within a set period following major life events, such as marriage, birth of a child or increasing your mortgage, without fresh medical evidence.

Otherwise, if your health has deteriorated, cover may be more expensive or difficult to buy.

Renewal options

Some term assurance policies can be arranged on a renewable basis, which means that at the end of the policy term, typically 5 or 10 years, you have the right to take out a further policy for the same term as the original policy, without the need to provide further information about your health.

Buying a renewable policy is cheaper at the outset than a normal term assurance policy because the period of insurance is shorter, making these policies attractive to people on a limited budget when they are young.

However, you should bear in mind that the cost of the ‘renewed’ cover will be based on your age when you renew, so the long term cost will be higher than a standard term assurance policy bought at the outset.

Critical illness

Some life assurance policies allow you to buy critical illness cover as a 'bolt on,' for an added premium. Critical illness pays a lump sum if you are diagnosed with a life threatening illness or condition, such as certain cancers, a heart attack or stroke and survive a certain amount of time thereafter (typically 30 days).

Critical illness is a complex product and policies vary considerably so it may be advisable to take independent financial advice.

How much will it cost?

Premia for all types of life assurance are based on a number of factors, such as your gender, health, lifestyle (smoker or non smoker), age and occupation. The lower the likelihood of you dying during the term of insurance, the cheaper the premia will be. 

Under most term asssurance policies, the premium is guaranteed to remain the same for the term of the policy.

Prices vary from insurer to insurer, but the term assurance market is extremely competitive because of rapidly rising longevity and a highly competitive market.

The table below shows the typical cost of the policies described above.

Source: Defaqto February  2008

As with any purchase, price should not be the overriding factor to determine which policy you buy. It is essential to find a policy that is suitable for your current needs and that can adapt to meet your future needs.

It is best to take independent financial advice before buying any insurance product so that you purchase a policy that is fit for purpose. Preferably you should seek this advice from an independent financial adviser who is able to recommend from the whole market.

This will also provide you with the protection of the Financial Ombudsman Service if something goes wrong, which is not the case if you buy a financial product without advice.

How do I get cover?

Once you and your adviser have selected a policy, you will need to complete a proposal form which will ask you about your health and lifestyle.

It is absolutely essential that you are entirely honest when completing the application form. If in doubt, include every last detail of your medical history..

If you hold any 'material information' about your medical history or lifestule, you could invalidate your policy and the insurer might refuse to pay out in the event of a claim.

The insurance company will consider the information you have provided and may give you a quote based on this information only. 

If you are applying for a very large amount of cover (usually over £500,000), or you have history of ill health, the insurer may write to your GP for more details.

In some circumstances, the insurance company may also ask you to attend a medical examination with an independent doctor.

Once it has all the information required, the insurer will issue an acceptance letter which will confirm the basis of the cover and the premium.

If you have a history of ill-health, the insurer may charge a higher premium to reflect the increased risk. High blood pressure, obesity and diabetes are examples of conditions that could give rise to a higher premium.

If your condition is very serious, the insurer may decline cover altogether.

Putting policies in trust

Although life assurance benefits are paid free of tax when you die, the proceeds could form part of your estate and become liable to inheritance tax, if the policy is not written in a trust.

Placing a policy in trust means that the proceeds can be paid directly to your beneficiaries, rather than having to go through probate and being taxed when you die.

Estate planning and writing policies in trust can be complicated, so seek advice from a suitably qualified adviser to ensure you have covered every eventuality.

Taking out a life insurance policy should be treated as an investment, rather than an expense. Once you have taken it out, you and your loved ones can relax in the knowledge that if the worst happens, at least their financial future is secure.