Life insurance - What is it?
Put simply life insurance, the oldest form of financial protection, is a way of a person guaranteeing that in the event of their death their family can pay the bills, eat and remain clothed. In other words, pay for the essentials in life.
But with so many options for insuring a life available, many are able to use it as a way of saving money.
There is a resplendent array of policies on the market but all work by transferring risk to the insurer. The insured person receives a policy, which guarantees a sum of money to be paid under certain terms, and they pay their insurer a premium in exchange. The risk is assessed based on the chances of the insured dying. Therefore anyone wishing to take out a policy usually must undergo a health assessment.
Risks vary from personal person to person. And everyone's circumstances are different. So choosing the best insurance policy requires careful planning. A policy should be reviewed regularly to ensure it accounts for changes in life events and to take advantage of better deals.
There are a number of options available:
- Term Insurance
- Mortgage protection
- With profits
- Unit-linked
Term insurance, also known as term assurance, is a form of cover ideal for people on a limited income as it's the cheapest.
All Term insurance runs for a specified period, but comes in various guises.
The cheapest are
Level Term, Renewable Term, Convertible Term and
Decreasing Term. For these, the term can be selected to run for the duration of a mortgage or while children are growing up. They pay any outstanding balance of the debt in the event of the policyholder dying early. A word of warning: at the end of the term nothing is payable and there is no surrender value.
Level Term is the most straightforward providing insurance for the same amount during an agreed term.
Renewable Term insurance provides the insured with the chance, after a specific period such as five years, to take out a further policy for another term providing the new cover does not run beyond a certain age, often 65.
Convertible Term insurance allows the policyholder to convert to more sophisticated whole of life or endowment polices without providing a health report.
Decreasing Term/Mortgage Protection insurance – see
Mortgage Protection.
Other term life insurance available is
Increasing Term or
Family Income Benefit.
Increasing term insurance allows policyholders to increase their protection as their earnings rise. Therefore the sum goes up as the premiums increase year-on-year.
Family Income Benefit insurance provides a regular – monthly, quarterly or yearly - income to dependants for the rest of the term should the policyholder die while the policy is active.
Critical Illness insurance also comes under the term insurance banner. A policyholder can take out insurance at an extra cost where the sum assured is payable if the holder is diagnosed with a critical illness.
- Mortgage Protection Insurance
A type of term insurance, Mortgage Protection is also known as Decreasing Term. It is one of the cheapest types of life insurance available and has a fixed premium. However, the sum reduces by a specific amount each year to zero at the end of the term. It is usually designed to run in line with the outstanding amount on a repayment mortgage and means allows the insured to leave a cash sum to dependants to pay off the loan if they die during the period of the policy.
A more expensive option, whole of life insurance pays the lump sum insured upon death and is not limited to a specific period. Premiums are expensive because the insurer is certain it will have to, eventually, pay the sum insured. It is essentially a savings scheme.
There are two types of whole of life insurance:
With-profits and
Unit-linked.
With-profits policies involve the policyholder making regular payments which are then invested with insurer.
Each year the holder will receive a bonus from the insurer, the size of which varies depending on how well the insurer's investments have been performing and how much its profits have risen. It's a bit like putting money into the bank and receiving interest.
Except the bonus payment is sent annually to the policyholder to keep. At the end of the policy they will receive a final payment known as a terminal bonus. With-profits can be volatile and if policies are surrendered early the policyholder will probably receive less money than they invested as fees are high.
Unit-linked policies gain value through investment in stock markets. The policyholder's premiums are used to buy units in a fund run by the insurer. These funds invest in stocks and shares on various different stock markets and so the money being paid in by the policyholder has the potential to gain value as the markets rise.
The insured can choose from a range of funds covering a variety of markets and can check their units' prices in the newspapers. Unit prices can go down as well as up, although over the long term they tend to make gains.