Types Of Life Insurance

Life insurance comes in many different forms and it's important that you buy the right type for your circumstances.

Life insurance explained

Families that have mortgages on their homes could well be advised to take out a policy that repays the mortgage should one of the bread winners die. This should also be extended to Mums and Dads that may be at home all day but are involved in the vital role of bringing up children.

The type, the amount outstanding and the term remaining on your mortgage all affect the premiums you pay for this cover.

Level Term v. Mortgage Protection

Repayment mortgages are mortgages where the monthly payment you pay covers the interest charge on the money you owe, plus a little extra payment to repay a part of what you owe. Over time the amount you owe reduces and hence the interest portion falls and the capital repayment portion rises meaning you repay the loan quicker and quicker during the policy term.

This chart explains how mortgage protection life insurance works, in this example for £200,000



The chart shows how a mortgage protection life insurance covers less and less each year the policy is in force. This is because it is only designed to repay the amount you owe on a repayment mortgage.

The schedule of how much the policy pays out is usually set in stone at outset, which means that should the mortgage not follow the same profile, due to higher or lower interest rates, falling behind with the payments or borrowing extra funds, the life insurance may not cover the whole amount, or may pay out more than is required.

This chart explains how level term life insurance works - in this example for £200,000:



Here the chart shows that the policy pays out a fixed level amount of life insurance for the whole term. It's easy to understand and simple to explain and remember and is a popular choice for customers comparing cheap term life insurance.

Level term life insurance is used for covering all types of mortgage loan even though, if the mortgage loan type is repayment, there is a possibility that the life insurance will pay out more than is required to repay the mortgage. The small extra premium payments are considered by many as justified based on the more "guaranteed" nature of the cover against a mortgage and the fact that any overpayment might be useful to repay short term debts like personal loans and overdrafts.

Reducing Life Insurance Costs v. Level Term Insurance Costs

For a typical non-smoking male and female aged in their mid-30's the cost of level term life insurance compared to the cost of reducing life insurance is higher by around 30%.

So for £200,000 of cover over 20 years the premium would rise from about £12.40pm, for reducing to about £16.22pm for level term insurance through payingtoomuch.com.

Is the extra premium worth it?

Only you can answer this question as some would say it's cover we hope never to claim on and so let's not spend any more than absolutely necessary.

Others would say that technically speaking the level term insurance provides around 37% more life insurance over the term, (for the technically minded that's the area under the curve), most of the extra occurring at the higher ages where cover is more expensive anyway. So for only 30% more premium this means better value for money. Ultimately the choice is yours!

Family life insurance

It is estimated that bringing up a child from birth to the age of 21 can cost over £200,000. All parents know that children bring extra costs and that sometimes these are difficult to control even with both parents working.

For this reason many parents take out life cover to help financially if a parent dies whilst bringing up a family. Typical policy types for this need include Family Income Benefit, which is a life cover that pays a recurring monthly payment from death for the remaining policy term, or level term insurance where the whole £200,000 is taken at outset.

Indexed linked life insurance

Life insurance pay-outs can be set to increase year by year to account for inflation. These policy types would always have increasing premiums and because the policyholder ages the extra cover can rise in price faster than the sum assured rises.

Whole of Life Assurance

Whole of life assurance is designed to eventually pay out the life cover amount as it will cover you until you die (provided you pay the premiums) no matter how long you live.

So once you're underwritten and the policy is in force the insurance company cannot withdraw the cover simply because you fall ill or they decide they wished they hadn't offered the cover.

Insurance companies can however alter the premiums during the term unless you have opted for a guaranteed premium policy of which there are only a few available. Premium alterations cannot be made specifically for you but can apply to a group of policyholders if, for example, the insurer is experiencing a poor return on it's investment. These days premium reviews upwards are viewed with suspicion by all and are the subject of review by the financial services regulator the Financial Services Authority or FSA from time to time.

Uses for Whole of Life Assurance

Whole of life assurance (or sometimes incorrectly referred to as whole of life insurance), is usually used as a financial planning tool to help mitigate the effect of inheritance tax (or death duties) by the wealthy. The policies are typically set up as joint life policies that pay out on the second death of the two lives.

The pay-out is written in Trust for a third party so it does not form part of the estate of the second life. This allows the beneficiary to settle the inheritance taxes (or death duties) on the estate from cash rather than being forced to sell property or other assets at a time that might be unsuitable.

This type of whole of life estate planning is best performed by an Independent Financial Adviser on a fee basis rather than a commission basis due to the size of the premiums and commission involved and the complexity of ensuring the Trust work is carried out properly when required.