Basic Definitions
Benefit The money that a policy pays out
Premium The payment for a policy – usually monthly but can be yearly
Beneficiary The person who receives the money from a policy
Term The duration of a policy
Policy The insurance agreement
Underwriting The assessment of an application
Is Life Insurance Right For Me?
If you have a family who would suffer financial hardship if you were to die, then you should seriously consider life insurance. It should also be reviewed from time to time, typically when taking on a new financial commitment such as renting or purchasing a home, getting married or having children. Life insurance is one of a range of insurances that are suitable at various stages of life.
The acid test is to ask yourself two questions:
1. Who is financially dependent on me?
2. If I die will that/those dependent(s) suffer financially, or will their way of life suffer?
If the answer to question two is “yes” then you should consider life insurance.
The Different Types of Life Insurance
Level Life Insurance
What it is: This type of policy provides a fixed lump sum benefit payment at any point the policy term.
Benefit: This is ideal for family protection and interest-only mortgages, where a predictable level of benefit is required.
Suitability: This suits anyone needing a large lump sum of cash on death, to look after family, such as providing a deposit for a home, or other high value goods that might be needed.
Increasing Life Insurance
What it is: It provides a lump sum, but it increases in value in order to protect against inflation. Note that the premiums also increase.
Benefit: The purchasing power of the benefit payment will not be devalued over time.
Suitability: This can be a robust form of financial protection where long-term inflation is a concern.
Decreasing Life Insurance
What it is: This type of cover has a benefit that reduces over the policy term.
Benefit: The cost of reducing insurance is lower than level and increasing cover because the amount of benefit will always reduce, so the cost is less.
Suitability: Decreasing insurance is used to match a reducing debt such as a repayment mortgage, or other form of long term loan. It is not suitable for interest-only mortgages, or for providing long term family cover because the benefit reduces over time, whilst the need for financial security remains or the debt does not reduce.
Family Income Benefit Life Insurance
What it is: This type of cover pays a tax-free income, instead of a lump sum, for the term of the policy.
Benefit: This cover aims to maintain an income to cover the family budget and is very cost-effective. It is used to replace income for the family or the guardians of children.
Suitability: It particularly suits a family dependent on income from the breadwinner.
Single Life or Joint Life
A life insurance policy can be set up in the name of one person, or two people.
A single life policy pays out on the death of the owner of the policy.
A joint life policy insures the lives of two people who have a mutual debt (mortgage) or interest (family). Joint life policies can be set up to pay out after the death of the first person, or after the death of the second person (both die).
“First death” is used where the benefit of a policy is needed to pay off a debt. This might pay off a mortgage, so that the survivor can live free of debt such as a mortgage.
“Second death” policies only pay out after the deaths of both the first and the second insured person. The purpose is to pay inheritance tax and for estate planning.
Life Insurance Variables
Types of Premium
There are three types of premium: reviewable, guaranteed and increasing.
Reviewable premiums mean that the insurance is subject to review of premiums every few years. Whilst the initial premiums are cheaper, the risk is that premiums might become much more expensive later on.
Guaranteed premiums are fixed through the whole term of the insurance and will never alter. This means that the insurance is not subject to review and the premiums will never change. The cost is a little higher than reviewable premiums, but they are ideal for long term budgeting as they stay the same.
Increasing premiums are used where you want to ensure that the benefit payout is not eroded by inflation over time. They can increase at a fixed rate, or be linked to the Retail Price Index. There are no further health checks
Waiver of Premium
If someone is signed off as unable to work through illness or accident, then the insurance company will stop taking the premiums after a qualifying period if waiver of premium has been selected. This option is slightly more expensive. Sometimes waiver of premium can be declined due to poor health or extreme activities.
Guaranteed Insurability Options (GIOs)
Most insurance policies allow increases within limits without underwriting due to important life events. These are typically:
• Marriage
• Birth of a child
• House purchase
Note that this is less common on decreasing term assurance.
Underwriting, Standard, Rated And Uplifted Premiums
When assessing someone for insurance an application is “underwritten”. This is where the insurance company makes an assessment which includes age, health (medical issues), smoker/vaping status, BMI, occupation, family history.
Standard Premiums: Where someone is fit, healthy and a non-smoker, premiums will be “standard”. That means that they will receive the lowest premiums as the person has the lowest likelihood of dying during the term of the insurance.
Rated Premiums increase when a client’s health or lifestyle poses a higher risk of dying at a lower age. Smoking automatically attracts a higher premium, as does vaping which is considered as risky as smoking tobacco. Premiums depend on the risk of death. Where the risk is greater premiums will be rated. “Rating” means a percentage uplift which can be anything from 25% to 200%. If a health condition is particularly risky it will result in life insurance being declined.
Uplifted Premiums: Where someone is involved in regular high-risk activities, such as motor racing, competition horse riding, parachuting and so on, then a fixed additional sum will be added which is expressed as £1s per £1,000.
Common Exclusions or Limitations
There are rare occasions when a life insurance policy will not pay out.
The most common is non-disclosure or misrepresentation. This is the failure to tell the insurance company something vital about health or lifestyle that would otherwise have influenced the decision to offer cover in the first place.
Suicide, typically within first 12 months is usually excluded.
Failure to maintain the premiums invalidates an insurance, although most insurers do offer a “grace period” of a few months so that the premiums can be brought up to date in order to keep the cover running.
Terminal illness claims may not pay out near the end of the full policy term where there is a requirement for a minimum remaining term of the policy
Trusts
Life insurance policies are often placed into a trust. This is usually a free service and completed when setting up a new policy. There are three key purposes for a trust:
Reducing the tax bill for family on a high value inheritance.
A trust can make a huge difference because the insurance pay-out does not form part of the deceased person's estate, so doesn’t need to be assessed for tax purposes. Funds can be paid in a matter of weeks instead of waiting for months to process.
Making sure that the benefit goes to the people you want it to go to.
A trust is also very specific and avoids confusion over who should benefit from an insurance policy.
Making sure that the benefit is paid to the right people as quickly as possible.
Where the deceased person’s estate might fall into the bracket for inheritance tax, the benefit of a life policy in trust will not be included in the calculation and can make a very important difference to how much is paid to HMRC.
Assignment of a Life Policy
When a couple divorces, a life insurance policy may be assigned to one of the parties as part of the financial settlement. Many joint life policies can be assigned, but only with agreement from both policyholders and subject to insurer terms. It is not automatic, and professional advice is usually recommended when assignment forms part of a divorce settlement.