Life insurance explained

Last updated by on July 21st, 2020

Life insurance can be a difficult subject to talk about but having a policy in place can ensure your family and loved ones are financially secure should the worst happen.

To help you make an informed decision about the types of policies available and to clarify what’s right for you, here are the answers to some frequently asked questions.

What is life insurance?

Life insurance pays out money to family or loved ones (the beneficiaries) in the event of your death.

The policy holder can choose whether the money (the sum insured) is given as a lump sum or as a monthly instalment, they can also specify how the money should be spent – such as on a mortgage, for funeral costs, or for everyday living expenses.

Broadly speaking, plans fall into one of two main categories – term cover and whole-of-life cover.

What is term life insurance?

Term life cover runs for a set amount of time (known as the policy term), as the policy holder you can decide how long the term is – typically this can range from five to 25 years.

Term insurance only pays out if the policy holder passes away during the term period. For example – if you had a 25-year plan and died in year 10, then your beneficiaries would receive payment, but if you passed away in year 26, then they wouldn’t.

Term cover can be split down even further into several types of policy:

Decreasing term cover
The amount of money these policies pay out gets smaller over time – so if you passed away in year five, your beneficiaries would receive more than if you died in year 24.

These policies are usually associated with mortgages and are sometimes known as ‘mortgage life insurance’ as they reflect the reduction in what you owe your lender. As the sum insured reduces with time, so too does the cost of your premium.

Level term cover
This pays out an agreed lump sum on death, the amount is the same regardless of when you pass away during the policy.

Increasing term cover
Policies are the exact opposite of decreasing term plans so as time goes on, the sum insured increases by a set amount every year in order to offset the rising cost of everyday expenses through inflation.

Some increasing term policies use the Retail Prices Index to work out how much to increase the amount of cover by, because of this, these policies are sometimes called ‘index-linked cover’.

Convertible term cover
Policies offer flexibility by letting you convert your term policy into a whole-of-life plan should you want to. One of the big benefits of convertible term cover, is that no matter what happens to the state of your health, your insurance provider is obliged to convert your plan if you choose to.

Renewable term cover
With these policies, you can renew your existing term insurance plan without the need for a medical review.

What is whole-of-life cover?

Unlike term cover which only pays out on death if it occurs during the policy period, whole-of-life policies pay out no matter when you pass away. As you’d expect, whole-of-life policies are more expensive than term insurance plans because there’s a guaranteed payout.

As with term policies, there are different types of whole-of-life plans:

    Underwritten policies take into account your medical history and can have either a fixed or reviewable premium
    Over 50s guaranteed acceptance require no medical information or evidence

Single vs. joint life insurance policies

Whether you opt for a single or joint policy depends on your circumstances, such as whether you need the same amount of cover and what your budget is.

Life insurance only pays out once, so if you’re a couple and each of you has a single life insurance plan, your respective policies will pay out when you pass away so neither partner is left without cover. With joint policies, the sum insured is typically paid out on a ‘first death’ basis, so when the first policy holder dies, the policy comes to an end.

Joint policies tend to be cheaper than single plans but when one named policyholder passes away it potentially leaves the other partner without life cover – which becomes increasingly expensive with age.

What does life insurance cover?

Life insurance is only paid out on death and usually policies will contain specific clauses detailing what circumstances they won’t cover, for example if the policy holder dies due to drug or alcohol misuse.

The money that’s paid out can be used to cover whatever expenses your family and loved ones need to meet – whether that’s mortgage repayments, funeral costs, rent, school fees, or childcare.

How much is life insurance?

There’s no easy answer to ‘how much does life insurance cost’ as plans are tailored to your specific circumstances and a variety of factors are taken into consideration to work out the cost of your premium, such as:

    • The sum insured (the amount of cover you want)
    • Your age
    • Your overall health and lifestyle (for example, whether you smoke)
    • The type of policy you choose and how long you want it for

Ultimately, the younger and healthier you are, the lower your premium is likely to be, which is why it can be a wise investment to make early on rather than waiting until you’re older, when policies can become more expensive.

Because there are so many factors that influence the price of your premium, comparing quotes online really is the quickest and simplest way of seeing what’s on offer in one place.

Do I need life insurance?

If you have dependents, then life insurance is certainly worth considering as it means you can be confident your loved ones are financially secure in the event of your passing.

If you don’t yet have dependents, having life insurance can save your family and friends the worry of funeral costs at an already difficult time.

How much life insurance do I need?

The amount of cover you opt for influences the price of your premium, so it’s important to think about what your beneficiaries really need. A very general rule of thumb is that you should aim for the sum insured to be ten times your annual salary, but you should consider:

    • Your mortgage and how much your beneficiaries would need to pay this off
    • Any outstanding loans or debts such as a car or personal loan
    • Whether you want your insurance to cover funeral expenses
    • Any regular outgoings such as school fees or childcare
    • The future of your family and while that might feel like a lot of forward planning, it’s worth thinking about things that you may want to include for example university tuition fees.

Do you need life insurance to get a mortgage?

Legally, you don’t need life insurance to take out a mortgage but your lender will urge you to consider it. Having an appropriate policy that covers the cost of your remaining mortgage means that if you do unexpectedly pass away, your loved ones can remain in the family home.

Does life insurance pay for suicidal death?

Some life insurance policies do pay out if the cause of death is suicide, but it is worth checking the small print of the policy to confirm what circumstances they will cover.

Most life insurance policies will have a set period of time during which payment for death caused by suicide will not be made – this is typically the first 12 to 24 months from when the policy was taken out.

If the policy holder dies after this time then beneficiaries can expect a full payout to be made, but insurance providers can refuse to pay out if the policy holder has failed to disclose details about their mental health.

Is life insurance worth it?

The answer to this really depends on your situation. If you’re the primary source of income and have dependents then having a policy can offer you some comfort, knowing that your family won’t have to deal with financial stress and upheaval in addition to grieving.

What’s the average life insurance payout?

According to the Association of British Insurers, the average term life insurance claim in 2017 was for just over £78,000 while the average whole-of-life policy paid out £4,500 per claim.

Can you have more than one life insurance policy?

The short answer is yes – you can have as many life insurance policies as you want and different policies may serve different needs.

For example, you might choose to have a decreasing term policy to pay off the mortgage as well as having level term cover to meet other living expenses.

Of course, it’s always best to try and find a policy that’s flexible enough to meet your changing needs such as if you decide to get married or start a family, which is why comparing policies before making a final decision can save you hassle in the long-term.

If you already have a policy in place and want to amend it to reflect a change in circumstances, always speak to your provider first to see if your policy can be amended.

How do life insurance companies make money?

There are three main ways that insurance providers make money:

    Income vs. payout – insurers work out the cost of premiums by assessing every policy holder and calculating the risk of paying out – known as underwriting. Having a robust and accurate underwriting process means that insurers can accurately gauge potential income compared to how much they need to pay out whilst ensuring premiums are competitive.
    Investment – insurers invest money they receive from premiums and receive an income from this.
    Lapsed policies – a lapsed policy is one where the term has expired without a payment being made which can happen when a plan reaches its contractual end, or if a policy holder simply decides to stop paying their premiums. Either way, all the money from lapsed policies is kept by the insurer.

How to find out if someone has life insurance in the UK

If someone close to you has passed away and you think they had a life insurance policy then you can try searching for it in a number of ways.

The first is to search any files, check whether they left policy documents in a safe at home, or in a bank deposit box. You can also check old bank statements to see if there were regular payments made to insurance firms.

If you’ve explored all these avenues and if you’re the executor of a will or have power of attorney you can request a search using the Unclaimed Assets Register (UAR), alternatively, the solicitor managing probate can organise this on your behalf. There is a £25* fee for using this service.

Is life insurance taxable?

Life insurance payments are typically tax free (as you have already paid tax on the premium) but depending on the value of the policy holder’s estate, life insurance could be subject to inheritance tax.

Any potential payout from life insurance is included in the valuation of your estate. Currently, inheritance tax is 40 per cent and needs to be paid if your assets are worth more than £325,000. Any amount over £325,000 will be subject to inheritance tax.

So, for example if you left assets valued at £450,000 then inheritance tax would be applied to £125,000 (which is £50,000).

To prevent life insurance settlements being taxed, you can write your policy ‘in trust’. You can arrange to leave your policy in trust at any time (even if you have an existing policy) all you need to do is ask your insurance provider to organise this (there should be no charge).

You’ll need to arrange for trustees (typically at least two) to manage and oversee the trust in the event of your death. It’s up to you as the policyholder to decide how much input trustees have in the management of the plan but you can stipulate all of these terms within the trust.

Why life insurance is important

Nobody wants to think about death, let alone their own, but arranging life cover means you can protect your loved ones from financial burden in the event of you passing away.

Life insurance payments can pay off mortgages, as well as other debts, so even if you don’t have immediate financial dependents, if you owe money then it can cover this too. Similarly, if you part own a business, a life insurance payout benefitting a business partner can provide some financial reassurance.

When do life insurance policies pay out

Life insurance policies only pay out on death but remember there may be exclusions such as if death was caused by drug or alcohol abuse, or if there was any failure to mention pre-existing health conditions. Any exclusions will be outlined in the policy details.

For additional protection, critical or terminal illness policies are available as standalone plans or can be combined with life insurance cover.

How does group term life insurance work?

Group term life insurance is sometimes provided by employers as part of an employee benefit scheme. The policy is in place for the duration of employment and as with personal life insurance, the money goes to the employee’s chosen beneficiaries if the employee passes away. This is also sometimes known as ‘death in service insurance’.

The amount of cover is usually between two and four times the employee’s annual salary and is paid out as a lump sum that’s tax free.

The main difference between group cover and personal life insurance, is that the business or organisation is the policy holder and sets the amount of cover and the length of the term.

What is the best life insurance policy for me?

Life insurance should reflect your needs which is why it’s a good idea to reassess any existing policies annually – just to make sure you’ve got enough cover if your circumstances have changed.

One of the easiest ways to work out what you need, is to think about what it is you want from a policy – do you want the sum insured to pay off a mortgage, cover funeral costs, or just provide loved ones with enough for day to day expenses?

Any plan you choose, needs to provide your loved ones with enough money to protect their financial security – whether that’s through a decreasing term policy, or an increasing term plan that counteracts the effects of inflation.

Comparing quotes can give you an idea of what’s available and at what cost – and while budget and cost is important, it’s worth remembering that price shouldn’t be the only factor you consider when it comes to choosing a policy.

So, if you’re looking for a quote or it’s time to renew your existing cover, remember you can search for a new policy right here.

Alternatively, if you’d prefer to get a quote over the phone please call 0330 022 4687 and one of the team will be happy to help.

*Correct as of 10 August 2018

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