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What is life insurance?
Life insurance is an insurance policy taken out to protect not yourself but your loved ones. In essence, it is a contract between you
and an insurer, where you pay the insurer a premium in exchange for the guarantee that the insurer will pay a sum of cash to the
beneficiary if you die during the term of the contract. Depending on the policy, other events such as a terminal or critical illness
may also trigger payment.
The most basic type of life insurance is term insurance, this means you choose the amount of cover and the period for which you need cover when you buy the policy. Your beneficiaries will receive a payout if you die within the predetermined term of the contract. This type of insurance is not a savings or investment vehicle, your premiums will not be returned to you if you don't die during the term of the contract.
Level term insurance
Level term means the amount you're covered for remains the same throughout the specified term. This type of cover is typically used to ensure your family will not suffer financially in case you pass away early. It's also used to cover outstanding mortgage debt in case of an interest-only mortgage.
Decreasing term insurance
A decreasing life insurance policy pays out a sum of cash that decreases over the term of the contract. This type of policy is usually bought to cover a debt that reduces over time, like a mortgage. Decreasing policies are generally much cheaper than level policies.
Increasing term insurance
Increasing term life insurance is the opposite of decreasing term cover, the value of the cover increases over the term of the policy. For instance, you could choose to buy a cover of £50,000 during the first five years of the policy and increase it to £100,000 for the next five years and £200,000 for the five years thereafter. The increase can also be a fixed percentage or it can be linked to the inflation index. Increasing life cover is not used as often as it requires you to pay higher premiums over time.
Family income benefit
Instead of policies that pay out a lump sum of cash some insurers also offer a policy called a family income benefit. These schemes will pay out your family a regular, tax-free income until the end of the cover's term.
Whole of life assurance
Contary to term assurance, whole of life is an ongoing cover that will pay out a lump sum when you die, regardless of how long you live. As such, whole of life is generally much more expensive than term assurance because the policy has a guaranteed payout. A whole-of-life policy is sometimes set up in a trust and used to cover inheritance tax when you die, meaning more is passed to your beneficiaries.
Guaranteed vs reviewable premiums
Another important distinction in life insurance is the choice of premiums:
- Guaranteed premiums remain the same throughout the term of the cover, unless you alter your plan.
- Reviewable premiums can increase over time. Typically, the insurer will agree not to change the premiums in the first five years of your cover but in the years thereafter the insurer can do a premium review and decide to increase your premiums. Factors in the review include the insurer's claim history, expectation of future claims, economic conditions, interest rate expectations, the impact of medical advances, etc. Your state of health will not be considered.
Policies with reviewable premiums usually start off cheaper but the total cost is typically higher than plans with guaranteed premiums.
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