Types of Life Assurance Contracts
This type of life policy pays out when the policyholder dies within a set period of time. Most policies run for between 10 or 25 years, but you specify how long you want the term to be.
If you die during the term, the policy will pay out the amount agreed at the start, which is known as the ‘sum assured.’ Some policies will also pay out if you are diagnosed with a terminal illness if you have chosen this option.
If you live beyond the term of the policy, the cover simply terminates – there is no investment element or any return of premiums.
There are three main kinds of term insurance policy:
- Level Term – With level term insurance, the amount of cover – the ‘sum assured’ – is the same in the final year of your policy as it is in the first.
- Decreasing Term – If you have decreasing term insurance, the potential pay-out will reduce over the term. This sort of cover is often taken out by people to back a repayment mortgage, with the sum assured shrinking along with the outstanding mortgage debt. The cost is less than for level term cover.
- Increasing Term – With this third option the pay-out increases over time to keep pace with the rising cost of living, usually by a fixed amount each year, typically 5%, or is pegged to the Retail Prices Index (RPI) measure of inflation. As the amount of cover increases over time, premiums for this sort of policy will be more expensive than for level or decreasing cover.
Whole of Life
If you don’t want to take out life insurance for a set term, but want it to last a lifetime, one option is to take out whole of life assurance.
(Insurers tend to use the word ‘insurance’ where there is a risk that something might happen within a given time frame, and use ‘assurance’ when something is certain to happen.)
This type of policy doesn’t have an end date, so you keep on paying premiums until you die at which point the policy will pay out (some policies require premiums to be paid only until you achieve an advanced age – perhaps 85).
As a pay-out is certain, this type of cover is more expensive than term insurance.
Critical Illness Cover
Many people opt to take out critical illness insurance at the same time they take out life cover.
Critical illness cover pays out a tax-free lump sum in the event you are diagnosed with a serious illness such as cancer, stroke or heart attack or if you are incapacitated following an accident.
You can use the pay-out for whatever you want, perhaps to pay off your mortgage, or to cover the cost of private medical treatment, refurbish and adapt your house, or pay for a convalescent holiday. In other words, you don’t have to account for how the money is spent.
According to statistics, one in five men and one in six women will suffer a serious illness at some stage in their life.*
*Source: Moneysupermarket website (October 2015)
Income Protection Insurance
We all insure our cars and homes however we often forget to protect what pays for it all – our earnings. This type of policy is designed to cover the core monthly financial commitments such as your mortgage/rent, bills and food should you suffer an accident or illness and are prevented from continuing to work. (Short term policies can also insure for periods of unemployment).
The policy will pay a fixed percentage of your gross salary (eg, 75%) from the date of the accident/illness up until your retirement (whereupon your pension will provide you with an income).
The policies usually impose a deferment period (a period of time before the benefits start being paid) and like an excess on your car insurance, the longer the deferment period, the lower the premiums.
Policy payments can be either level or indexed linked to cater for increased costs.