Life Assurance
The need for life assurance stems from the certainty that everyone will die, but that the timing is unknown. There is no way of ensuring absolutely that everything has been taken care of before you die. Life Assurance will provide your family or other dependents with a capital lump sum or regular income. Life Assurance can also be used to minimise the effect of Inheritance Tax in the event of death. In most cases, payments from these policies will be paid tax-free to the person nominated to receive the benefit.
Insurance companies will require the completion of medical questionnaires, and occasionally medical examinations before agreeing to insure someone. This is to enable them to determine the level of premium. In the event that the applicant has had previous health problems, or a family history of health problems, the likelihood is that the premiums will be higher. In some cases, the insurance company may refuse cover or only offer limited cover, as the risk is too great. There are specialist providers who offer preferential terms to applicants who have been refused cover elsewhere. Your adviser will help you find the most suitable provider.
Term Assurance
Term assurance comes in various forms. Term plans guarantee to pay out some form of benefit in the event of death within a specified time. At the end of that time, the plan will cease without any return. In the event of death after that date, no benefit will be payable. There is no investment. The premiums are known at outset and, in most cases, guaranteed throughout the selected term. This type of cover is commonly used where the period for which cover is required can be easily determined e.g. to repay a loan or to pay school fees. The insurer will not accept policies until the applicant has been medically assessed – known as underwriting. If underwriting highlights a problem that will reduce the applicant’s life expectancy - and therefore the greater likelihood that the plan will have to pay out - the premium will be increased or exclusions applied. Term assurance can be written on single life or joint life bases. It is most common for these to be taken out on a joint life first death basis, as they tend to provide protection for the surviving partner.
Level Term Assurance
This type of plan offers Life Assurance of a fixed amount, payable only in the event of the death during the term of the policy. The benefit and premiums will remain constant throughout the term. It must be noted that inflation will have an effect on the eventual purchasing power of the benefit, and also that, at the end of the specified term, the plan will cease without any money back.
Decreasing Ter Assurance
This is commonly used in relation to the repayment of a loan or a capital repayment mortgage. The level of cover will gradually reduce over the specified period, in line with the reduction of borrowing. This type of cover is generally the cheapest available and, again, the premiums will remain level throughout the term of the contract.
There are exceptional circumstances whereby the life cover will fall at a faster rate than the outstanding capital of the loan. Each individual policy will warn of this, and the most common circumstance is where interest rates for mortgages increase above 10%. At the end of the term the plan will cease with no money back, as there is no investment element included within the contract.
Increasing, Renewable and Convertible Term Assurance
Each of these contracts is a variation on the Level Term Assurance detailed above and they all carry slightly higher costs. Increasing term assurance allows the benefit to increase over the specified term. This can help to counteract the effect of inflation. The premiums will also increase in conjunction with the benefit.
Renewable term assurance offers the option to renew the policy at the end of the specified term. Premiums may increase but fresh medical evidence is not required. This can prove to be an expensive way to renew cover, as a new plan with new medical evidence is often a cheaper option. However, it can be very valuable where the health of the applicant has deteriorated since commencement of the original plan.
Convertible Term Assurance allows an element of investment linking to be included within the plan. This can effectively turn the contract into a Whole of Life contract or an Endowment plan. Again the premiums will increase to take account of the on-going cover, but this can be offset to a certain extent by the inclusion of the investment element. Medical evidence will not be required when the conversion takes place, which again can increase the relative cost of the plan.
Pension Term Assurance (PTA)
It is possible that you may have an old life assurance contract, which was set up on a “pension” basis. This means that the monthly premiums attract tax relief in the same way as a pension contribution. (For every £8 of premium paid, you actually buy £10 worth of life cover, with potentially a further 20% of relief available if you are a higher rate taxpayer). A new, more flexible version was introduced in April 2006 but due to concerns by the Chancellor about the amount of tax relief that could possibly be granted after the contracts were heavily advertised, the decision was taken in December 2006 to remove tax relief on any new applications. This effectively ended their sale.
Whole Life
This is the most comprehensive form of life cover, and usually the most expensive. In return for a monthly premium, the insurance company will pay out a pre-determined lump sum in the event of death, whenever it might occur. Cover might either be provided for a fixed Sum Assured on premium terms established at the beginning or flexible terms are available that permit increases in cover once the policy is in force. This caters for changing personal circumstances.
As the insurance company must pay the benefit for each policyholder, assuming the payments are maintained, an element of investment is built in to each contract. Over the years, this investment should grow and help to subsidise the more expensive premiums in later years. Equally, the investment growth can be used to maintain a lower level of life cover, in the short term, if premiums reduce or cease. If a policyholder should decide to surrender the policy completely, any investment growth that has built up will be paid to the policyholder.
Premiums
As with most protection plans, premiums are determined by age, health and gender. In addition the cost will depend on the level of investment risk that you are prepared to take, and also the basis of the contract. Policies can be written on minimum, standard and maximum bases. If minimum is selected, this means that the minimum amount of the premium is paid towards life cover and the majority is paid into the investment. This is the most expensive option at outset, and provides the highest chance that premiums will not have to be increased in future. Conversely, the maximum basis will be the cheapest option. This provides the highest level of life cover for the premium paid, but only a minimal amount of the premium will be allocated to the investment element. This means that there is unlikely to be sufficient investment growth to maintain the premiums in future.
Premiums are usually subject to a review every five or ten years. At these reviews, it is possible that the premiums required will be increased. This will happen where the investment growth has been insufficient to cover the increased cost of cover. The increase will depend on the age and sex of the applicant and the investment growth that has occurred. Once an insurer has accepted a plan, no further medical evidence is required, on the assumption that the sum assured remains constant.
Policies can be written on joint or single life bases. Joint life plans guarantee to pay out a specified lump sum following the death of one of the policyholders. They will either be written to pay out following the first death, or the second death. The latter is commonly used for Inheritance Tax purposes and the former for family protection.
Investments
The investments selected will depend upon your attitude to risk and circumstances. There is a range of investments available, including Cash, Fixed Interest, With Profits, Equity and Specialist funds. Most companies will permit switches between some funds at various times.
Charges
The charges are all included in the premium you pay each month. With Profit investments have hidden charges that are calculated as and when annual bonuses are declared. Unit linked investments will have explicit charges that will be clearly documented in the paperwork provided. In addition to these charges, there are additional options such as waiver of premium, and guaranteed insurability (see below) that will be offered for a small additional premium.
