A Guide to life Insurance
Things you should know about Life Insurance
Life insurance offers valuable financial protection in the event of your early death if you have family dependent on your earnings. But it is also a means of saving. This combination of protection and saving makes life insurance unlike any other financial product. Some policies protect, some help you to save and some do both. This guide describes the many different types of life insurance. It has been produced by the Association of British Insurers (ABI) on behalf of its insurance company members who offer life insurance. Your sales person, adviser or insurer will be able to answer the questions this leaflet prompts.
Life Insurance as Protection for your family
Loss of income and problems paying debts or meeting tax liabilities can result from loss of life. To help with these costs there are three basic types of life policy – term insurance, whole life insurance and endowment insurance. All these provide you with protection by paying a lump sum on death. People on a limited income may find that term insurance is the best buy. The term (period of cover) can be chosen to cover the time when children are growing up and expenses are high.
Some families find a regular income more useful than a lump sum. For them a family income benefit policy could be best.
Whole life insurance gives more extensive protection. You know your family is financially protected whenever you should die.
An endowment policy gives the best of both worlds – protection and saving. Although dearer than term or whole life insurance it will help your family’s finances should you die, while at the same time it is a method of long-term saving.
Term insurance (or “temporary insurance”) gives you financial protection if you die within a specified period known as “the term”. This period might be 10, 15 or 20 years although you can arrange policies to cover you for periods as short as one month. If you are alive at the end of the term no payment is made and there is no surrender value – meaning that if you stop paying the premiums the cover ceases and there is no refund or premiums paid.
Term insurance is the cheapest form of protection and it can offer high life insurance cover for a low premium. This can be ideal if you have a limited income. Cover can usually be arranged to cover just one person, but in some cases cover will also be available for spouses/partners in the same policy.
There are different types of term insurance;
- Level Term – You are insured for the same amount throughout the agreed term.
- Renewable Term – You have the option, after a specified period (usually 5 years) to take out a further term policy without the need for any further evidence of health, providing the policy will not continue beyond a certain age (often 65 or more).
- Convertible Term – You can convert the policy to a whole life (see below) or endowment (see below) insurance without giving further evidence of your state of health. If you decide to convert, the new policy will usually cost the same as a normal whole life or endowment policy based on your age at the date when you exercise the option. If you have a young family and a limited income these policies might be best. Not only do they provide cheap life cover at the outset, but they give you valuable options in later years if your income has risen or your health has declined.
- Decreasing Term – The sum insured reduces by a fixed amount each year, decreasing to nil at the end of the term. The premium will normally stay the same throughout the term. These policies are usually used to cover a mortgage or other loan as they pay any outstanding balance of the debt if you die early. They can also protect a liability to Inheritance Tax on gifts to others (see Taxation below). Remember, though, at the end of the term nothing is payable and there is no surrender value.
- Increasing Term – The sum insured and premium increase each year by a fixed percentage of the original sum insured. These policies are designed to increase your insurance protection as your earnings increase.
- Family Income Benefit – If you die during the term of the policy a regular income is paid to your dependants for the rest of the term. The income can be paid monthly, quarterly or yearly. Some policies provide an income which increases each year at a fixed rate – say by 3% or 5%
Whole Life Insurance
This pays the sum insured whenever your death occurs. Whole life insurance is not limited to a specific period like term insurance. Premiums are usually more expensive because it is certain that the insurance company will eventually pay the sum insured. With some policies you will have to pay the premiums until you die, but with others you may not have to pay premiums any more once you reach a chosen age – say 65 or 80 – but the insurer will pay the sum insured when you die. In these cases the policy is then known as “paid up”. Whole life insurance can be arranged with or without profits or can be arranged with or without profits or can be unit-linked (see below).
Life Insurance as a form of saving and protection
The long-term nature of life insurance allows you to make clear plans for long-term saving. Life insurance companies have long and wide experience of successful investment as well as providing protection in the event of your early death.
This both protects your family and saves for the future. Endowment policies can be issued with or without profits or can be unit-linked (see below). You pay premiums for an agreed number of years – say 10, 15 or 20. At the end of this time you receive a lump sum, which is either the sum insured together with bonuses in the case of a with-profits policy, or – with unit-linked endowments – the lump sum is the return of all money invested together with the investment growth. If you die before the maturity date the insurance company will pay the sum insured – plus any bonuses applicable so far.
With and Without Profits
A with-profits policy lets you share in the profits made by the insurance company from the investment it makes. These profits are usually added to your policy as an annual bonus and once they have been added they cannot be taken away.
The amount of bonuses allocated to your policy depends on the profits made by the company. These profits and bonuses cannot be guaranteed in advance but it is likely that bonuses will add significantly to your sum insured, bringing you a good investment return over the years of your policy. The with-profits endowment policy is a means of long-term saving with a minimum of risk and the potential for a good return. It smoothes out fluctuations in the value of investments, although there is no guarantee of the final (maturity) value of the policy.
Without profits policies do not share in profits made by the insurance company. The amount paid out on death or maturity will be the basic sum insured only.
With a unit-linked policy there is no guaranteed sum insured payable except in the case of death. Your premiums are invested by the insurance company, who manage these investments. The amount payable under your policy depends on the value of the investments at the time your policy matures. Insurance companies offer a range of different funds to which your policy can be linked. You should ask for an explanation of the different funds so that you understand the different risks and opportunities.
There is no guarantee of the value of the sum to be paid on maturity. The potential benefit from a unit-linked policy can be greater than from a with-profits endowment policy. But of course there is also the risk that the eventual benefit could be lower.
The value of investments can fall as well as rise.
A bond is an investment usually purchased with a single premium lump sum, although regular payments can sometimes be made. Your payments are invested by the insurance company either in its with-profits fund or as a unit-linked investment (see above) where you can choose the fund it is linked to.
Guaranteed bonds are also investment contracts where you pay a single premium into the with-profits fund. In return the insurance company guarantees to pay you a fixed sum at a fixed time, perhaps four or five years hence.
A guaranteed income bond pays you an income at a guaranteed rate of interest for the duration of the bond. It then returns your original capital on the maturity date.
With unit-linked single premium bonds your premium is allocated to one or more funds rather than to the single with-profits fund (see above). The eventual return you receive depends on the movement in the unit prices over the period of the policy. Insurance companies offer a range of different funds to which your policy can be linked. You should ask for an explanation of the different funds so that you understand the different risks and opportunities.
Most life policies have optional extras:
- Waiver of premium – If you cannot follow your normal occupation because of illness or injury, the insurance company will pay your premiums to maintain the benefits under the policy.
- Critical Illness – This provides cover against the risk of you having a serious illness such as a heart attack or cancer. If you develop one of the illnesses listed in the policy a lump sum (or occasionally a regular income for a set period) will be paid. This type of insurance can be bought on its own or as an addition to whole life, endowment or term insurance.
Inheritance Tax Planning
On your death your estate might be liable to pay Inheritance Tax. This tax is payable if the value of your estate is over a certain limit, which changes from time to time. If you won your house your assets could easily exceed the amount above which Inheritance Tax is due (although any amount owed, such as a mortgage, are excluded from the calculation). You may want to save your family from having to find money for Inheritance Tax.
Life insurance can be arranged in such a way that on your death the sum insured does not form part of your estate and will not then be liable to tax. The policy proceeds can then be used to pay any tax for which the estate is liable or to meet day-to-day expenses while your dependants wait for money from your estate to become available.
Gifts given in the last seven years of your life can also create a liability to pay Inheritance Tax. Life insurance can be arranged to cover this liability.
Provided your policy is a “qualifying policy” the benefits paid on death or maturity are not subject to income tax. To qualify, a policy has to satisfy certain statutory conditions. These include the need to pay premiums at annual or shorter intervals for at least 10 years or until your earlier death. Your sales person, adviser or insurer will tell you whether or not your policy is a qualifying one. The surrender of a policy within the first ten years may result in a liability to pay some income tax.
Many business people recognise the value of property and liability insurance but they often forget the part that life insurance can play in protecting the business from the financial loss that the death of a key individual could cause.
Key Person Insurance
You may rely on a key employee who is vital to the profitability or even the existence of the business. You can protect your business from the disruption which might follow the death or such a colleague by taking out a life insurance policy on his or her life. The policy can be used to cover costs of finding and training a successor. There may be liability to corporation tax in respect of some – or all – of the amount paid out under the policy.
The business could be at risk if one of the partners dies. Life insurance can help the other partners to buy the deceased partner’s share of the business from the estate to which it would otherwise automatically pass.
Directors’ Share Protection
Life insurance can protect you and the other surviving directors from any withdrawal of capital following the death of a director. The payment from a life insurance policy may help with the purchase of the deceased director’s share of the business.
Who Can Sell Life Insurance?
Any person advising on or selling investments must either be a company representative or an independent financial adviser. The sales person will make his status clear and explain whether he is authorised to offer the products of one company only or whether he can advise on a range of different companies’ products. Insurance companies deal direct with potential customers either by telephone or through their sales persons but it is also possible to buy through independent financial advisers or other insurance intermediaries.
Are there controls over selling life insurance?
All sales are subject to some control – most are governed by the rules of the financial services regulator – currently the Personal Investment Authority, but soon to be the Financial Services Authority.
Assessing Your Life Insurance Needs
It takes careful planning to choose the right life insurance policy for yourself, family or business. It is also important to review regularly your life insurance needs to make sure that they keep up with changing personal and economic circumstances. Surveys have shown that one person in three has no life insurance at all. A further third have not reviewed their life insurance needs over the previous five years – meaning that they may now be underinsured.
When you have decided on a policy you will have to complete and sign a proposal form. This form asks about such matters as your age, occupation and health. You must answer all questions truthfully. If you fail to do so, it can, in some circumstances, mean that your policy will not pay out.
A lift insurance policy is a long-term commitment. It is not designed for you to cash in early. Insurance companies and independent advisers can help you decide what products are suitable for you.
Never surrender a life insurance policy without taking expert advice.
What if I change my mind?
Every effort is made to ensure your application for life insurance is made in the full knowledge of all its terms and conditions, but all these policies have a “cooling off” period (usually two weeks). During this time you can tell the insurer you do not want the policy and receive a refund of any initial premiums you have already paid. With unit-linked policies it may not be the full amount you originally paid if the value of the units has decreased since purchase.
What should I do if I want to complain?
Occasionally things go wrong and you might want to complain. You should in the first instance take your complaint up with the salesperson, adviser or insurer. Your policy document will provide details of the insurer’s complaint arrangements. The aim will be to ensure that your complaint will be thoroughly investigated at the right level.
This document is reproduced with the permission of ABI – The Association of British Insurers.