IS IT WORTH IT?
By Rob Griffin
Thursday, April 29, 2010.
Editor’s note: This article is targeted at UK-based readers. Please seek expert opinions before making financial commitments.
Taking out life cover means you can rest assured a sum will be paid out in the event of your premature demise, taking care of your family or paying off your mortgage to make life less financially stressful for them. But the insurance giant Swiss Re estimates that less than half the UK population has bothered to buy life cover. By its calculations, only £1.8 trillion worth of the £4.2 trillion needed to protect our loved ones has been purchased, which means there’s a worrying £2.3 trillion shortfall.
It’s worth emphasising that not everyone actually needs this cover. If you haven’t got any dependants it’s not worth taking out life cover because there’s no one to look after when you die. If you want some form of health cover instead, consider critical illness which pays a lump sum if you ever suffer one of the listed conditions, or income protection which pays a monthly benefit if sickness or an accident prevents you working. You may have adequate cover from your employer. Often you are offered life cover worth four times your salary, which may be sufficient if your salary is substantial and your commitments few.
For everyone else, however, cover is a vital consideration. Deciding you need some is the most important step, but it’s the first of many decisions you’ll need to make. You will need to start by choosing between whole of life cover, which pays out when you die, regardless of when that happens, or term cover, which pays out if you die within a specific period. Your decision will depend partly on the reason you are taking out cover.
If you are taking out a policy to cover your mortgage, most people opt for term insurance. It can be set up to run for the same length of time as your loan, and can ensure it always pays whatever is outstanding on your mortgage. This is a great deal cheaper than whole of life cover. According to Lifesearch, if a healthy man of 35 was to take a 25-year decreasing term policy, he could pay as little as £10.65 a month for £150,000, compared to the £107.45 he could pay for guaranteed whole of life cover.
On the other hand, whole of life cover is eminently more sensible for inheritance tax planning because it will pay out whenever you die. If you work out roughly how much your inheritance tax liability will be on death then you can write a policy to cover it, but you must write it in trust, so it will go directly to your beneficiary.
Lessening family trauma
In some cases you’ll need to weigh up the pros and cons of each type of cover. Nowhere is this more true than the most common reason for buying cover – to ensure dependents are financially catered for and not left with any debts.
Whole of life policies will pay out a sum when you die – regardless of when that is – so your dependents are looked after. Depending on the amount of cover, it’s possible for them to use the cash to settle any outstanding debts, pay off the mortgage and have a nest egg for the future.
However, this can be quite costly. Even reviewable premiums cost our healthy 35-year-old man £80.01 a month for his £150,000 cover – seven and a half times more expensive than term cover. This is increasingly convincing people to opt for term insurance. Taking out a policy for, say, 25 years, will often provide cover for people to retire, pay off their mortgage and see their children leave home.
Supporters of the term approach will point out that you can extend the cover at a later date should an unexpected event happen, such as another baby coming along. This is fine if you have remained fit and healthy during the intervening period, points out Stuart Lawson, protection marketing manager at Axa. “If you need protection beyond the end of the term you might not be able to get it if your health has worsened or you’ve had a cancer scare,” he explains. “However, with whole of life you will always have the option to extend the cover.”
If you choose term cover it’s a case of finding the right terms at the right price. If you decide to opt for whole of life cover you have another series of options to consider.
Although single premium (lump sum) policies are available, the vast majority of people will buy cover through one of three types of contract, paid for through regular monthly premiums.
Non-profit insurance policies
These guarantee to pay a set amount of life cover on the death of the person, regardless of whether their untimely demise happened two days or 80 years after the policy was taken out. This guarantee means the policy does not depend on investment growth, and therefore premiums are often very high. Our healthy 35-year-old man looking for £150,000 cover would, for example, pay £107.45 a month for this.
With-profits insurance policies
These use investments to bring the cost down. It pays a minimum amount of life cover on the death of the assured life, although this amount will be increased annually by the addition of annual bonuses. These annual bonuses are calculated by the insurance company and are based on the performance of the underlying investments, with an element of smoothing built in – holding back some performance in good years to ensure it can pay out extra in the bad years. These bonuses permanently increase the basic guaranteed sum.
These allow you to choose between a minimum and maximum level of guaranteed assurance, while the initial cover selected can be changed at any time. The premiums you pay buy units of an investment fund, which is then used to pay for your life assurance. The level of premiums will be reviewed during the life of the policy and can change as performance does.
How much cover?
The minimum required should be enough to pay off all outstanding debts, as well as a lump sum for each of your dependents. As a rough guide, calculate how much you need to sustain your standard of living over an average 12-month period and then multiply this by 25 years.
While it is broadly accepted that whole of life policies are more expensive than term policies, it’s worth looking around to see what deals are available, as prices have actually started to fall in recent years. Your best bet is to do your research – most providers and online brokers have detailed information on their websites – so you are properly briefed before you go to see your financial adviser or an insurance broker about taking out the cover.
With thanks to Interactive Investors.