Terms of endearment: family's future covered

When does it pay to purchase life insurance to protect your loved ones? Chiara Cavaglieri examines the ins and outs of life cover

Most of us don't want to think what would happen to those we leave behind if the grim reaper suddenly came knocking. But for those who do want to safeguard their loved ones' futures, there is life insurance. Despite the doom-laden headlines of late, life cover costs have fallen by an estimated 40 per cent in five years as a price war has broken out between insurers all keen to top the charts on the price comparison websites.

However, the headline premium rates can be misleading and only those in perfect health are benefiting from the cheapest quotes. "Providers are desperate to get to the top of price comparison sites, but they are subsidising low premiums for those in perfect health by charging those with less than perfect health much more," says Matt Morris from insurance adviser Lifesearch.

Life insurance premiums are based on the probability of the policyholder fulfiling an average life expectancy and any factors that reduce this probability will lead to higher premiums or, on occasion, exclusion. Short-term impacts, on the other hand, such as the outbreak of swine flu, have little effect on premiums because providers assess risk over long periods of time.

"Insurers will look at a variety of factors in setting premiums including age, pre-existing medical conditions and lifestyle," says Jonathan French from the Association of British Insurers. Those with high blood pressure or weight problems, smokers or heavy drinkers will face substantially increased premiums. High-risk jobs and dangerous sports such as diving and parachuting will also make premiums shoot up. But it is important to note that definitions of what constitutes a high-risk job or hobby will vary from one insurer to the next so it is worth getting as many quotes from as many providers as possible.

Life insurance falls into one of two basic types – term assurance and whole-of-life cover – but within these two categories there are many variations. Whole-of-life cover guarantees to pay out a lump sum, irrespective of when the holder dies. Because there is no time limit, premiums are more expensive. With term assurance, however, cover is guaranteed for a limited period of time, typically 10, 15 or 25 years, after which a new policy will have to be taken out. The cheapest and most straightforward option is level term insurance which guarantees to pay out a fixed amount of money upon death for a fixed-rate premium. By paying extra, it is usually possible to include a waiver of premium which covers monthly payments if the policyholder is unable to work due to ill health. Switching policies is relatively simple, but premiums may have gone up because of increased age or new medical conditions. Anyone looking to switch insurers should leave their current policy in place until they are fully covered by the new policy.

When deciding on the level of cover necessary, there are several factors that should be taken into consideration, most notably, childcare costs, university fees, mortgages and other debts, as well as any investments such as pensions. In most cases, it is worthwhile seeking independent financial advice. "We would always recommend that you get some advice and get the adviser to do the work for you," says Emma Walker, head of protection at price comparison site Moneysupermarket. "Some people may decide that their savings and pensions provide enough financial security for their families and they need life insurance only to cover their mortgages. Homeowners on repayment mortgages, for example, can opt for a decreasing term assurance, when the cover and monthly premiums decrease by a fixed amount each year in line with the mortgage debt."

Alternatively, premiums and cover can be set to increase each year to provide protection against inflation. Renewable term assurance is another option that gives the policyholder guaranteed insurability, irrespective of their health, at the end of the term. Some may also want to consider a policy paying a family income benefit which provides a regular, tax-free income rather than a lump sum.

Experts say one of the most important things to do is to write the policy into trust so it does not form part of the holder's estate and incur inheritance tax. It will also allow money to be paid direct to beneficiaries and most insurers include the option to write the policy in trust at no extra charge. Joint life policies for couples may not be a good idea: the surviving partner will be left uninsured when the first partner dies and because premiums increase with age, they are likely to pay much more when looking for new cover.

It is vital to be completely honest and disclose all relevant information when filling in the application forms; companies will refuse to pay out if policyholders mislead them about their health. "It's better to get everything out in the open, even if it means paying a slightly higher premium, to avoid risking them not paying out," says Ms Walker.