flow chart: 2. spend on your life
Term assurance is making a comeback. But what kind should you buy?
Wednesday 07 February 1996
Term assurance cover is cheap to buy because policies pay out only if you, the policy-holder, die and they pay nothing at all if you live beyond the chosen term of the policy. It is possible to get decreasing cover, for example to pay off the reducing balance on a repayment mortgage, and this will obviously be the cheapest cover of all. But most policyholders will want at least a level sum to cover other financial commitments. Twenty years is the minimum necessary to provide for children to grow up and get a start in life, but shorter policies are possible, and they are also cheaper than longer-term policies.
Term assurance policies are arranged to pay out a lump sum, which insurers recommend should be around five times the policyholder's annual income. For practical reasons policyholders almost always pay a monthly premium. The premiums are set by actuaries who work out the life expectancy of the policyholder, depending on his/her age, gender, occupation and lifestyle. To all intents and purposes lifestyle means whether the policyholder smokes or not. Smokers can pay a lot more for similar cover.
But premiums will vary from company to company so it is always worth asking a broker, an independent financial adviser, or ringing round yourself for a number of quotes from leading life assurance companies, and direct sales operations.
The next cheapest form of insurance will be family income benefit or family income policy, which also pays out only if the policyholder dies within a fixed period of time. It offers a choice of a lump sum or a monthly income, which is payable for the rest of the period, and the choice depends on when the policyholder dies and also on his or her family circumstances at the time.
These are both budget products for the prudent but poor. Those who can afford to pay a bit more could consider a whole of life policy, which pays out a lump sum when the policyholder dies, whenever that is, and are not limited to a fixed term. Unlike a term assurance policy there is always a payout and a beneficiary from the policy.
But once again the policyholder who actually pays the premium is the only person who will not benefit personally.
Traditionally whole of life policies have been with-profits policies with part of the premium invested in a mix of assets including shares, property, cash and fixed interest stocks to provide a guaranteed payout plus a terminal bonus. But the most popular form now is unit-linked and invested in shares, and the eventual sum paid out is based more directly on the success of the investments.
Policyholders choosing a whole of life policy can often select between a minimum option, which is mainly a savings vehicle with a low amount of life cover; a balanced option, which assumes the investments will grow fast enough to guarantee that the premiums will remain unchanged throughout the life of the policy; and a maximum option, which is increasingly popular because it gives the largest guaranteed payout for the cheapest premium. This option does require premiums to be reviewed, usually after 10 years and every five years thereafter, to make sure they are enough to cover the increased risk of an ageing policyholder claiming.
Whole of life cover is nowadays often combined with critical illness cover, which pays out if the policyholder suffers from a stroke, heart attack, cancer or other specified incapacitating illnesses. Premiums will be higher than a standard whole of life policy. But as many policyholders already have a whole of life policy, critical illness cover can also be bought as a free-standing policy, from the same or a different life company.
All these policies have one thing in common, however. They only pay out if something nasty happens to the policyholder. In order to enjoy a return on the investment the policyholder has to take out some form of endowment policy that combines a life assurance premium with a contribution to a savings plan, which is intended to build up a lump sum over a set period and then pay out.
Most endowment policies in recent years have been taken out for the specific purpose of paying off a mortgage, and we will look at them in this context next week.
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