Life Insurance FAQ
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Convertible term is the same as level term insurance, but with the extra option of being able to ‘convert’ the cover into another life cover plan, usually a whole life policy, offered by the provider at the time of conversion without any medical evidence and with guaranteed acceptance. The premium for the new policy will be based on your age at the time the convertible term plan is ‘converted’.
Family income benefit life insurance pays out a tax-free guaranteed regular income, usually on a monthly basis (but some insurers pay out quarterly or annually) in the event of your death. It can provide, for a relatively low cost, a guaranteed regular income for your family. It is ideal if you wish to provide for an income until a certain point. For example, until your children are financially independent.
The income starts the month after your death and is normally payable monthly thereafter for the remaining period of the term. For example, if your policy had a 20 year term, and you died after 3 years, the regular tax-free payment will be paid out for 17 years. The cover will end on a specified date, which will be detailed in the policy document. There will be no cash return, except in the event of a valid claim within the term of the cover.
You can choose to have the income indexed-linked. Unless there is a specific need for a level income, you should always take the option of an indexed benefit, in order to provide your family with protection against inflation reducing the ‘purchasing power’ of the income payments.
Point to Note:
A family income benefit life policy is designed to pay out a regular tax-free income, usually index-linked, in the event of the death of the insured person. It is common for an insurance company, at the time of a death claim, to offer a lump sum under which, the future income stream from the policy is commuted (swapped) for a one-off payment.
This lump sum offer may be tempting but it would probably not be in the financial interest of the surviving family to accept it, as it would mean giving up the guaranteed tax free income.
Level term is life insurance that pays out a guaranteed fixed lump sum on the death (or, if critical illness cover selected, on diagnosis of a covered illness) of the insured person within the term of the plan. The cover will end on a specified date. There will be no cash return, except in the event of a claim within the term of the cover.
If the premiums of the level term plan are guaranteed, this means they are fixed and will not increase for the duration of the level term plan, unless indexation has been selected at outset, in which case the premiums and the sum assured will increase in line with the chosen indexation. If the premiums are reviewable, the premiums can be increased if the insurance company has heavier than expected claims from its customers.
Mortgage Protection is a type of insurance where the amount of cover reduces over the term of the policy and for this reason, is cheaper than level term insurance. It provides for a guaranteed (decreasing) lump sum to be paid out on the death (or, if critical illness cover selected, on diagnosis of a covered illness) of the insured person within the term of the plan.
The lump sum benefit decreases each policy year usually in accordance with a set table laid out in the policy document. This type of cover is most commonly associated with providing cover for a repayment mortgage or loan, where the outstanding mortgage or debt balance reduces over the loan term.
It is not suitable for a non-decreasing debt such as an interest-only mortgage. The term of the policy would usually be the same as that of the mortgage it is intended to repay in the event of a claim. For example, a 25-year mortgage would have a 25-year decreasing term policy. The cover will end on a specified date.
There will be no cash return, except in the event of a claim within the term of the cover.
This is a form of life insurance that can only provide death benefits. It is set-up by an employer to provide life cover for an employee.
Crucially, there has to be an employer / employee relationship, so where this relationship does not exist, the cover cannot be taken out. For example a self-employed person cannot take out relevant life insurance on his or her own life. On the other hand, if someone is trading with a Limited Company, then the employees of that company (including the business owner, assuming he or she is an employee) can take out relevant life insurance. The main benefit of relevant life cover is that the premiums are paid by the Limited Company, and should be an allowable expense against Corporation Tax. In addition, the premiums are not subject to National Insurance by either the employer or the employee, nor are they counted as a taxable ‘P11D’ benefit in kind on the employee.
Renewable term life insurance pays out a guaranteed lump sum on the death (or, if critical illness cover selected, on diagnosis of a covered illness) of the insured person within the term of the plan. It is similar to level term assurance, but normally only has a term of 5 years.
Some insurance companies offer renewable term insurance for a term of 10 years. However, immediately prior to the expiry of the 5 or 10 year term, the insurance company will allow the cover to be renewed without any medical evidence and with guaranteed acceptance. The policy can usually be renewed in this manner every 5 or 10 years without any medical evidence, up to an age - which would be stated in the original policy - at which the insurer will not allow the cover to be renewed any further.
The premium will be fixed for each 5 or 10 year period, but upon renewal, the premium for the next 5 or 10 year period would be based on the age of the insured person at the time the cover was renewed, and is thus likely to get progressively more expensive. The cover will end on a specified date, which will be detailed in the policy document. There will be no cash return, except in the event of a claim within the term of the cover.
Whole life assurance is life insurance that, providing the premiums continue to be paid, will pay out on the eventual death of the insured person. It is a form of life cover that would often be considered for meeting a possible Inheritance Tax liability. It can provide a very large sum assured (at least for the first 10 years) if set-up on a joint-life second death basis.
Joint-life second death pays out nothing on the death of the first insured person, it pays out the sum assured on the death of the second insured person. It is possible to have guaranteed premiums (fixed-price) whole life assurance, but this can be expensive. A cheaper option, at least initially, is reviewable premium whole life cover, whereby the premiums are fixed for an initial period, normally 10 years, and can then be increased. The policy owner would usually also have the option of maintaining the premium, but reducing the sum assured. The premiums would then be reviewed at regular intervals by the insurance company. At each review, the premiums can be increased or decreased. If the policy owner does not wish to pay the increased premium, the sum assured can be reduced.
Not so common now, but older whole life policies may have a cash surrender or fund value building-up, in which case, the amount paid out on death (or, if the policy has critical illness cover, on diagnosis of a covered illness) is normally the greater of the cash-in value of the policy, or the guaranteed sum assured.
For example, if the cash-in value is £20,000 and the guaranteed sum assured on death is £50,000 the amount paid out on death would be the higher of the two figures. The insurance company would pay out £50,000 but would keep the £20,000 cash-in value.
If your policy has guaranteed premiums the cost of your policy will never increase. Premiums would only increase if you had chosen to have the policy benefits indexed.
If your policy has reviewable premiums the cost of your policy is not fixed and can be increased by your insurance company. This would typically be in the case where, even if you have never made a claim, if your insurance company has heavier-than-expected claims from its other customers. In theory, the premiums of a reviewable premiums policy could also be decreased.
There may be an initial period, for example, the first 10 years of a policy, during which your premiums are guaranteed not to be increased, but after which time, they can be increased. Reviewable premiums would usually be initially cheaper than guaranteed premiums. However, if you wish to retain your cover, you have no control over the future costs of a reviewable premiums policy.
Waiver of Premium Benefit
Waiver of premium is an optional, relatively low-cost, benefit. If a policy has waiver of premium, and ill health (see ‘definition of ill health’, below) prevents the insured person from working, the insurer will waive the premiums for the duration of the insured person’s illness, if necessary, until the policy ends.
The benefits of the policy are maintained, which means that if an insured event occurs (e.g. the insured person dies) the benefits of the policy are paid out in full. In the event the insured person recovers his or her health, premiums have to restart, but the premiums that were waived while the person was ill and unable to work are not repayable to the insurance company.
If the insured person makes a claim for premiums to be waived, there is usually a period of time, known as the ‘deferred period’, and premiums will not be waived by the insurance company until the end of the deferred period. A deferred period is commonly six months, in which case, the insurance company would waive the premiums (assuming the claim was valid) from the start of month seven. If waiver of premium benefit is not selected at outset, it normally cannot be added later. However, some insurance companies do allow it to be added upon request, but they may request evidence of good health.
Definition of Ill Health
The definition of ill health would be stated in the policy conditions. For example, the best definition of ill health normally is ‘an inability to carry out - for reason of ill health - the material and substantial duties of your own occupation’.
In the event you are unable to work due to ill health, there is a short period of time, known as the ‘deferred period’, before the waiver of premium benefit will start to pay the premiums on your policy. This is usually 6 months, but some insurers offer a shorter deferred period of 3 months.
During the deferred period, you will need to continue to pay your normal premium, but from the end of the deferred period, and for the duration of your inability to work due to ill health, the insurance company will pay your premiums for you, if necessary, for the full remaining term of the policy.
Many life insurance policies automatically include, at no extra cost, a benefit called ‘terminal illness benefit’. Terminal illness benefit should not be confused with critical illness cover. Terminal illness benefit means that if you are medically diagnosed as having less than 12 months to live, with no prospect of recovery, your life insurance pays out before you actually die.
It is therefore effectively an advance payment of the death benefit. Most insurers exclude claims for being diagnosed as being terminally ill in the last 12 or 18 months of a policy (but would still pay out for death), but there are a few insurers who provide terminal illness cover to the very last day of a policy.
A critical illness policy may also provide ‘total and permanent disablement’ cover, which pays out if the insured person becomes totally and permanently incapable, for reason of ill health, of working (see below for definition of ‘working’).
For the avoidance of doubt, total and permanent disablement cover would normally be in addition to the full range of named illnesses, and if the insured person is diagnosed as suffering from a named critical illness, they will be paid out, even if the illness does not result in their being totally and permanently disabled.
What does ‘total and permanent disablement’ mean?
Don’t be put off by the phrase total and permanent disablement because it does NOT mean (unless you have the ANY occupation definition) that you have to be unable to carry out any work whatsoever.
It depends upon the definition that is offered to you.
The five definitions are outlined below. The exact wording of your relevant definition would be clearly stated in your policy document.
This is the best definition. It means that you are unable by reason of illness or injury to perform the material and substantial duties of your occupation.
Material and substantial duties are those normally done in your occupation and which cannot reasonably be left out or changed by you or your employer.
Although not as good as the ‘own occupation’ definition, this is still a good definition. It means that you are unable to perform the material and substantial duties of your occupation and any other occupation for which you are suited by reason of education, training or experience.
Material and substantial duties are those normally done in your occupation and which cannot reasonably be left out or changed by you or your employer.
Aspects of Daily Work
This is a definition that may be offered if you have a higher-risk occupation. If the cost of the cover is not expensive, then it can still be worthwhile adding to your policy. It means that you would have to be unable to carry out a minimum number (typically 3) out of a list of 10 or so typical working tasks.
Aspects of Daily Living / Functional Ability Tests:
This is a definition that may be offered if you do not have a job or are a homemaker. If the cost of the cover is not expensive, then it can still be worthwhile adding to your policy. It means that you would have to be unable to carry out a minimum number (typically 3) out of a list of 10 or so typical aspects of daily life, for example, sitting, kneeling, bending, etc.
You are unable to carry out any work whatsoever. This is an extremely poor definition and by the letter of the wording you would have to be so severely disabled as to literally be unable to do any work of any description before the a policy with this definition would pay out. The Financial Ombudsman Service takes the view that this is an unfair contract term, and that it should be regarded as having a similar meaning to the ‘suited’ definition, above.
If your policy has a cash value, then it may be an option to make the policy paid up. This is an alternative to surrendering the policy.
The ‘premium’ is the cost of your insurance. A premium can be a single one-off premium, or could be payable on a regular basis, usually monthly or annually, but occasionally on a quarterly or half-yearly basis.
The sum assured is the guaranteed amount of money which will be paid out in the event of an insured event, e.g. death, critical illness, etc. happening to the insured person. Depending on the type of policy, and how it was set up, a sum assured can be paid as a lump sum or as an income.
An insurance policy, such as certain types of whole life cover, or an endowment, may have a cash value. If you no longer require the policy, it would usually be possible to take the cash value. This is known as surrendering the policy. Depending on the policy conditions, you may or may not be allowed to take out the full fund value of your policy if you surrender it. If there is a surrender penalty you will be offered a reduced encashment value.
If you have a policy with a life insurance company that goes into default, the Financial Services Compensation Scheme provides protection in the event of a firm going into default.