Insurance has played an important part in trade and commerce for thousands of years. For the insured, it represented a guarantee of compensation for lost goods and property, for the insurer, it was a calculated gamble that the money collected would outweigh the total of losses for which the insured needed to be paid.
Life insurance is a different concept because it’s not about assets but people. The origins of life insurance can be traced to ancient Rome and the burial club created for his soldiers by the Roman military leader Caius Marius. The idea was that the members of the club would pay the funeral expenses of a comrade who was killed and the incentive for taking part was the knowledge that everyone who paid in would receive this death benefit.
Today, life insurance is a much more sophisticated product. Nobody wants to talk about death – their own or that of their loved ones – but the way to look at life insurance is to put the emphasis on life. By insuring your own life, you make it possible to help your family, by removing from them the burden of your debt and to give them a significant financial boost. These are positives that arise from a time of grief.
Most of us have people who depend on us in some way and in the case of children, spouses and other relatives, that dependence involves money. Should you die, your income comes to an abrupt halt, leaving your dependents to plug what could be a considerable hole. Life insurance is an extremely effective protection against this. There many kinds of financial responsibility that will otherwise go unmet, such as mortgages, loans and credit card balances, as well as day to day living costs, utility bills, student fees and more. There are even funeral fees to be paid and inheritance tax obligations to be fulfilled. The right life insurance policy will provide the means for those who survive you to meet these multiple demands.
It is an agreement with an insurance company, the terms of which stipulate that the person insured will pay prescribed regular premiums and the insurance company will pay a specified amount on the death of the insured.
There are essentially two types of life insurance: whole and term. Whole life policies last for the lifetime of the insured and pay out upon death, whenever it occurs. In some cases, they include an investment element to increase the cash value.
Term policies last for a predetermined period, typically 20 or 30 years. They are generally favoured by people who have very specific and time-limited financial obligations. Some policies include an option to renew at the end of the period but occasionally you will be required to undergo a medical examination.
As you would expect, because life policies last longer and will always have to pay out, they are more expensive than term policies.
Not everyone will need to purchase life insurance. For example, it would be unnecessary for a single person with no dependents who has sufficient reserves to cover their debts as well as the costs associated with death. Equally, someone with significant personal wealth may be able to provide for their family independently.
Such people tend to be in the minority. The rest of us have financial responsibilities that require a continuous source of income to discharge. Supporting children or other dependents and covering mortgage or loan repayments are the most obvious examples. But it’s possible that you’re a signatory to co-signed debts such as private student loans, the entire burden of which will fall on the other co-signatory should you die. Even if you have no family apart from your spouse, life insurance coverage will provide invaluable protection for them.
The proceeds of any life insurance policy can, of course, be used to pay off outstanding mortgage balances, but there are specific mortgage life insurance policies you can take out at the same time as the mortgage itself. If your sole concern is the security of your home then these can be a cost-effective solution. They are structured so they provide sufficient funds to repay the outstanding debt at any given point in the life of the loan. This means that as the balance you owe falls so the pay-out decreases. This kind of policy is called decreasing-term life insurance. It will pay off the residual amount remaining when you die, but this will not leave any additional money for your dependents. You’ll find a mortgage life insurance calculator or quotation service on many well-known insurance company websites.
If you’ve carefully considered your obligations and your financial situation and concluded that life insurance is something you need, the next question to ask yourself is how much. Only you can answer this, but to do so you’ll need to make some calculations, so we’ll look at these next.
The best way to start is to identify all those people whose positions would be affected if you were suddenly not there. How would their finances by affected? Are some of them essentially self-sufficient, making any help you could give desirable rather than necessary? Would others be unable to maintain their standard of living or pursue settled plans without your support?
Most financial experts suggest as a rule of thumb that you should take out a life insurance policy that will pay out the equivalent of between 10 and 15 years’ worth of your annual income. This is only a starting point, but it is a very useful basis on which to build your personal model.
If you earn, for example, £50,000 per annum, then you should be looking at coverage between £500,000 and £750,000. This takes no account of inflation over such a long period and although we have enjoyed low inflation for over three decades it always lurks as a threat, capable of soaring as it did in 1980 to 13%. Current volatility in the economy suggests we could reach this level again. Even a rate of 10% would significantly erode the pay-out value of your policy. If you apply a 10% annual compound interest rate to the £50,000 salary you’ll find you need to add a further £80,000 to the policy value.
Of course your policy will be dependent on the premiums you can afford. If our example above makes this solution seem unachievable, don’t be discouraged. We’re talking about the ideal scenario. Any provision you can make is better than none, so take these kinds of figures as an ambition then tailor your policy to the affordable reality.
The multiplication of income is the simplest way to arrive at a reasonable figure but there are other methods. You can be more specific with the income calculation by basing it on the number of years you would expect to keep working until retirement, which may be much longer than the 10-15 suggested above. Alternatively you can put an annual figure on what your dependents will need and multiply it by the number of years they’ll rely on it. The idea is that the total sum insured can be invested and the dependents can draw on it annually.
A slightly different approach to arrive at a minimum level of coverage is to focus on debt, income, mortgage and education (or those of the four which are relevant to you). The purpose of this method is to ensure there will be enough to cover all debts, including any outstanding mortgage, then to pay any school or university fees, and finally to replace your income at least until the youngest of your children is able to earn their own living.
In every calculation you should take account of your assets. If you have dependents you won’t want to include your home in this list, but you should certainly set any savings against the amount promised in the policy because this money will go to your loved ones in addition to any pay-out.
It’s easy to find simple tools to decide on how much for life insurance will be enough for you. You simply have to key in some very basic information about the amount of cover required, the length of the policy and the level of premium you can afford. It’s important to remember that for the most accurate life insurance calculator UK sites are essential.
You may be directed to American calculators which may not give you such a reliable result.
Many people believe that life insurance should be taken out when you’re young, like a pension. This isn’t strictly accurate. It’s certainly true that premiums tend to be cheaper the younger you are, largely because the insurance companies are gambling on how long you’ll live and people in their 20s are a better risk than those in their 60s. But any comparison with pensions is unhelpful because the best they can offer is a forecast of how well your pension investments will perform. That impossible to know since no one can accurately predict long-term interest levels or the state of the investment market.
Life insurance is based on an agreed pay-out, so you have the certainty of knowing what the return will be. It’s therefore quite possible to take out life insurance at any age. As we’ve said the premiums will be higher because the risk to the insurer is higher, but it’s fairly rare for any insurance company to refuse to cover you if you are willing and able to pay those premiums.
Many insurance companies provide dedicated policies for the over 50s which offer guaranteed acceptance and a fixed pay-out whether you die in the first few years or at the end of the term. Premiums will be fixed to make budgeting easy. If you need to consult an over 50 life insurance calculator UK websites owned by insurance companies provide these as well as personalised quotation services and you can use Free Price Compare across multiple providers.
A standard life insurance policy won’t be any use should you become disabled and unable to work. However, it is possible to add elements such as critical illness cover, which closes this loophole. Adding it to your main policy is usually cheaper than taking out a separate one. Critical illness policies cover a range of the most common serious conditions such as cancer and heart disease but you should always check to see what’s included and ask for amendments if anything is missing which you think you need.
Funeral costs are not something most people want or need to think about, but ultimately someone has to pay. According to a report prepared by Sunlife called the Cost of Dying, the average cost of a basic funeral is £4,056 . You could either factor this sum into your policy or consider a separate funeral plan. The advantage of a specialist plan is that the insurance company will usually liaise with the undertakers and other parties involved in the funeral process, taking that administration burden away from your family.
Many employers offer life insurance as part of the remuneration package for their employees. This usually takes the form of a ‘death in service’ policy which remains in force for as long as you are employed by the company but it will end as soon as you leave its employment. It’s certainly worth factoring this into your calculations and reducing your private life insurance accordingly, but remember its limitations and should your employment circumstances change, you would be wise to increase the cover under your own policy to replace the value lost.
There are many independent financial advisors you can pay to give you more detailed guidance on your specific needs and aspirations. You can also ask a qualified member of Citizens Advice for equally independent advice which is also free.