It’s easy to get life assurance quotations and it looks like a simple commodity. But you need to think smart get the best-value protection package for your family.
Most online life assurance quotation engines ask if you want level term assurance. This is the cheapest, plain-vanilla product. Then they ask if you want to add Critical Illness (CI) cover, which pays out a lump sum if you’re diagnosed as having one of a long list of horrible life-terminating illnesses.
You may well think: ‘Yes, if I got cancer I’d like the mortgage paid off’, and try adding enough CI to do that. It looks a bit expensive, but you think: ‘At least I’d get to live out my last days without financial stress’ and hit the ‘Accept quote’ button.
There is a better way to get protected
If you think: ‘Well, that’s too pricey, but I’ll investigate further’, the rep who calls to follow up your quote will find out what you’re really prepared to pay and tailor a combination of term assurance and CI you’re likely to buy.
Stop right there. There is a better way to buy protection and it will cost you less money.
To explain this, I’m going to use the example of Tim, who’s a 30-year old advertising manager in Swindon and earns £40,000 a year. Tim and his wife Carol own a house worth £250,000 with a £100,000 mortgage and one daughter Emma, aged 4.
In what follows, I’m going to ignore Carol, just in order to keep it simple without too many numbers - with two lives being covered it gets complicated, but the principles are the same.
Focus on your objectives
Think about what Tim’s trying to achieve. He wants to get enough cash in the bank if he dies to pay off the mortgage and see Emma through to adulthood. That’s the prime objective. Now consider the less important objective: to get a payout if Tim becomes so ill he can’t work.
Tim’s chances of getting one of the illnesses covered by CI during the period of cover (in this case up to age 60) are quite low. But they are still a lot higher than the chance of him dying. So CI cover is about four times as expensive as life cover.
Now there’s an even greater likelihood of Tim being too ill to work but not having a life-threatening illness. So if Tim does want extra protection, insuring an income benefit if he’s unable to work because of illness is a better buy. Its scope is far wider. And combining this with term assurance is cheaper than buying CI.
Insure your income before critical illness
If Tim was to buy £200,000 of life cover plus £100,000 of CI, he’d pay £29 per month (he’s a non-smoker in good health). If instead he was to buy £200,000 of term assurance plus an Income Protection (IP) insurance policy with a benefit of £2,000 per month, he’d pay £23 per month. That’s on the basis that the IP policy only starts paying out after a six-month period of illness – if it pays out sooner, the premiums are higher.
So the IP plus term assurance package will cost Tim about 20% or £72 a year less than CI plus term assurance, a total saving of £1,440 over the life of the policy.
The monthly tax-free IP payout is more than enough to take care of the mortgage payments, and since the payout runs to age 60, the mortgage should be paid off if Tim suffers a long-term illness.
Get the same result at less cost
Suppose instead that Tim gets a critical illness that kills him off after three years. Then the IP policy pays its monthly benefit up until death and then the term assurance pays off the mortgage.
So the combination of term assurance and IP gets you to much the same result as term assurance plus CI, but at lower cost and with wider cover. With IP, you can make multiple claims - once you’ve started the policy the insurer can’t cancel it, and whatever happens to your state of health you still stay insured so long as you pay the premiums.
With both IP and CI, insurers do pay attention to the medical questionnaire. If you’ve had serious illness in the past, or your parents died young, or you’re overweight, you may well find that the insurer asks for a higher premium. They don’t really bother with this stuff for term assurance because even if he’s unfit, a 30-year old is still most unlikely to die before age 60.
Swap a lump sum for an income
The only thing you don’t get with term assurance plus IP is the lump sum on diagnosis of the life-terminating illness. In practice, though, today’s medical technology means people in this situation are likely to live several years, and simply having a replacement income is a satisfactory solution.
Both CI and IP policies are available with guaranteed premiums or reviewable premiums. Reviewable premiums can be lower, but often not by much - no more than 5-10%. I strongly recommend guaranteed premiums, since if there are significant changes in claims levels over the next decade, reviewable premiums could rise sharply, and it’s hard to see any reason why premium levels would fall.
