Life cover – explained

Clients ask me quite a lot to explain what their particular life cover plan does (besides pay out if they are dead), so today’s blog is an explanation to the different kinds of life cover and bells and whistles that you can get today. The plans I deal with today only pay out on death. I will talk about plans that pay out in other scenarios in a future blog.

Level Term Life Cover

The most common kind of life cover. You take out cover for a fixed amount and for a fixed number of years. The premium and the cover does not change throughout and if you are still alive at the end of the policies life, your reward is you are not dead. €250,000 cover for 25 years for 40 year old husband and wife would cost €53 per month.

Indexed Linked Term Life Cover

Under this cover, the level of cover increases each year and so does the premium. How much it goes up varies per provider. The lowest is the cover and premium both increase by 3% each year. The highest is the cover increases by 5% and the premium by 8%. So be aware. Cover that is the cheapest in year one will most probably be much more expensive over the term of the policy. Using the example above, the initial premium for cover that increases by 3% for cover and premium each year is €75 per month and the final premium is €152 per month. The cheapest initial premium is €56 per month but the cover increases by 5% and the premium by 8%. At the end of the term, the monthly cost is €353. In total, you would pay an additional €16,100 over the term of the policy by going with the “cheapest” initial premium.

Mortgage Protection Cover

As the name would suggest, this cover is typically bought when getting a mortgage. The level of cover reduces over the term of the policy, not exactly in line with your mortgage, usually assuming a mortgage interest rate of 6% per annum. It is usually assigned to the bank as a condition of you receiving the loan. As it is assigned, you cannot cancel it without the banks permission. Should there be a claim, the bank will take what they require to pay off the mortgage and any surplus is paid to the deceased’s estate. Using our example, this will cost our 40 year old couple €41 per month.

Conversion Option

This is about giving you choice. By adding the conversion option to your life cover, you have the choice of extending the term of your cover in the future without any medical underwriting requirements. Now, when you extend the cover, you in effect take out a new plan and it is priced at your age at that time but no medical evidence is required, so you can imagine, it is very useful if you are healthy now and you develop a serious illness in the future and need life cover. To have this choice does come at a cost, usually an additional 7%. In our example, the cost of level term cover (remember what that is?) has gone from €53 per month to €58 per month.

Monthly Income on Death

This is relatively new to the Irish market and I am a big fan of for a couple of reasons. Usually on the pay out of a death claim, the surviving spouse is given a cheque for hundreds of thousands of euro and that is what they have to live on. What do they do with it? Put it all on deposit and risk inflation eroding the real value of it? Invest some of it? But what if there is a market crash? There is a lot of worry and uncertainty on how to manage such a large amount of cash. With the monthly income on death plan, you chose at outset a monthly amount that is paid out to the surviving spouse on death. It is then paid as a tax-free income for the remainder of the term. No more worries on someone blowing the money or bad investment. For our couple, they will receive a lump sum payout of €25,000 on death along with a monthly income of €1,000 per month for the remainder of the term and pay €44 per month.

Whole of Life Cover

Whole of life cover means is life cover without an end date. As long as you continue to pay the premium, the insurer will provide the cover. Typically this is used if on death, their children will be left with a big inheritance tax bill, especially if their inheritance is mostly in illiquid assets. You can take out a policy that is designated at outset as being used to pay the tax bill to the Revenue and so the proceeds of the policy does not form part of the taxable assets of the estate. Another use of a whole of life policy is if you have someone you want to provide for after your death. For our 40 year old couple, €250,000 whole of life cover which is indexed linked (you have to index linked something that might last another 50-60 years), will have an initially premium of €219 per month. It is expensive.

Unit Linked Life Cover

This is an old form of cover that is not used much anymore but some people may have some in place. These plans are made up of two elements, a life cover plan and a savings plan. The idea is that your money is invested in a fund with the insurance company and the cost of the life cover is taken from this fund. There is an assumption that the fund will grow by 6% per annum but we all know that markets don’t go up in a straight line like that. The insurer revalues the cost of the cover every 5 years. If the savings fund has not performed well, there is a massive premium increase to maintain the cover. As the cost of the cover increases as you get older, the more reliant you are on the fund to perform to maintain the required level of cover. I am not providing costs for this as they aren’t used very much any more.