It was reported last week that the Department of Finance is going to examine the reviewable whole of life life cover policies. I read about this on Twitter and got into a discussion with a couple of journalists, asking why the need to review a product that is largely obsolete? I was told that these products were mis-sold to customers, despite the Financial Ombudsman receiving over 700 complaints between 2010 and 2014 and not finding any cases of mis-selling. It seems that policyholders want a pay out from these plans. Given we are talking about life cover, they will have to be dead for there to be a pay out.
I strongly disagree the need to pay into a life cover plan past retirement (there are some exceptions) and that people with these expensive policies should simply cancel them. I want to look at what life cover should be for but I will start with looking at what a reviewable whole of life policy is.
A reviewable whole of life policy is a life cover plan that is open ended and as long as you continue to pay the premium, the cover will be in place. There is a savings plan element to it so the policy does accumulate a value which you can cash in at any time. The cost of the life cover is deducted from this savings plan.
The idea is that when you are young, the chances of you dying is low, so the cost of the life cover is very cheap. This gives the savings element a chance to grow over time. The cost of the cover is actuarially reviewed over time and as you are older, the chances of you dying increases, so the cost goes up.
The problem is that the savings fund hasn’t increased by enough to cover the additional expense of the life cover so the fund empties out. Policyholders then get letters saying that if they want to continue with the level of cover, they have to pay hundreds more per month. Or if they want to maintain the premium as it is, the cover will be drastically decreased. These high costs tend to come when the policyholder is in their 60’s and retired, so the cover ends up being too expensive to maintain.
These products are very poor value and life companies have long seen that they don’t work; that is why they have discontinued them. When I started working, I remember seeing the cost of life cover eating into people’s fund values and thinking what a bad policy these were. They were literally using up all the value of people’s pensions (the reviewable contracts were available through pension plans too) at a time when they needed their pension plans to grow, not shrink.
Now we will have a look at what life cover should be used for:
We have a number of years that we will earn an income. This is called Human Capital. We start off on a low salary and expect it to increase over our working lifetime. We also have no savings, which we call Financial Capital. As time goes on, our Human Capital reduces and our Financial Capital should increase (or our ability to generate Financial Capital increases).
When we are a long way from retirement with decades of salary to earn and very little savings, we need to protect that income, especially if you have a young family. As time goes on and your Financial Capital increase and your children become more independent, the level of life cover required reduces. When you get to retirement, you now have unearned income to live off, so there is no need to insure lost salary.
The other big need for life cover is to pay off debts on death. When settling the affairs of an estate, the debts must be paid off before any assets are distributed to the beneficiaries. If you have a mortgage, the bank will want payment, so people take out mortgage protection policies to pay off the bank upon death so they won’t be repossessing the home of a grieving widow(er). If you have your mortgage paid off, there is no need for this cover, so most people just cancel them. The same can apply to car loans or if you have other debts but no savings. These debts will have to be paid out of your estate first.
A common reason for continuing to pay into life cover plans is to leave an inheritance “to the kids”. If you live into your 80’s, these kids will be 50+ years of age and probably have their own family. They have taken care of their own lives and are certainly not waiting for the day they will get the proceeds of a life cover policy. They certainly wouldn’t want to see their parents going without now so they can benefit from a life cover policy at some unknown date in the future.
It doesn’t matter if you have a reviewable contract or an ordinary term policy, if you no longer have to protect lost income or pay off debts, there is no need for life cover. Life cover is insurance in the case of a catastrophe ie you die prematurely. If it doesn’t pay out, you are still alive. That is a good thing.
If you have any questions, drop me an email at firstname.lastname@example.org