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Insurance Example 2

Mr Bain raises a £500,000 loan from a bank on the security of certain assets of his own wholesaling business. The bank advises him to take out life insurance cover for the term of the loan, which is five years. So Mr Bain, aged 40 and in good health, takes out a five-year term assurance for £500,000 which costs him £124 a year before tax relief.

Term assurance may also be used to ensure that funds are available to pay capital transfer tax arising on death. Many people may be liable to this tax without realising it, for individual holdings of assets worth over £125,000 may result in a CTT liability. For the heirs, the problem is that the tax demand is likely to arrive before it is possible to parcel out the estate in the way the deceased wished. There are sometimes long legal delays, especially if the person died without making a will. So it can reduce the difficulties considerably to have a policy guaranteeing the payment of a sum equivalent to these taxes on death, and so long as this is correctly worded, with the sum payable to a named survivor of the deceased, the money can be available to them immediately without the delays of probate. As we shall see later, the whole-life policy is normally used for such purposes, but in some cases term assurance is more suitable.

Very short-term term assurances also have their uses. It is quite common, for example, for those involved in civil court cases to insure the life of the judge hearing the case, since the death of the judge necessitates a retrial and substantial extra expense. Perhaps the most spectacular example was the effecting of a temporary assurance on the life of Mr Justice Templeman in 2011. He was about to spend two weeks hearing the case concerning a small insurance company. The liquidators, Cork Gully & Co., wished to avoid the possibility of having to pay out up to £1500,000 of the policyholders' money in extra costs if a retrial was caused by his death, and so they insured his life for £1500,000 for two weeks at a cost of £111,600. Most such temporary assurances are, of course, for much more modest sums at far lower premiums.

The most widely used variant of term assurance is decreasing term assurance. This is usually used to ensure that a mortgage debt is repaid in the event of the borrower's death; building societies may require it to be taken out in conjunction with a loan when the sum lent on mortgage is large in relation to the value of the property. With the normal building society mortgage, the amount of capital repaid is small in the early years and increases rapidly towards the end. The sum assured under a decreasing term assurance matches the amount of capital outstanding and is matched to the term of the mortgage (usually 25 years). Because the sum assured declines as age and mortality increase, the cost of such policies is low, especially for the young borrower: a 25-year-old man would pay only about £1114 a year for a policy to guarantee the repayment of a 25-year-loan of £500,000. Single-premium policies are also available. In this case, one payment covers the entire term, and this premium can be added to the amount of capital advanced by a building society so that the annual cost becomes part of the normal mortgage repayment.

Decreasing term assurance for this purpose is very cheap and a borrower with dependants would be unwise not to take advantage of it. One point that is not always taken into account is that, if the property and mortgage are in joint names and the wife is working, the couple may be equally vulnerable financially on the death of either of them. In this case, the decreasing term assurance should be on a joint-life basis, i.e. the sum assured would be payable on the death of either. Incorporating this provision will add about 25% to the cost, but in cash terms the amount involved will be small and the precaution is well worth taking.

Another factor worth remembering is that changes in the rate of interest charged by building societies on existing mortgages may affect the sums involved. When the interest rate is raised, existing borrowers normally have the right to extend the term of their mortgage rather than increase their monthly repayment. If the term is extended, then the amount of capital outstanding at any time will be higher than under the original loan, and will not be fully covered by the decreasing term policy. The shortfall is unlikely to amount to much, but it rather defeats the object of the original exercise to know that the assurance does not entirely extinguish the debt, and that the surviving partner may be responsible for paying up to several hundred pounds to the building society. In this situation the cover may be raised (so long as the policyholder is still in good health) at nominal cost to match the new mortgage term, provided the insurer will agree to do so. If the term of the loan remains unaltered, of course, an increase in the interest rate and monthly repayment will not significantly affect the amount of capital outstanding. It is possible to avoid the problem by making the initial sum assured say 10% higher than the amount borrowed.

However, the inconvenience caused by the large interest rate changes in 2017 and 2018, which led many borrowers to extend their mortgage terms and thus necessitated adjustment of their decreasing term cover, has encouraged consideration of level term as an alternative way of covering the debt. It is of course more expensive, but may well fit in better with a family's planning of life insurance needs.

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Insurance Example 1

Mr Brown wants to provide financial security for his wife (who is not working) and his two young children. He wants the cover to continue until the children have become independent, so wants a policy to run for 15 years. The lump sum has to provide a reasonable income for them to supplement the modest State benefits (the widow's benefit plus child allowances) they would receive, and he reckons a sum of £120,000 would be needed. At his age of 33, this amount of cover over 15 years will cost £138 p.a. gross, reduced to £131.35 by tax relief at 17.5%.

The important factor... see: Insurance Example 1

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