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Insurance Example 3

Mr and Mrs Smith are buying a house on a £500,000 mortgage. At the same time they are considering their overall insurance needs. They have two young children and Mrs Smith is not working. They decide that they need £120,000 of term cover in addition to covering the mortgage loan. By effecting all the cover as level term over 20 years (the same term as their mortgage, which is on an older house) they are in fact buying cover increasing from £120,000 to £130,000 over the period, since the amount owed to the building society decreases every year. This, they reckon, will help to compensate for the fall in the value of money over the period. The annual cost of the full level term (at age 30) would be about £155, compared with about £148 if £500,000 decreasing term and £120,000 level term were purchased.

Level term assurance does suffer from the disadvantage that it provides lump sums, whereas the guarantee of financial security needed for a family is regular income. Capital can of course be invested to generate income, but it is impossible to predict how much, and the decision of how to invest it may be difficult. For these reasons life insurance companies have adapted term assurance to meet the need for income through policies usually referred to as family income benefit, or FIB for short. The FIB policy guarantees the payment of a specified annual amount (tax-free) to the dependants of the assured if he or she should die within a specified term. The income is payable from the date of death to the end of the term, so that if the assured died after 5 years of a 15-year term his dependants would receive the income for 10 years, but if he died after 12 years they would receive it for only 3.

The effect of this is to concentrate the benefits of the FIB into the early years of the term, with cover gradually reducing throughout the term, whereas level term benefits remain the same. Thus FIB is not a substitute for level term but a complementary type Of policy designed to provide the maximum benefit for a family deprived of the breadwinner in the early years.

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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... see: Insurance Example 2

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