What is life insurance and how does it work?


Financial Guidance

There are a number of financial milestones you might reach in your lifetime – your first bank account as a child, insuring your first car, and maybe even getting a mortgage for your new home.

But there is one financial product that some consider to be the most important, and that's life insurance. Unfamiliar with this type of insurance policy? We take you through what life insurance is and how it works.

By definition

Life insurance is a policy that pays out a lump sum or a regular payment if the person covered dies. It is designed to give you peace of mind that your dependants – your partner if they don’t work or if you have any children – are looked after if you're no longer here. 

The amount of money your loved ones would get will depend on the cover you take out. You can decide how this money is given (in full or instalments) and whether it covers specific payments such as a mortgage or rent.  

There are two main types of life insurance, term life and whole-of-life.

Level term life – this type of policy runs for a set time and the amount of cover does not change during this period. If you don't pass away during the term of this policy, it lapses and you will need to take out a new one if you want to remain covered.

Whole-of-life – this type of policy will cover you for the rest of your life, as long as you keep up with your premium payments. This means your dependants will get a guaranteed pay-out when you die.

There are other types of life insurance cover including joint life insurance.

What does it not cover?

A life insurance policy will only cover you for death. If you have to stop working due to an illness or disability you won't be covered unless you add extra cover to your policy, such as long term illness or critical illness cover.

Most insurers will exclude certain things as well. For example, you're unlikely to receive a pay-out if you die as a result of drug or alcohol abuse. If you have a serious health problem at the start of the policy, your insurer might exclude a cause of death related to this illness. You might have to pay extra for cover if you take part in risky sports as well.

It's crucial to remember that life cover is an insurance policy and not a savings or investment product. There is no cash value available unless a valid claim is made.

Do I need it?

It's usually recommended that you consider life insurance if you have dependants. You might have a child and partner that rely on your income, or a house with a mortgage that you're still paying off. Or you could just want to make sure your family can cope with the cost of your funeral. 

Even if you're a stay-at-home parent, you might want to consider taking out a life insurance policy. This is because someone will still have to continue doing your daily tasks which might include childminding and household chores – and if your partner cannot take time off work to do them, they might have to pay someone else to do this.

You probably don't need life insurance if you're single and you have no mortgage, but it still might be worth thinking about a critical illness policy.

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