Distinguishing between two types of Life Cover

8/8/2007 4:57:32 PM

This editorial will continue our discussion about Long term insurance. I want to focus on two types of cover: Term and Whole Life insurance. What does it mean, how do these differ and what should you be looking out for?

Term vs Whole Life

Term insurance generally refers to life cover which is limited to a specific period. The term may be for 10, 20 or 30 years or to a specific age i.e age 65. Let’s say for example you buy a house and take out a loan at a bank. The loan amount is R500 000 and the repayment period is 20 years. You can take out term insurance for the R500 000 for 20 years. This means that if you were to die within the 20 year period an amount of R500 000 will be paid out to your estate or to the nominated beneficiary which could be the bank. This then serves to settle your bond.

The advantage of this kind of cover is that you fix the amount and the premiums (premiums can escalate over time) so you know what you will pay and you know what you will get if you where to die within the specified term. Because the time period is limited and typically the insurance company will not have a definite payout, this kind of insurance is usually cheaper.

The disadvantage however is that after 20 years the insurance falls away. You have paid premiums for 20 years and did not claim from the insurer thus you loose your cover. You may also have accessed some of the repaid bond after say 10 years and extended the repayment period but did not change the term policy. Now you may still have outstanding debt and no cover.

Whole life cover on the other hand pays out at death regardless of age or term hence the term whole life. As long as you pay your premiums you have cover. If you die at age 70 your estate or beneficiaries will receive the insurance payout. You are guaranteed (if the conditions of the policy are met) of a payout.

The disadvantage of this kind of insurance is that you pay premiums when you are retired which increases your household expenditure at a time in life when you need to reduce your fixed expenses’.

The advantage is however that very often the insurance payout received at a spouses death helps to reduce the financial burdens when one is in the last phases of life. Financial compensation can never console one at the loss of a loved one but providing for loved ones financially is a necessity.

So which one is best, Term or Whole life? Well the answer depends on your specific need. If you have a specific debt to cover or if you know somehow that you will have sufficient financial assets at some stage in future to make you financially independent, then term insurance is appropriate. Be careful however that your term insurance does not expire at a too young age.

Whole life is appropriate for most people since we do not know when we will die and secondly our families may need the financial injection if we were to die.

When determining what kind and how much life cover you need, do not forget to take your group life cover into account. If you are employed and belong to a pension or provident fund, chances are that you may have group life cover. A pension or provident fund will shop for insurance on behalf of their members. Because they include all their members, an insurance company may provide life cover at substantially reduced rates to the members. You still pay for the cover but at much cheaper cost. Another advantage is that the premiums are paid with pre-tax money although the disadvantage is that the insurance payout will under these circumstances be taxable.

There are different options when taking out life cover. One can take out cover with increasing premiums which means that the premiums are lower when you are younger and earn less money and increase over time. The advantage is that you have sufficient cover when you may not be able to afford the full amount. The disadvantage is that when you get older the cover can become very expensive.

It is good to start early with life insurance because the younger and the healthier you are the cheaper life cover is.

A word of advice, many policies called endowment policies, combines life insurance and savings. In my opinion this is not the best way of saving. Life cover on its own is fairly inexpensive but using policies as a way of saving can be an expensive vehicle. I am not saying this is true in all cases. In my opinion savings though unit trusts or other direct investment products has many advantages over endowment policies but this is a topic for another day.

Next time we will look at disability cover and how insurance companies differ in this regard.