Protect and survive survey: When life is not so sweet

LIFE INSURANCE is arguably the one financial product to which the word "essential" could be applied. While the effect of an unexpected death is emotionally shattering for surviving relatives, that distress is multiplied if a family then finds itself in the midst of a personal financial crisis.

The cost of life insurance has been falling at an unprecedented rate. Not only are people living longer but companies have been indulging in a cut-throat war to attract business. The type of life insurance to take out requires careful thought and the difference between the cheapest and most expensive can be marked.

Financial Discounts Direct, a discount broker, can quote a monthly premium of pounds 8.50 from Guardian for a non-smoking female aged 30 next birthday to assure a sum of pounds 100,000 for a 25-year term. This compares with pounds 10.95 from CGU Life.

Term assurance is the simplest and cheapest form of life insurance. It involves taking out a policy which will pay out if the holder dies within a set term.

A variant, family income benefit assurance, will pay a regular income for however many years are left on the term. Buying a combination of both enables outstanding liabilities to be covered by the lump sum while the income is there to provide for dependants' futures. For both these the level of premiums and the level of payout remain the same over the term. The cover ceases at its end and premiums are not returned.

So-called "whole-of-life" insurance is more expensive but can provide cover for a lifetime. As with term assurance the policyholder pays premiums for life cover to pay out an agreed sum on death. Every 10 years or so the policy is reviewed and a new level of premium set. The level of payout and premiums can be inflation-proofed but as policyholders age premiums can rise sharply.

To cover this whole-of-life policies usually enable policyholders to pay an extra, variable sum, into an insurance fund or funds. The idea is that as the level of premiums starts to spiral, money invested is used to help cover increases.

If written in trust these policies can be used as a means of paying off children's inheritance tax liabilities by using a joint life policy which pays out on the second death.

Mark Howard, managing director of independent financial adviser Maddison Monetary Management, says: "The main thing in choosing the type of cover is cost. Term is the cheapest but whole-of-life can be more flexible. It can be altered if you have children within each 10-year review period."

The next question is how much cover to take out. Kim North of Independent Financial Adviser Pretty Financial, says: "The old-fashioned rule of thumb was to take out 10 times your income. In today's age that may be a bit extreme. Young families should have five times their income worth of cover at the very least."

The one form of life cover most people are likely to have is taken out to cover a mortgage. For a simple repayment mortgage, term assurance is most appropriate. But for interest-only mortgages there are two options, depending on the savings vehicle being used to pay off the mortgage.

An endowment comes with life cover as standard. As the funds invested in it grow, the cost of cover drops as the amount needed to pay off the mortgage as a result of early death falls.

But mortgages that are linked to investment vehicles such as the new Individual Savings Account can be considerably cheaper. The life insurance is bought separately, enabling people to shop around for the cheapest cover.

Endowments are also less flexible. If times get tough you cannot dip into an endowment to help out, unlike an ISA.