What is term life insurance & how does it work?

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When you’re looking for a life insurance policy, you may have seen the words “level cover policy” or “decreasing term cover”. But what do we mean by term life insurance, and how does it work?

In this guide we will explain each of these terms and discuss when they are commonly used.

The information on this page should not be considered as financial advice. If you are unsure what’s right for you, please make sure you speak to a financial adviser.

What is term life insurance?

In the context of life insurance, term means the length of time that the policy lasts for. This could be anywhere between 1 and 50 years, although different insurers may have set different minimum and maximum policy lengths and ages that can be covered.

There’s no specific policy that is just “term life insurance”, instead you’ll find three types of term life insurance: level, increasing and decreasing.

What is level term life insurance?

Level term life insurance is where the amount of cover on your policy, sometimes called the death benefit, remains the same throughout the term. This means the amount of money your beneficiaries get if they need to claim doesn’t change. Level term life insurance is ideal if you want to give any beneficiaries a sum of money to help with replacing your lost income, funeral costs or to cover any fixed debts they may have once you’ve passed.

However, with level term life insurance, it’s worth noting that the sum of money doesn’t account for inflation. This means that while the amount of cover you selected for the policy at the start may have seemed a good amount, it could be worth significantly less in terms of real-life value towards the end of the policy period.

What is increasing term life insurance?

Increasing term life insurance (also known as inflation-linked or index-linked cover) is where the cover amount goes up over the term of the policy. This type is most commonly used to protect the ‘buying power’ of the chosen amount of cover by helping to counteract inflation. This option is often chosen when a person wants to give their family a good sum of money, regardless of the economic situation at the time the cover is paid out.

With increasing term life insurance, the amount of cover either increases by a fixed amount every year, or increases are linked to an index (for example the Retail Price Index (RPI) or Consumer Prices Index (CPI)). The way the cover increases is commonly determined when you take out the policy, but some insurers may vary. Most insurers also increase the premiums throughout the policy as the cover increases, but again, this does depend on the policy and the insurer.

At LV= we don’t offer this type of policy directly through LV.com. If you would like to find out more, you’ll need to speak to a financial adviser. We’ve partnered with LifeSearch who will offer you independent professional advice based on your individual needs.

What is decreasing term life insurance?

Decreasing term life insurance cover is when the amount of cover decreases over the term of the policy. People with capital and interest repayment mortgages often use decreasing term policies as the money they’d need to pay off their debt reduces over time. This is because with a capital and interest repayment mortgage the regular repayment is made up partly of interest, and partly of the money borrowed, so the amount outstanding on the mortgage reduces as it’s gradually repaid.

Depending on when you pass away decreasing term life insurance may not give your beneficiaries as much of a payout, but if this is purely to help pay off a mortgage or other debt you’ve also been paying off, then this shouldn’t be an issue. Bear in mind that decreasing term life insurance premiums don’t decrease over the policy term, but are usually less than the cost of an equivalent level term life insurance policy.

How does term life insurance work?

Term simply refers to how long the policy will cover you for. Once the term of your policy expires, the cover stops. For people who have life insurance to cover a debt or a mortgage, this can be beneficial, as you know that for the duration of your policy, you are covered for the amount you need.

For example, if you had taken out a capital and interest repayment mortgage on your home, then you might choose a decreasing term life insurance policy for the length of your mortgage. Then, if you sadly passed away during the term of the policy, your beneficiaries would receive the cover amount specified in a lump sum, to help pay off the remaining mortgage.

This does depend on the type of term life insurance you have chosen.

Term life insurance vs whole of life insurance

Unlike whole of life insurance policies which last until you die, term life insurance policies will end after a set amount of time. You choose how long you’d like the policy to run, between the minimum and maximum period the insurer offers. Term life insurance policies are often cheaper per month than whole of life policies, as the risk of the insurer needing to pay out is lower.

However, some may see whole of life insurance as a better choice over their lifetime, especially if the reason for taking out the cover is one that will remain for their lifetime (for example to help cover funeral costs). It very much depends on your personal circumstances and the reasons you want a life insurance policy.

Please note that at this time, LV= does not offer a whole of life insurance product.

What are the benefits of term life insurance?

The primary benefit of term life insurance for many people is the cost. As term life insurance policies have no payout, cash value or benefits past the end date of the policy, the monthly premiums are often considerably lower than an equivalent whole of life insurance policy.

The other benefit is that if something were to happen during the term of your policy, you would get the money needed to pay off any debts and/or for your loved ones to live comfortably.

What are the downsides to term life insurance?

Perhaps the only downside to term life insurance is the fact there is no payout or cash value at the end of the policy term. If you had been using a term life insurance policy to cover your mortgage, for example, then this may not be an issue for you as hopefully you will have repaid all your mortgage debt by the end of the life insurance policy.

Depending what type of term life insurance policy you choose, the amount of money your beneficiaries receive might be less than you expected.

What term life insurance policy should you get?

It’s completely up to you which policy you should get and it very much depends on your circumstances and personal choice.

As an example, when you take out a mortgage, your mortgage broker or lender may ask you to consider a life insurance policy, especially if you have dependants living with you. The choice a lot of people might go for here is a decreasing term life insurance policy, as it is often cheaper each month, and the cover aims to decrease in line with the amount left in your capital and interest repayment mortgage.

Speak to LV= for term life insurance policies

We offer life insurance policies from just £5 a month, with all claims aiming to be paid within 3 days of our final decision. Learn more about our application process, or if you want to get a quote, you can get a quick quote in just a few minutes here.