One of the more complex financial products is a life assurance policy. You need to understand the definitions of the benefits taken and the conditions under which they will be paid out. You also need to be aware of the various exclusions that are applied. The explanations have over time been simplified but you still need to study the policy carefully so that you know what to expect in the event of a claim.
Here are some answers to questions which should help you understand the broader aspects of life assurance.
What is the purpose of life assurance?
Life assurance is a provision in your financial plan which becomes available in the event of you dying, becoming disabled or contracting a severe illness.
It follows the basic principle of insurance where a group of people contribute to a pool which pays out should anyone have a life changing event. Those that claim are effectively subsidised by those that do not. It’s about paying a small premium to cover you for a large amount should something happen, thus taking away the financial risk. Ironically, you do not really want to claim from this policy. You really are paying for peace of mind should some happen.
How much cover should you have?
The payout is normally a lump sum which should be enough to pay off all your debts leaving enough behind to maintain the lifestyles of you and your dependents well into the future. Make sure that you include enough cover to wind up your estate. There are certain costs and debts which need to be paid when you die and if you do not have sufficient cash available in your estate then your executor may need to sell off assets which may not be ideal. Don’t underestimate the effects of inflation on your provisions over time.
How long do you need assurance?
You need it for as long as you are in debt and have dependents.
If life assurance makes a capital provision for a life changing event at a time when you do not have the money, then you need to have the cover for as long as it takes you to build up your own capital through your investments. Let’s face it, assurance is very expensive if you never use it. The price you pay for the cover depends on your age. So the older you get the more it costs. Ideally, you need to wean yourself off the dependency of assurance as your wealth growths over time. You should frequently evaluate the amount of cover relative to your personal balance sheet. If your financial plan is on course your debts should be diminishing as the value of your assets appreciate.
Life assurance is necessary in a sound financial plan. You should frequently evaluate your need for the cover relative to where you are in your stage of life.