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How does life insurance work?

Life insurance provides financial support to your family when you pass away or are diagnosed with a terminal illness. Find out about the different types of cover and how to find a policy that’s right for you.

Eve Powell
Eve Powell
Updated 11 April 2022  | 5 mins read

Key points

  • Life insurance can help cover things like mortgage or loan repayments, funeral costs and everyday living expenses
  • How much you pay each month will depend on factors like your medical history and the level of cover you need
  • Different types of policies have been created to suit different situations
  • Make sure you check policy exclusions and disclose pre-existing health conditions when you take out cover

What is life insurance?

Life insurance is a type of cover that’s designed to provide your family with some financial support when you’re no longer around.

If you die during the policy term, or are diagnosed with a terminal illness (that’s covered by your policy), your insurance provider will pay out to those you leave behind.

This money can help to cover costs like mortgage repayments, funeral costs and living expenses. And it can give your family financial stability when they need it most.

How does life insurance work?

When you take out a life insurance policy, you’ll decide on a set period of time or number of years you want the cover to last - this is known as the policy term.

You might decide to take out cover until you retire, or your children leave home, or you may choose a policy to match the number of years left on your mortgage.

You’ll also need to decide how much money you’d like your family to receive when you pass away - the higher it is, the more your policy will cost.

You pay a monthly premium for life insurance, and you’ll need to do this for the duration of your policy. If you die during the policy term, your beneficiaries will receive a payout.

What are the main types of life insurance?

There are different types of life insurance products available and the right one for you will depend on your needs and personal circumstances.

Term life insurance

Term life insurance is the most common type of cover. This lasts for a set amount of time and once the policy term ends the cover will also finish.

There are two main types of term life cover:

Level term - This type of policy will pay out a fixed amount when you die. This amount will stay the same throughout the length of the policy

Decreasing term - This is sometimes called mortgage life insurance. It pays out less as time goes on and is often used to cover a debt like a repayment mortgage, where there’s less to pay off over time

What other types of life insurance are there?

Aside from term life insurance, other types of policy you can choose from include:

Whole of life insurance

This type of life cover runs throughout your life until you pass away, whenever that may be. Because it guarantees to provide a payout when you die, the premiums are more expensive than term life cover.

Over 50s life insurance

It can be harder to take out life insurance the older you become, but there are some insurers that provide life insurance to the over 50s. This type of protection can cover you for the rest of your life and will pay out a fixed amount when you die.

Increasing term

If you’ll need an increasing amount of cover as life goes on - for example, to cover your children’s university fees - this type of cover will increase the payout amount each year and can protect your policy’s value against inflation. Of course, this means that your premiums will increase annually.

Family income benefit

This is a type of term life insurance where your dependants will receive an annual or monthly income in the event of your death during the policy term.

This income will only continue for the remainder of the policy. So, if you take out a 20-year policy and die 15 years into the term, your family will only receive their income for the five years left on the policy.

Joint life insurance

With most types of policy, it’s possible to take out joint life insurance. This is often cheaper than taking out two single policies. Joint life insurance policies will usually only pay out once, when the first person dies. The policy will then end, and the surviving partner will no longer be covered.

How much does life insurance cost?

The cost of life insurance varies and will depend on several factors. As well as the amount of cover and the type of policy you choose, your monthly premiums will also depend on things like:

  • Your age
  • Your health
  • Your lifestyle
  • Whether you’re a smoker
  • Your family medical history
  • How long you’ll need cover for

What does my life insurance cover?

Life insurance is designed to help your family financially if you die during the policy term. Many policies will also pay out if you’re diagnosed with a terminal illness.

This money can help loved ones to stay in the family home and keep a familiar routine, as well as provide the financial support they need for everyday living costs.

The amount of money that’s paid out will depend on the level of cover you buy.

You’ll decide whether it will cover a specific payment - like a mortgage or loan - or if your family will be left with a lump sum. If you’re worried about being diagnosed with a serious illness in the future, you could also consider taking out critical illness cover - you can usually buy this as a policy add-on.

Can I choose who the money goes to when I pass away?

Yes, when you take out your policy you can name who should receive the payout, but this will also depend on the type of policy you take out.

For joint life policies:

If you have a joint life insurance policy, the money will usually automatically go to the surviving policyholder unless you’ve made other arrangements. If you divorce or split up during the policy term, a joint policy can usually be split into two single policies.

For single life policies:

With single life insurance policies, the money will automatically be made part of your estate and will then be distributed as part of your will.

If you want the money to go to a named beneficiary instead, you could consider writing your life insurance into trust. This can make it exempt from inheritance tax and protects it from creditors if you have outstanding debts.

Who needs life insurance?

Whether you need life insurance will depend on your personal situation, your lifestyle and your finances.

You might need life insurance if:

  • You have dependants that rely on you financially, like school-age children
  • Your spouse or partner’s salary alone wouldn’t be enough to cover living expenses
  • Your family is living in a home with a mortgage to pay on it
  • You want your funeral expenses to be covered so your family don’t have to find the money
  • You haven’t made any provisions for your family if you were to pass away

What is the average payout of a life insurance policy?

How much a life insurance policy will pay out can vary a lot, depending on the amount of cover you’re insured for and the type of policy you choose.

In 2021, figures from the Association of British Insurers (ABI) showed the average payout on term life insurance was £79,304.

The figures also highlight that in 2019 a total of £3.4 billion was paid out in UK life insurance claims to help families cope following a bereavement.

How much life insurance do I need?

When you’re taking out life insurance it’s important to think about the amount your family might need to help them manage financially during a difficult and stressful time.

The general advice is to take out cover for around ten times your annual salary.

You should factor in costs they might need to pay, like a mortgage or loan repayments, as well as everyday living expenses.

You’ll need to balance this with what you can afford to pay monthly. The higher the lump sum payout, the more your monthly premiums will be.

When you get a quote with us, we’ll provide an online calculator to help you work all this out.

Why might life insurance not pay out?

While life insurance is designed to provide your family with some financial security when you die, there are some circumstances that will make your policy invalid, these include:

  1. Non-disclosure

    When you take out life cover it’s important you’re truthful with the information you provide to your insurer. A typical reason for a claim being rejected is pre-existing health conditions not being declared when the policy was taken out

  2. Missed premium payments

    If you miss a payment your policy is likely to be cancelled. So if you can’t make a payment for any reason, you should let your insurer know as soon as possible - they may be able to give you a grace period to make the payment

  3. Suicide

    Most life insurance policies won’t pay out if the policyholder commits suicide within the first 12 or 24 months of taking out cover

  4. Outliving your policy

    If you don’t die during your policy term your insurer won’t pay out and your cover will end. You can then decide whether you still need cover and look at your options

Do you pay life insurance until you die?

This depends on the type of policy you take out. With term policies, you’ll only pay premiums for the duration of your policy, or until your death if you die before the end of the policy term.

A whole of life policy will guarantee a payout when you die, whenever that may be. So with this type of cover, once you take out a policy you’ll pay monthly premiums for the rest of your life.

What happens at the end of a life insurance policy?

When your life insurance policy ends, it means you’ll no longer be covered. At this point you’ll normally have the option of extending your cover, although it’s likely your premiums will increase.

You might choose to convert your term policy to a whole of life policy to get cover for the rest of your life - but try to discuss this with your insurer at least 12 months before your cover is due to end.

Another option is to take out a different type of policy. Your needs may have changed and your family may have grown up, or you may have had more children since you first took out cover.

Taking out a new life insurance policy is an opportunity to make sure your cover still suits your needs.

Do you get money back at the end of a term life insurance?

No, life insurance doesn’t work like a savings account. So, although you’ve been paying monthly premiums over the years, if you outlive your policy term your insurer won’t pay out and your cover will end.

How to find the best life insurance for you?

To work out the right type and level of cover you need, you’ll need to consider a number of factors.

These include whether you need to cover any outstanding financial commitments - like a mortgage or loan repayments - plus, how long you’ll need cover for and how much you’d like your family to receive.

We can help you compare quotes and policies from a range of providers and our life insurance calculator will help you work out how much cover you need.