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Updated: 19 May 2023

What is life insurance? The different types explained

There are several different kinds of life insurance, so we explain the differences, how they work and where to find the best deals

Which? Money Team

what is life insurance and how does it work?

In this article

What is life insurance and how does it work?
What are the different types of life insurance?
What is the difference between life insurance and life assurance?
Do you need life insurance?
What affects your life insurance premiums and cost?
How do I buy cheap life insurance?
Can I get life insurance from a friendly society?
Can I have two life insurance policies?

What is life insurance and how does it work?

It's a financial product that enables you to leave money for your family when you die.

This can be used to support them, to replace lost income or to pay off a large debt such as your mortgage.

Your age, health, lifestyle and how much cover you need, as well as the type of policy you have, can all determine how much you pay.

Find out more about the different types, how they work and how to find a cheap policy.

Looking to buy life insurance?

Find the right life insurance policy using the service provided by LifeSearch.

Find out more

What are the different types of life insurance?

Term assurance

The most basic type is called term life insurance, where you choose the amount you want to be insured for and the period you want cover for.

If you die within the term, the policy pays out to your beneficiaries, also known as death benefit. If you don't die during the term, the policy doesn't pay out and the premiums you've paid aren't returned.

There are three main types to consider – level-term, decreasing-term and increasing-term insurance. Depending on your circumstances, it could be that taking out more than one type of policy (for example, a combination of level and decreasing term cover) works best for your situation.

With level term insurance, the payout that your loved ones will receive remains level throughout the term of the policy. If you pass away during the term of the policy, no matter what year that may be, your loved ones will receive the same payout from your insurer.

For example, you might take out a level term policy for a £100,000 payout over a 40-year term. Whether you die in year one or year 39, your family will receive that £100,000 payout.

With increasing term insurance, the size of the payout increases as the term of your policy continues. In other words, the later into the term that you pass away, the bigger the payout your family will receive.

The idea here is to combat inflation - as the cost of goods becomes more expensive, each pound in cover that you have needs to stretch that little bit further. But with increasing term insurance, you know that the cover your loved ones are entitled to will increase too.

Family income benefit policies

Family income benefit insurance is a type of decreasing term policy. Instead of a lump sum, though, it pays out a regular monthly income to your beneficiaries until the policy's expiry date if you die.

At the outset, figure out what sort of cash value or income would be needed for your family to be financially stable should you pass away.

If you die after the term of the policy has finished, there will be no monthly payout to your loved ones.

Find out more: Income protection explained

Whole-of-life policies

As the name suggests, whole-of-life insurance policies are ongoing policies that pay out when you die, whenever that is.

Because it's guaranteed that you'll die at some point (and the policy will have to pay out), they're more expensive than term assurance policies, which only pay out if you die within a certain timeframe.

Whole-of-life policies broadly come in two main types - balanced cover and maximum cover:

With a maximum cover policy, your cover is linked to an investment fund. The insurer invests the money you pay each month, in the hope that the returns generated from that investment will be sufficient to cover the cost of the eventual payout.

Your premiums will then be reviewed on a periodic basis. If the investments are not performing to the level that the insurer wanted, your cover may be changed. The insurer may increase your monthly premiums, or reduce the size of the payout your loved ones will receive after you die.

While these policies are likely to be cheaper initially, premium increases are likely and can, in some cases, be substantial.

What is the difference between life insurance and life assurance?

Life assurance is where an insurer or assurer pays a designated beneficiary a sum of money upon the death of an insured person. All term policies are technically assurance policies.

Do you need life insurance?

Having some form of life insurance in place is important in a variety of situations:

If you have people who are financially dependent on you, such as children or a partner with whom you own a property, who would be left worse off if you passed away.
If your loved one wouldn’t be able to meet your monthly mortgage repayment and the other household bills without your income.
The loss of a parent can create additional costs, such as a greater need for childcare.

These costs may be less relevant with older or adult children, or a mortgage that’s been paid off – hence the attraction of whole-of-life insurance.

Some of these policies will allow you to cash them in and get some level of payout before you die.

If you're tempted, be sure to check the terms of your policy as the surrender value of your policy may work out as significantly less than what you have paid in premiums over the years.

What affects your life insurance premiums and cost?

Life insurance premiums are calculated based on you age, your health (any pre-existing medical conditions such as diabetes) and your lifestyle (alcohol consumption, smoking and any dangerous leisure activities). This is then applied to the sum you want to be insured for.

The younger you are, the cheaper it is to get life insurance. You can't stop ageing, but the earlier you apply for life insurance the better. This means that although you may only be applying for a small sum to cover your first mortgage, you might be better off buying a large sum of insurance at a young age.

You'll be asked if you have ever had certain conditions, such as cancer, whether other illnesses have been diagnosed within the past five years and if you have received any medical treatment in the past 12 months. If you answer yes to any of these, the insurer will ask for further details. Insurers will also check your answers with your GP. Pre-existing conditions increase premiums.

You must also tell your insurer how many units of alcohol you drink and whether or not you smoke or vape (or use nicotine-replacement products). These also add to your premiums.

If you do any dangerous activities – even commuting to work on a motorbike – you will also pay more.

Find out more: accidental death insurance explained

How do I buy cheap life insurance?

It's not just banks, building societies and insurers that sell life insurance nowadays. High street retailers and supermarkets are also worth considering.

Quite often, one company sells another's life insurance policies. The price will vary depending on where you buy it, even where the underlying product is identical and provided by the same insurer.

A word of warning, though. Getting cheap life insurance doesn't necessarily mean you'll be getting good cover that's properly tailored to your circumstances. Look out for the following:

Low start life insurance policies These will appear cheap on comparison sites, but the monthly premium increases throughout the term of the policy.
Reviewable policies The premium is only guaranteed for the first few years (often the first five or 10 years), at which time it is repriced.
Pre-existing health conditions You should still be able to get life cover, but it may be harder to find and cost more. Relevant charities should have information on specialist life insurance providers.

Speaking to a financial adviser about your needs can help ensure you find the right policy and the right level of cover.

Online life insurance brokers

Online insurance brokers may be able to offer cheaper prices as they pay back to you some or all of the commission they receive from insurers.

In the latter case, the company rebates you all the commission throughout the term, reducing the ongoing premium. It's worth checking the overall cost of both options.

However, you'll only get this commission rebate if you buy life insurance without financial advice.

Price comparison sites

One way to compare different life insurance providers is to use a price comparison website such as comparethemarket.com, confused.com or moneysupermarket.com.

Make sure you visit a selection of sites as no individual site covers the whole market, and the same insurer may offer a better deal through one comparison site compared with the others.

Remember, the prices you see on a comparison site may not be the price you get when you finally apply for life insurance, after a medical questionnaire has been completed.

Cash back websites

If you buy life insurance online, cashback sites such as Quidco and TopCashback may help you get an even better deal. You're not buying the insurance policy from the cashback site, but accessing the insurer's own website through the cashback site.

The cashback site rebates to you some of the commission it receives from the company selling the insurance.

What is critical illness insurance?

Can I get life insurance from a friendly society?

Most friendly society tax-exempt savings plans include life insurance cover. This means that if you die during the term of the plan, your estate will receive the guaranteed sum assured stated in your personal illustration, plus any bonuses.

As the sums involved are relatively small, it's common for friendly societies to offer life insurance without prior underwriting. In effect, a friendly society tax-exempt savings plan is a type of endowment.

Some of your monthly premium is used to buy life cover, which will pay out if you die before the end of the term. The rest of the premium is invested.

Find out more: are you ready to invest?

Can I have two life insurance policies?

It's common to have multiple life insurance policies, either for different purposes (a decreasing term policy to match a mortgage and a level term policy to leave a lump sum) or an additional policy to increase cover later in life.

You might have a decreasing term policy to pay off your mortgage, a family income policy to replace your salary and a level or increasing term policy to provide a lump sum to be invested for your children’s future.

Find out more and get advice on life insurance using the service provided by LifeSearch. Discover more.

Should couples have joint life insurance or separate policies?

Couples can buy joint policies that cover them. both or each person can have one policy each. Joint-life policies pay out on the first partner's death, while dual-life policies pay out on the second partner’s death.

First-death policies are often used to provide a lump sum for your family if you or your partner dies to cover mortgage repayments, for example.

Second-death policies can be used to cover an anticipated inheritance tax bill.

And yet, if you're looking for cover for you and your spouse, two single-life policies may offer much better value than a joint-life one. The combined premium for two policies may be very similar to the premium for a joint policy, but in the event of a tragic accident that killed both of you would result in two payouts instead of one.

And not all couples stay together, so separate life insurance polices can be continued in the event of a split. Remember, the younger you are when you buy life insurance the cheaper it is, so having to buy a new policy after a relationship breakdown will be more expensive.

Find out more: over-50s life insurance explained

Why two policies may be better than one

For a start, two individual policies will often be no more expensive than a joint policy. And if both partners die within the period covered, that's double the payout to their beneficiaries.

Also, as a joint policy ends on the death of one partner, if the surviving spouse wanted to take out a new policy in their own name, they'd pay more for the cover at that stage as they're older at the outset of the new policy.

An extra benefit is that single-life policies give more flexibility as the payout goes to your estate and is distributed under the terms of your will. Joint-life policies tend to pay out to the surviving spouse.

Find out more:how much is statutory sick pay?

Life insurance and inheritance tax

If you take life insurance to make a one-off payment or regular income to your dependents when you pass away there is no income tax or capital gains tax to pay on the proceeds.

However, the money will be added to the total value of your estate and that might then be subject to inheritance tax (IHT), which is charged at 40%.

Is life insurance taxable?

Whether you'll have to pay IHT depends on the value of your estate – work out yours using our calculator.

One way to avoid this is to have your life insurance policy written 'in trust'.

When assets are placed within a trust, you effectively give up ownership of them. They're now under the management of the trustees, not you, and are no longer classed as being part of your estate.

This is an important distinction. It means that should you die, the insurance policy will be handled separately to your actual estate and so won't be subject to IHT if your estate is valued above the tax threshold.

Writing life insurance into trust also means that your family will not need to go through the probate process – which is where your estate is divided up according to your wishes – in order to receive the insurance money.

Most insurers will offer it as an option when you initially take out the policy, and there should not be any extra charge for doing so.

A life insurance policy can be put into trust at any time - you can do it when the policy is first written, or at a later date, it's entirely up to you.

Transferring an existing life insurance policy into trust may involve the assistance of a financial adviser or solicitor, and so could incur some costs.

It's important to think carefully about what you want from your life insurance policy before having it written in trust.

That's because once it has been written in trust, it is no longer under your control - it has been handed over to the trustee or trustees. This is classed as an 'irrevocable act', and cannot be undone.

As a result, you need to make sure that your life insurance policy offers sufficient cover and that you are unlikely to need to change the policy in any way before you write it in trust.

There are two main forms of trust: a bare trust and a discretionary trust.

In a bare trust, the money is held by a trustee, and all of the proceeds should go to the person or people you nominate, when they turn 18 (or 16 in Scotland).

A discretionary trust gives the trustee greater power to decide how much the beneficiaries get and how frequently they get the money, as well as any other conditions you put on it (such as when they are able to receive the money).

There are more options - such as a gift trust, split trusts and more. What you use will depend on the types of life insurance products you hold and what you want to use the trust for. It's best to seek professional advice if you have complex needs.

Does life insurance cover critical illness?

Critical illness cover pays out if you get one of more than 100 illnesses that disable you or prevent you working at full capacity.

They can either be added when you take out a life insurance policy and wrapped up into a single premium, or you can buy a separate critical illness policy from a different provider.

If you wrap it up together, this often results in the payout for death being reduced if the insures has paid out already for critical illness.

If you have separate life insurance and a critical illness cover, the payouts for each remain separate and may be paid in full.