How much cover is enough?

Death and taxes are inevitable and, rather than ignoring the facts of death, we should be sorting out the needs of our dependents, writes Caroline Madden.

As with pensions, the thorny issue of life assurance tends to bring on severe cases of "head-in-the-sand" syndrome, as many people prefer to ignore the unpleasant realities of life, such as growing old and dying, for as long as possible.

While conventional wisdom suggests that it's never too early to start a pension, the same logic does not necessarily apply to life assurance. True, the younger you are, the cheaper the premium is likely to be. But the basic principle of life cover is that in the event of the policyholder's death, their financial dependants receive a lump sum, which is clearly superfluous for the young, free and single.

"Not all life stages require life assurance," says John Geraghty of LABrokers.ie. "The whole reason for taking out a life policy is that someone stands to lose [financially] by that person's death."

He points out that it is also extremely difficult for young single people to predict what type of cover is going to be appropriate for them several decades down the line.

Jennifer Hoban, life assurance manager with the Irish Insurance Federation (IIF), says single people with no dependants may prefer to put their money towards type of cover that could pay out during their lifetime. Income continuance policies, for example, protect the individual's income if they are out of work, while critical illness cover pays out a lump sum if the individual contracts an illness specified in the policy.

In theory, critical illness protection sounds like a reassuring financial safety net to have in place, but there are several onerous caveats attached. The illnesses covered tend to be very specific (for example, a policy may cover only very aggressive types of cancer) and in some cases extremely rare, and it is also difficult to compare products on the basis of price, as they generally cover different ranges of illnesses.

"My own experience is that people generally don't live very long after claiming on critical illness," Geraghty says, suggesting that other forms of life cover may be more beneficial if the policyholder has dependants.

As people's circumstances change and they get married and start a family, the need for life assurance becomes more pressing. The first step in choosing appropriate cover is to determine the lump sum that would be required in the event of the untimely death of ones spouse or partner.

Various rules of thumb tend to be bandied about, such as 10 times  salary, but the best approach is to sit down and take a cold, hard look at the financial impact of such a tragic eventuality.

The income to which the surviving spouse would be entitled should be calculated.

As well as including sources of income such as state benefits and pensions, it's important to factor in any existing life assurance policies held by either person. For example, one spouse could be provided with death-in-service cover by their employer, which generally pays out a multiple of the employee's salary.

In addition, most couples will already have mortgage protection in place, which will take care of monthly home-loan repayments. In an ideal situation, any shortfall between the combined income sources and the family's projected spending requirements is then covered by a life assurance policy.

However, quite a considerable lump sum is required to generate what may seem like a relatively small income. For example, a lump sum of just under €490,000 would be required to provide a weekly income of €350 (assuming an interest rate of 5 per cent). Therefore, in reality, financial constraints often dictate the level of cover taken out.

When it comes to selecting a type of product, term life assurance is becoming an increasingly popular option for young families, Geraghty says. Not only is it the simplest product on the market but is often the cheapest.

As the name suggests, term assurance lasts for a fixed term, for example 20 years. The lump sum payable on death is fixed at the outset, as are the monthly premiums.

If the person covered survives the term of the policy, there is no payout - only peace of mind.

These policies are particularly suited to young families facing a particularly heavy financial burden as they raise a family.

An alternative form of cover - whole-of-life assurance - is designed to be capable of lasting for the entire life of the policyholder and comes in two forms - a unit-linked renewable product and a guaranteed version, which guarantees that a certain lump sum will be paid out at some point in the future.

"Unless you have that policy inflation-proofed, having a lump sum which is valuable in today's terms is not going to be worth very much in 50 or 60 years," Geraghty points out. "Plus it's extremely expensive."

In addition, policyholders will still have to make premium payments during their retirement, which may not be the best use of their resources at that stage of their life.

It is also arguable whether people living on a pension with few financial obligations need significant life cover.

Whatever type of assurance is selected, shopping around for the best deal can result in considerable savings for the same level of cover.

A cost comparison conducted by the Irish Financial Services Regulatory Authority reveals that a 26- year-old female non-smoker can get 30-year life cover worth €200,000 for a monthly premium of €13.07 with Ark Life. However, if the same customer went to Irish Life, she would have to pay €20 a month.

While age is one of the main factors dictating the cost of life cover, smoking is also a major determinant.

If the customer in the previous example were a smoker, Ark Life would charge her monthly premium of €20.28.

Consumers are also becoming increasingly aware of the benefits of shopping around for mortgage protection (which is now obligatory when taking out a mortgage) rather than taking the cover offered by the mortgage provider by default. "People are now realising that they can shop around," Mr Geraghty says. He recommends that any savings made by shopping around for the cheapest possible mortgage protection should be ploughed back into the mortgage in the form of accelerated repayments, thus reducing the total interest that has to be repaid over the life of the mortgage.

The need to review life policies is equally important. Changes in personal or financial circumstances, such as a growing family, increased borrowings or starting a business may lead to the need for extra coverage. At the other end of the spectrum, parents whose children have finally flown the nest may find themselves not quite young and single again, but without the same financial ties, and therefore may wish to scale back their cover accordingly.