How life insurance works

Life insurance is a policy that pays an agreed sum of money to people you choose, your beneficiaries, if you die while the policy is in force¹. You pay a set amount every month for the insurance during the policy's term, and if you die within that term, your loved ones receive a cash lump sum from your insurer¹. The payments are tax-free and can be used for any purpose, from paying off a mortgage to simply keeping the household running¹.

The most common form is term life insurance, which covers a fixed number of years³. If you outlive the term, the insurance ends with no payment³. Other kinds behave differently: whole-of-life cover pays out whenever you die, provided you keep paying the premium, and some policies stop taking money when you reach 90⁴. Over 50s plans promise a lump sum when you die, guaranteed to pay out provided premiums are not missed, and are not medically underwritten, so pre-existing health conditions do not affect the cost⁴. Some policies also pay out early if you are diagnosed with a terminal illness and are not expected to live more than a year⁵.

Life insurance is sometimes called life assurance, decreasing cover or mortgage protection insurance⁶. It is one part of the wider family of protection insurance, which also includes critical illness cover and income protection, each of which pays for something different.

Life insurance pays a lump sum if you die during the policy term

The core promise is simple: life insurance pays an agreed sum of money to people you choose if you die while the policy is in force¹. Term life insurance pays out a lump sum if you die within the policy term, and if you pass away during that time frame, your loved ones will get a cash lump sum from your insurer². If you outlive the term, the insurance ends with no payment³.

Not every policy works the same way, and the differences matter when choosing:

• Term life insurance covers a fixed number of years. You only pay premiums until the end of the term, and it only pays out if you die within it⁴.
• Whole-of-life insurance pays out whenever you die, provided you continue to pay premiums, at least until you reach 90².
• Over 50s life insurance promises a lump sum when you die, guaranteed to pay out provided you do not miss any premiums. It is not medically underwritten, which means any pre-existing health conditions will not affect the cost⁴.
• Family income benefit pays a regular income to your family rather than a single lump sum, over the rest of the policy term¹⁰.
• Joint life insurance covers two people, typically a couple, and pays out on the death of the first policyholder, after which the policy ends¹¹.

Some policies pay out on diagnosis of a terminal illness as well as on death. TSB's life insurance, for example, pays a lump sum if the life insured dies or is diagnosed with a terminal illness during the term of the policy¹². Tesco's guide describes the same trigger: a cash lump sum if you die during the policy term or are diagnosed with a terminal illness and are not expected to live more than a year⁵.

Life insurance is not the same as critical illness cover, which pays out on diagnosis of a serious illness listed in the policy, such as cancer, heart attack or stroke¹³. It is also not the same as accidental death insurance, which only pays out if death is caused by an accident¹⁴. And it is not an alternative to mortgage payment protection, for the simple fact that it only pays out when you die¹⁵. The dedicated pages on term life insurance, whole of life insurance and over 50s plans cover each type in more detail.

Level or decreasing term: how each one behaves

Term policies come in three main shapes, and the shape determines what your family actually receives.

Level term means the amount paid out stays the same throughout the policy term, providing an agreed lump sum on death⁹. Whenever death comes during the term, the payout is the same fixed sum, which is why this shape is often chosen for family protection: the people the money is for know exactly what they would receive.

Decreasing term means the amount paid out decreases over the life of the policy, usually to match a decreasing debt such as a repayment mortgage⁹. With a decreasing policy, the final payout gets less over time so it matches the amount left on the mortgage¹⁶. This suits a repayment mortgage, where the debt itself is falling, and it is cheaper than level cover: level term life insurance is generally a little bit more expensive than decreasing term insurance, and cheaper than whole life insurance¹⁷.

Increasing term raises the sum assured over time, usually to keep pace with inflation, and depending on your plan and its terms and conditions, your premium may also increase to reflect your new sum assured¹⁸. Post Office, for example, offers a choice between level, decreasing or increasing term insurance¹⁹, and LV notes you can take out a level or a decreasing term life insurance policy²⁰.

Level, decreasing and increasing term: how the payout moves over the length of the policy.

Which shape tends to suit which circumstance is a matter of what the money is for. Decreasing term is built for a repayment mortgage, because the cover and the debt fall together¹⁶. Level term suits a family that wants a fixed amount available whenever death occurs, or an interest-only mortgage where the debt does not shrink. Increasing term suits long terms where inflation would otherwise erode what the payout buys. The comparison page on level versus decreasing term and the guide to level versus increasing cover go further, and mortgage life insurance covers the mortgage case in full.

Terminal illness cover: an early payout with 12 months or less to live

Many life insurance policies also include terminal illness benefit. This means the policy could pay out early if a doctor says you have less than 12 months to live⁹. Not all policies include it, so it is worth checking before buying⁹. Where it is included, the full amount is paid at once, and there is no repayment if you outlive expectations⁴.

The trigger is a medical one. Post Office's terminal illness cover pays out early if a doctor confirms you have a terminal illness and are expected to live only 12 months or less¹⁹. Phoenix Life's guide says the same: some policies may pay out if you are diagnosed with a terminal illness during the term and are given less than 12 months to live²². Joint policies can include the same clause, allowing a payout if one policyholder is diagnosed with a terminal illness and given less than 12 months to live¹¹.

Terminal illness cover is not the same as critical illness cover, and the two are often confused. Terminal illness insurance pays out if you are diagnosed with a condition that is expected to be fatal within 12 months, whereas critical illness cover pays out on diagnosis of a serious illness that you may well survive, such as cancer, heart attack or stroke¹³. The comparison page on critical illness versus terminal illness cover sets out the difference, and the narrow guide to terminal illness payouts covers the detail.

An early payout can matter practically as well as financially. Marie Curie notes that claiming on life insurance, including any terminal illness benefit, can be part of sorting out money at the end of life, and that a family member or friend can help contact the insurer²³. The narrow page on funeral costs paid early from a life policy covers one common use of an early payout.

What life insurance costs and what changes the premium

There is no fixed price for life insurance. Premiums are based on your age, health and lifestyle¹⁶. The older you are, the more expensive life insurance becomes¹⁶. Standard life insurance is priced based on your age, your health and your lifestyle, including smoking, drinking and dangerous activities⁴.

The full list of factors is longer, and it is worth knowing what an insurer will look at:

• Your age, health and medical history, including your family's medical history²⁴
• Lifestyle habits, including whether you smoke or drink⁴
• Your occupation, particularly if it is dangerous²⁴
• The type of cover, the amount of cover and the length of the policy²⁴

Scottish Widows gives a similar list: the cost of life insurance is based on factors such as your age, your health, your job, whether or not you smoke, the length of the policy and the amount of cover²⁴. Post Office Life Insurance premiums are calculated based on your age, health, smoker status, occupation, lifestyle and the amount of cover you want²⁵. If you are a smoker, you can expect to pay more for life cover than a non-smoker because of the associated health risks⁵.

Life insurance is most often underwritten based on your personal circumstances, which is why two people of the same age can pay very different amounts for the same cover¹⁴. Over 50s plans are the exception: because they are not medically underwritten, premiums are based only on age, smoking status and level of cover⁴. The dedicated page on how life insurance premiums are worked out explains the mechanics, and how much life insurance you need helps with the other half of the question, the amount of cover.

One rule worth knowing: once a policy is in place, the premiums cannot be increased after a later diagnosis such as cancer, and you do not have to tell your insurer about a new health condition²⁶. The premium you agreed at the start is the premium you keep, as long as you keep paying it. The exception is increasing term cover, where the premium may rise alongside the sum assured by design¹⁸.

Applying: health questions, GP checks and medical exams

When you apply, you will be asked questions about your health and lifestyle²⁵. The questions typically cover your medical history, including whether other illnesses have been diagnosed within the past five years, and whether you have received any medical treatment in the past 12 months¹. You will need to make an honest declaration about all these issues¹⁶.

Insurers will also check your answers with your GP¹. In more complex cases, insurers may require a medical examination, and will often send a specialist nurse to your home for this²⁶. This is normal underwriting, not a sign the insurer is looking to refuse you: it is how the insurer prices the risk it is taking on. The narrow guide to GP reports explains when an insurer needs one, and applying and underwriting covers the whole process.

The duty of honesty runs through the whole application. Providing false information during the application process may lead to a denial of the claim¹. If you lie about your smoking, for example, and get a cheaper premium as a result, you will have committed fraud, your policy may be declared void and any payout refused when your family claims²⁶. The page on the duty of disclosure explains what counts as honest answering and what happens if you get it wrong.

Smoking, diabetes, cancer and other health conditions

A pre-existing condition does not automatically bar you from cover, but it changes what you will be asked and what you will pay.

Smoking and vaping. You must tell your life insurer if you smoke or vape using nicotine products, even if you do so only occasionally²⁶. Insurers weight premiums for people who use vapes, gum and patches the same as for those who smoke cigarettes²¹. For ex-smokers applying for new cover, some insurers only require you to have quit for a year, others for two, five or even 10 years, before treating you as a non-smoker²⁶. Most insurers will not discount an existing policy if you quit after taking it out, though a few will let you sign a declaration that you have given up and reduce your premiums²⁶.

Diabetes. People with diabetes can buy most forms of life insurance, with level term and decreasing term the two main types²⁶. When applying, you will need to provide full details of when you were first diagnosed, your medical history, and the specifics of your treatment and medication²¹. You must tell the insurer whether you have type 1 or type 2 diabetes or a rarer form, your HbA1c test results, hospitalisations, treatment changes and complications²⁶. People with Type 2 diabetes, particularly if it is well controlled, will often be able to get cover, though typically with higher premiums and sometimes exclusions²⁶. Insurers may consider you high risk, which could mean your premium is more expensive, and they may require a medical exam before covering you²¹.

Cancer. Life insurance usually pays out only when you die, so a cancer diagnosis will not automatically pay anything⁹. Insurers cannot cover certainties, so they are legally entitled to refuse cover where the medical prognosis is that you will die during the policy term²⁶. People who have recovered from cancer may be asked to provide detailed medical information and attend a medical examination, with higher premiums and restrictions on the maximum sum insured²⁶. There are also specialist, non-medically screened policies that offer guaranteed cover for anyone, but these are often more expensive, with limited term length or total sum insured²⁶. The narrow page on cover after a cancer diagnosis covers this in full.

Other conditions. People with pre-existing conditions can still access level term, decreasing term, increasing term or whole-of-life cover⁹. For mental health conditions, specialist insurers exist that help people with pre-existing conditions find competitive life insurance²⁷. Critical illness policies, by contrast, cover a defined list of conditions: all policies include cancer, heart attack and stroke²⁸, and most insurers also cover organ failure, multiple sclerosis, Alzheimer's disease, Parkinson's disease and traumatic head injury as standard¹³.

Two protections are worth holding on to. First, if you already have life insurance and are subsequently diagnosed with a condition such as diabetes, you do not have to tell your insurer or pay higher premiums²⁶. Second, as long as you made full and honest disclosures on your application and continue paying the premiums, the policy cannot be cancelled because of that diagnosis²⁶. The page on getting cover with a pre-existing condition goes further.

Where life insurance does not pay out

A life insurance policy is a contract, and it pays out only on its own terms. The main situations where a claim fails are:

• Outside the term. Term insurance only pays out if you die within the term; if you outlive it, the policy ends with no payment⁴.
• Non-payment. If the policy lapses due to non-payment of premiums, coverage stops, and no benefits will be paid upon the policyholder's death¹.
• False or incomplete answers. Providing false information during the application process may lead to a denial of the claim¹. A policy can be declared void for fraud, such as lying about smoking²⁶.
• Suicide in the exclusion period. Death by suicide or self-harm is mostly covered by life insurance policies, except in the first year or two after taking out the policy¹.
• Moving overseas. Some policies stop cover if the life insured moves overseas to a location not listed in the standard territories, unless the insurer agrees otherwise²⁹.

It also pays to be clear about what life insurance never was. It only pays out when you die, so it is not a substitute for income protection, which pays an income if you cannot work through illness¹⁵. Income protection has its own exclusions too: it will not usually pay out if you lose your job, are made redundant or choose to stop working, because it covers illness and injury, not unemployment³⁰. The narrow page on suicide exclusions and the guide to when income protection will not pay cover each of these in detail.

Missed payments, cancelling and changing a policy

Life insurance only works while you keep paying for it. Many policies come with a grace period, usually around 30 days, after a missed payment¹. What happens next depends on the insurer and the type of policy:

• If you miss a payment, your insurance policy could lapse, meaning you would not be covered. Some providers might offer a grace period or options to reinstate a lapsed policy³¹.
• Bank of Scotland's life cover states that if you miss your monthly payments, cover stops, the policy ends and you get nothing back³².
• Lloyds says the same: if you do not make payments on time, your cover will stop, your policy will end and you will get nothing back³³.
• TSB's policy terms are more specific: if your premium remains unpaid for any reason 60 days after the due date of any missed payment, your policy will be deemed cancelled, cover automatically ends, and there is no refund of premiums paid¹².
• With whole-of-life policies, some of the plan's value typically remains if you stop paying, but it is far lower than the original cover and can reduce over time³⁴.

From a missed premium to a lapsed policy: the grace period, the lapse, and the possibility of reinstatement.

Cancelling deliberately has the same result for term policies: the policy has no cash-in value, so you get nothing back³. If you cancel life insurance, it simply stops and you do not get any money back⁴. There is no cashback value to most life insurance policies, so if you have to stop paying later because you cannot afford it, that will be lost money⁷. Lloyds puts it plainly: if the policy ends without a claim, you will not get any money back³³.

One point matters for anyone covering a mortgage: a remortgage or second mortgage changes the debt the policy was sized against, and a cancelled policy cannot be reinstated at the original price, since any new policy would be underwritten afresh at the applicant's current age, health and lifestyle¹⁶. The pages on missed premiums and lapsed cover, reinstating lapsed cover and cancelling a policy held in trust cover the mechanics.

Writing a policy in trust keeps the payout out of the estate

A life insurance payout is not subject to income tax or capital gains tax⁸. But if your life insurance is not written in trust, the payout will usually be treated as part of your estate when you die³⁶, and life insurance does not then avoid inheritance tax: the payout is added to the value of your estate and may be subject to it⁷.

Writing the policy in trust changes that. Providing the life policy is written into trust, the payout will not form part of your estate³⁷. If a life insurance policy is written in trust, the payout is usually exempt from inheritance tax, meaning it can help beneficiaries cover the bill on the rest of the estate³⁵. It also speeds things up: your family receives the money sooner, as they will not have to wait for the often-lengthy probate period to be completed¹. All life insurance policies can be written in trust, including family income benefit, normally free of charge¹⁰.

How it is done is straightforward. You can write a life insurance policy in trust when you first buy it: most insurers offer this during the application, and there is normally no extra charge³⁶. A policy can also be put into trust at any time, later, by filling out the insurer's form¹⁸.

A trust does not replace a will. Writing life insurance in trust can help make sure the policy payout goes to the right people, but it does not deal with everything else you leave behind, so a will is still needed³⁶. The dedicated page on writing life insurance in trust covers trustees, forms and the tax detail, and the narrow guide to inheritance tax on payouts covers the tax position. Some people, particularly those with larger estates, take out life insurance specifically to cover the inheritance tax the family will have to pay¹⁶, and whole-of-life policies written into trust are one route for this³⁸.

Making a claim and getting help

When someone dies, the claim is made with the insurer. You can contact the person's life insurance company to find out about their policy and how to make a claim²³. If the person had cover through their employer, contact the employer to find out whether they had life insurance and how to make a claim²³. The page on claiming after a death lists the documents typically needed and how long a claim takes.

Where life insurance was tied to a mortgage, the payout can change what happens to the home. If the mortgage lender required life insurance, this may pay off the full amount of the loan. If there is not any insurance, or for second mortgages not covered, the property may have to be sold³⁹. You do not have to have life insurance in place to get a mortgage, and there is no law to say that you need it, though some lenders say you must have it to get a mortgage with them¹⁶. You also do not have to buy this insurance from your mortgage lender: you can use any life insurance company²⁴.

If a claim is disputed or an insurer refuses to pay, the Financial Ombudsman Service can look at complaints about protection insurance, including disputes over what a policy covers²⁸. The ombudsman is free to use and binding on the insurer if you accept its decision. The page on making a claim covers the process for critical illness and income protection claims, and what happens if your insurer fails covers the protection position.

For people moving abroad, two points are worth checking. Some policies stop cover if you move overseas to a location not listed in the standard territories, unless the insurer agrees otherwise²⁹. And if you live outside the UK, official guidance covers paying National Insurance while abroad, to protect your State Pension and entitlement to other benefits and allowances⁴¹. The international money guide covers the wider picture of living and moving overseas.