Once you have a mortgage, or any other liability, you should think about protecting the debt to ensure that it is repaid in the event of your death or ill health. This is especially true if you own the debt jointly or you have a joint economy where the surviving party would be unable to service or reply the debt in your absence. The most common type of protection is taken out to cover mortgages. Usually these are joint life, first death policies whereby the benefit is paid if one person dies. The policies are taken out for a fixed term, usually matching the length of the mortgage – hence they are known as Term Assurance policies.
If you are on a repayment mortgage your liability will decrease over time, so insurance companies offer a Decreasing Term Assurance where the amount of cover falls at the same rate as your liability. The policies tend to be low cost as the cost to the insurance company is likely to be lower as claims in the early years of a policy are less likely. If you have an interest only mortgage the amount of debt remains the same so you will need the insurance to be constant thought the term, such policies are called Level Term Assurance.
Some people prefer a level term assurance even if they are on a repayment mortgage as they believe it will offset the impact of inflation or provide additional capital for other expenses in the event of a claim. However, although it adds complexity and potentially means taking out a greater number of policies, best practice would be to isolate each of your risks and take a separate policy for each. In addition to policies that pay out a benefit in the event of death, you can also get policies that pay out the benefit in the event of you being diagnosed with a critical illness. The definition of critical illness varies from policy to policy so some care must be taken but generally they will pay out in the event of illnesses that make returning to work difficult or impossible.
Over time the definition of critical illness has evolved to match advances in long term survival rates of certain types of illness. For this reason, you should be particularly careful if considering surrendering an older policy as the definitions may be more generous than under a modern replacement. It is more expensive to cover a critical illness than a death because a claim is more likely. Sometimes people therefore work out a lower level of critical illness cover to sit alongside a higher death benefit.
The levels of cover should always be determined based on the liability or costs being covered, the affordability of the premium and your outlook towards the risk. Benefits payable under both life and critical illness policies are usually free from tax, regardless of whether it is a level or decreasing policy.