Life insurance - decreasing cover vs mortgage interest rate

tjhadder

Hi,

Can somebody please explain in detail the link between the 8%, 10% or 12% options on decreasing life insurance and the interest rate of my mortgage? I do not understand how one affects the other and therefore do not know which one to choose on my life insurance (8%, 10% or 12%).

I can't seem to find this info anywhere and would appreciate greatly if somebody could explain this comprehensively.

Nicko67

TJ - Not sure how much you're aware of, so I'll cover as much as I know (hopefully more than you!)

The amount of cover on a Decreasing Term Assurance (DTA) policy reduces in line with the balance on a capital & interest (repayment) mortgage. Every life company has an underlying assumed interest rate attached to their DTA policies - the ones you quoted above being examples of these. Providing the interest rate on the mortgage doesn't go above this underlying rate, the policy will pay out the amount required to clear the mortgage should a claim be made. If the prevailing economic conditions mean that the mortgage interest rate does go above this underlying rate, there is a possibility that the policy won't pay out the full amount, or that the policyholder may be asked to increase their premiums for a period of time to ensure that they maintain the cover at the level they need.

Some companies only have one option (e.g. 10% or 12%) but others - L&G being an example - give options as you suggested. What it means is that the premium you pay on the 8% option will be lower, but with the added risk that if rates were to go above that figure, you might have to pay a higher premium to ensure that there is no shortfall and that the mortgage is paid off if you claim.

If you choose the 12% option it's less likely that the rate would ever go above that figure, but the premium will be slightly higher because of the 'buffer' you have. I'd imagine that most residential mortgagees will not choose 12% given the extremely low rates which prevail at present. This option is likely to be more useful for business loan protection where the rates paid on borrowings are significantly higher.

Hope this helps

OshayAway

Nicko67 wrote: »

If the prevailing economic conditions mean that the mortgage interest rate does go above this underlying rate, there is a possibility that the policy won't pay out the full amount, or that the policyholder may be asked to increase their premiums for a period of time to ensure that they maintain the cover at the level they need.

I'm not familiar with this, not saying you're wrong, I've just never come across this situation. How does it work? Is it the policy holder's responsibility to contact the insurer when their mortgage interest rate increases above the policy interest rate? Or retrospective premiums made at point of claim? Is there anything relating to it in policy documentation etc? I'm very interested to know if you have any additional information.

Something I do know about this subject is that some insurers have a repayment balance guarantee on decreasing term policies whereby they will definitely pay out a sum equal to the remaining mortgage balance at claim. A good idea in theory but there are strict conditions that default to a set percentage (sometimes as low as 6%) if an flexibility options are invoked on the mortgage, such as payment holiday, additional borrowing or drawdown etc. I can't remember the statistics now but the vast majority of mortgage holders to take advantage of such options on their mortgage.

Nicko67

OshayAway wrote: »

How does it work? Is it the policy holder's responsibility to contact the insurer when their mortgage interest rate increases above the policy interest rate? Or retrospective premiums made at point of claim? Is there anything relating to it in policy documentation etc? I'm very interested to know if you have any additional information.

Good question(s)! Key features & technical guides refer to the possibility of a DTA not paying out the full amount under the circumstances mentioned, but nothing I've seen and no-one I've spoken to can confirm the practicalities of the process should interest rates increase above the underlying rate. My assumption would be that the onus is on the customer - (s)he has been alerted to the risk factors at point of sale. Anyone out there got a DTA policy document they could check?

The main reason for the lack of information about the subject seems to be that "it's never happened before, so we're not sure". Unfortunately, a lot of things have happened in past 2-3 years that haven't happened before!

tjhadder

Thanks Nicko67. I think I understand where I was going wrong now. I was assuming that the 8%, 10% or 12% was the rate the sum assured decreases at annually, so couldn't understand how that linked to the mortgage rate, and thought that it meant the sum assured would be decreasing at a faster rate. Unless I'm wrong again it is the interest rate that is paid on the sum assured, so as long as it is higher than your mortgage rate you will always be covered for the full amount. So my next question would be, if the rate on the sum assured is say 10%, but the mortgage rate has been around 4-6% for the term, does that mean there will be surplus when the policy pays out?
Thanks for your help here

Nicko67

Thought you might ask that! Although I reckon you probably know the answer already.

No, the policy will pay out the mortgage balance.

tjhadder

Ha ha typical. Thanks for your help.

OshayAway

Nicko67 wrote: »

Thought you might ask that! Although I reckon you probably know the answer already.

No, the policy will pay out the mortgage balance.

Are you sure about that?

Nicko67

OshayAway wrote: »

Are you sure about that?

This is my experience of DTA claims, but I wouldn't class myself as an expert. I'd be interested to hear if anyone else has a view.