Beware of cheap life insurance

Low-cost life insurance premiums may look tempting, but here's why the cheapest policy isn't always the best.

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If you're a regular lovemoney.com reader, you'll know all about our 'shop around' mantra. After all, that's the only way to guarantee value for money, right?

Of course, this often makes good financial sense, but cost isn't the only factor you should consider when shopping around for a financial product. Take life insurance, for instance. The cheapest premium doesn't necessarily mean you have found the best policy, for the following four reasons:

Reviewable premiums

When you compare quotes for life insurance, you'll normally find the cheapest premiums are 'reviewable'. This means the premiums will be re-assessed periodically by the insurer, and will almost certainly increase over the term.

For example, quotes I got from the lovemoney.com life insurance search engine showed that the cheapest premium for a woman aged 35, who needs £100,000 worth of cover over 25 years, comes in at just £5.83 a month.

But this cost is reviewable. The insurer estimates that in the final year of the policy, the premiums could rise to over £31 a month. That's more than five times the initial cost in year one.

I think it's much safer to choose the cheapest guaranteed premium instead. The cost is then known upfront and will always stay the same. True, the lowest guaranteed premium is more expensive to start with at £7 a month. But, this policy will work out far cheaper in the long run than the most competitive reviewable plan.

Joint policies

If both you and your spouse/partner need protection, it may seem logical to buy a joint policy. After all, it will be cheaper than a separate policy for each of you.

For example, the most competitive premium for a couple aged 35 who need £100,000 worth of cover over 25 years is £12.66 a month (guaranteed). But two individual policies would cost £7 a month for a woman and £8.74 a month for a man - with a combined monthly cost of £15.84. So £3.18 extra.

So, why pay more for two separate plans? Well, quite simply, if you pay that extra £3.18 a month, you'll get double the amount of cover.

This is because, with individual policies, each partner is covered separately for £100,000. So if both of you die during the 25-year term, your estate will receive £200,000 in total.

On the other hand, with a joint plan, the total amount of cover is only £100,000. So, the policy will only pay out £100,000 in total on the first death, even if both partners die within the term. And if you or your partner dies, the person who survives will be left without any life insurance cover.

Level versus decreasing term assurance

So far, all the premiums I have quoted are for a level term assurance policy. This type of plan provides an amount of cover which stays the same for the life of the policy.

If you want to cut the costs, you could go for a policy which provides a reducing amount of cover such as decreasing term assurance. These plans are often used to cover a repayment mortgage where the outstanding debt shrinks over time, and the protection under the life insurance policy reduces in a similar way.

But the difference in costs for each type can be pretty minimal. The most competitive premium is £7 a month for a £100,000 level plan for a woman aged 35, as we have already seen. But, the equivalent decreasing term assurance plan would cost £6.52 a month - that's a monthly saving of less than 50p.

In this case, I would go for the slightly more expensive level term plan which means I'll be covered for £100,000 throughout. This could provide a surplus amount of protection if a claim is made which can be used to cover other liabilities beyond the mortgage debt - or to help support your family financially.

Look closely at critical illness cover or income protection insurance

As well as life cover, you might also be thinking about protecting yourself against injury or ill-health. Policies such as critical illness cover (CIC) or income protection insurance (IPI) are suitable for this purpose. But the protection available can vary enormously from one policy to another.

It's really important you don't buy a CIC or IPI plan on the basis of cost alone because the cheaper plans may provide much less comprehensive insurance.

For example, CIC normally provides protection if you are diagnosed with any of the specific conditions covered by the policy. But the range of conditions included may be far narrower on some policies than others.

At the end of the day, the only way to be sure you're getting the right policy for your needs - and not just the cheapest - is to make sure you read the terms and conditions thoroughly so you know exactly what you're paying for, and the level of protection you're really getting. Quite simply, cheapest doesn't always mean best.

All quotes are based on non-smokers. The premiums shown are based on insurers' standard rates for policyholders who are in good health. The actual premium you pay could be higher depending on your own circumstances.

More: 12 things to ask before you buy life insurance | How to pick the right life insurance policy | Don't make this mistake with your life cover

* Until 12 June 2009