Understanding Life Insurance – The Basics

I want to start this post by making one point clear:

A life insurance cover is NOT an investment!

Whether it is advertised as an investment/education plan / bonus plan. It is NOT an investment.

With that out of the way, we can now discuss what life insurance is. This is the first of a two-post series on life insurance. Read the second post here.

A life insurance cover is a form of insurance that pays your dependents upon your death to replace what you provided for them financially while you were aliv3. This is the basic idea behind life insurance. The cover may do many other things which we discuss further down this post, but the basic thing it does is pay out a benefit when you die.

There are three main types of life insurance in Kenya.

The first is a what they call a whole-life cover or a life assurance cover. This cover pays out only when you die. It works pretty much like a medical cover, which you only benefit from when you get sick – and when you do not get sick, you do not get benefits. Just like a medical cover, you have to keep paying premiums to remain in cover, and if you do not wish to remain in cover, you can stop any time and the cover lapses. A different form of this cover is called a term assurance, which is usually in effect for a fixed period of time.

The whole-life cover is like the bare bones of life insurance. It is the cheapest form too. Most finance professionals will recommend that you take a whole-life cover to protect your dependents, then actually invest the rest of your money in actual investments. I recommended this cover as a risk-management tool when I wrote about why education plans are not what they seem to be – they are not a way to invest for your child’s education.

The second type is what they call endowment life covers. Endowment covers have a number of features:

1. They are for a defined period. You can take a 10 year, 15 year or 20 year endowment cover etc. The years represent the period of coverage and the period over which you keep paying premiums to remain on cover. The longer the period and the younger you are, the cheaper the monthly premiums are.
2. They pay back some of the money, in form of bonuses. For example, a 10-year cover will start paying you some bonuses from year 6.
3. At the end of the period, you get your full sum assured back as a lump-sum.
4. When you stop paying, you go out of cover just like the whole-life insurance, and you also lose any potential to earn bonuses or get the lump-sum back. The only exception here is if you had paid for a defined period of time (usually about three years), where you get a minimal amount of money back, called a surrender value.

An endowment cover is not an investment return, the bonuses and lumpsum are often the equivalent of, or slightly higher than what you have paid in premiums, so it does not fair well when compared with other investment options in the market. It is really just a cash payout.

The third type is a unit-linked life insurance cover. This is like an endowment cover, but part of the premiums go towards an investment scheme operated by the insurance company. This is the type of cover we analysed when we looked at why education plans are not an investment for your children’s education – the type of returns they promise pale in comparison to other investments.  The features of this cover will mimic the endowment cover, with the exception of bonuses. The unit-linked cover pays a return on investment, instead of a bonus. I am not a fan of mixing investments and insurance – let an insurance company provide insurance for risk management, while you build a credible investment plan for yourself and your beneficiaries.

These are the basic defining characteristics of the three types of covers. Most of what is sold as education plans is a variation of the endowment cover or unit-linked cover, where the payouts are aligned to a defined education period, e.g four years of high school or college.

The extras

Usually, life insurance will come with some additional benefits – which tend to be similar for both types of covers:

• Accidental death benefit. With this your beneficiaries get paid in full should you have an accidental death. How is this different from an ordinary payment? Well, some life covers require you to either take a medical check up and disclose your medical history in full, or the payout is less than the sum assured should you die of illness within three years of taking the cover. So if you had not done the check up then you die of accidental death, then this cover pays the full sum assured.
• Disability benefit. This is usually in two forms: payment of part of, or the entire sum assured, plus a waiver on outstanding premiums if you are on an endowment plan.
• Funeral expenses. This is the standard KES 100,000 funeral payment that comes with insurance.

In the next post, we look at the common complaints customers have about life insurance, and how to select and buy the right life cover for you.  In the meantime, share your life insurance questions, and experiences by either commenting below or on our Facebook page.

If you have not, watch this comprehensive video on how to buy motor vehicle insurance in Kenya.