Life Insurance Issues

Overview

Life policies are fundamentally different from other policies of insurance.  They are not policies of indemnity which compensate a person for loss actually incurred on the occurrence of an insured risk.

It is sometimes said that a life insurance policy is a contingency policy,  rather than an indemnity policy. Instead, a life policy provides for payment of a fixed or ascertainable sum on a pre-agreed event, usually death.

A life policy may have the characteristics of an investment.  A life or equivalent policy may have both a risk element and an investment element.

The general principles of insurance apply to life insurance. The principle of utmost good faith is especially important in the context of life insurance.  Any false or misleading answer in the application form will entitle the insurance company to avoid the policy. Any material fact known to the policyholder must be disclosed.

The most common form of life policy is one that pays out a fixed sum on death within a certain period.  These are typically taken out by a person during their working years, particularly where they have family and similar financial responsibilities.  Because it usually covers the years of life during which death is relatively unlikely, the premiums are relatively low.

Disclosure by Insurer and Intermediary

Where an individual signs a proposal form, a disclosure notice must be given under the Life Insurance (Provision of Information) Regulations.  This must set out details in two tables of the projected benefits and charges.  It must set out the amounts of premiums, projected growth, projected expenses, the projected cost of protection benefit and taxation effects. The projected growth is on a hypothetical basis.

A disclosure notice must be given at the proposal stage, which may be in a generic format.

A disclosure notice must be given on the issue of a life policy. There is also a cooling off period in which the policyholder may cancel and receive a refund of premiums. See the separate chapter on the principles of insurance.

Underwriting

The process of assessment of the underlying risk is referred to as underwriting.  The life insurance company’s actuary considers the risk, relative to the person’s individual health, lifestyle, age, smoking, gender, et cetera. The nature of the policy will determine the relative amounts of risk benefits and quasi-investment benefits.

Where a policy exceeds a certain amount, the person is over a certain age or certain health factors apply, the life insurer may arrange a medical examination.  Where a person is above average risk, a higher level of life assurance premium or reduced level of cover may be offered. Where the insured is an average risk, ordinary rate premiums will apply.

The extra premium for above average risks is referred to as loading.  This may be a percentage and may be determined by a factor such as being a smoker, et cetera. If the risk is above average, the insurance company may simply decline cover.

Medical Evidence

he medical history answers given by the life insurance applicant in the proposal form are critical to the ssessment of the risk. In some cases, a report will be sought from the proposed insured’s doctor (private medical attendance/PMA). Where the sums are large or a medical condition is disclosed, an independent medical examination may be undertaken.  Details of HIV status, blood tests and other tests may be undertaken.

Companies may not seek medical cover below certain benefit levels.  The degree of medical examination will depend on age, level of cover, smoker or non-smoker status and  other relevant risk factors.  A life company may decline cover.  If it accepts the proposal, it proceeds to underwrite the policy at the relevant rate.  The vast majority of applications are accepted at ordinary rates.

Once the policy is issued, it becomes effective. There is generally a policy documents setting out the terms of the contract.  As at most insurance policies, there will usually be a schedule of particulars together with detailed standard terms and conditions.  This schedule sets out the particulars of the life, amounts covered, date of birth and other relevant matters.

Interest

A person has an interest in his own life and in the life of his spouse.  Generally, there is no limit on the amount for which life insurance may be taken out. A person may have an interest in the life of another, if there is actual financial reliance and dependence.

Joint life policies may be taken out.  There are a number types of joint life policy.  The policy may pay out on the death of first of two co-insured persons, on the survivor of two or may pay separately on the death of each inured.  Such policies are commonly be undertaken by spouses.  A joint life first death policy will provide for pay out on the death of the first spouse.

A joint life survivor policy may be taken to cover inheritance tax liability.  This is because substantial inheritance tax is only likely to rise when assets  passed to children.  A special  policy type can be taken out, subject to satisfying certain conditions, in order  to pay inheritance tax.  Provided it meets these conditions, it has the advantage that the value of the policy itself is not counted as part of the estate for inheritance tax purposes.

Life insurance

Life insurance companies are sometimes organised and incorporated as mutual companies.  However, proprietary companies now pre-dominate. Mutual companies have been enabled to de-mutualised and become proprietary companies, in much the same way as building societies.

Life insurance premiums may be recurrent or one-off.  A recurrent policy is more common and typically involves a premium paid annually throughout the term.  A single premium insurance policy is sometimes called a bond.

A unit-linked policy is linked directly to the value of an  underlying fund which is managed by the insurance company.  The policy buys a certain amount of units in the fund at the time the premium is paid.  The fund’s investment risk depends on the nature of the assets in which is   invested. The encashment value will depend on the value of the units on maturity or earlier encashment.

Regulation

The regulation of life insurance business differs to that of  non-life insurance.  Insurers must keep their life and non-life insurance business separate.  They may have separate subsidiaries within the same group and under the same brand dealing with life, and non-life insurance. The same broad regulatory principles apply to life and non-life insurance.  However, there are significant differences in detail.

Life insurance is the issue of policies providing for liability to pay  lump sums or annuities on human life. From the regulatory point of view, life insurance would include the following

• contracts that pay annuities on a human life during lifetime;
• contracts to pay a sum on death;
• contracts to pay a sum on marriage or the birth of children;
• life insurance policies linked to investments;
• permanent health insurance;
• group pension funds;
• industrial assurance;
• tontines.  These are policies that pay dividends to people still living at the end of the period, effectively subsidised by those who have not survived.

Mortgage Protection

Life policies are commonly taken out in conjunction with mortgages.  The purpose is to pay off the loan in the event of the death of the principal earner. Such policies are generally mandatory for  consumer home loans, subject to exceptions. Life policies are commonly taken out in conjunction with mortgages.  The purpose is to pay off the loan in the event of the death of the principal earner.

An endowment policy provides for payment of a fixed or ascertainable benefit on death within a period.  However, a fundamental difference is that a fixed capital sum is paid at the end of the term. Because of the guarantee of payment at the end of a term, the policy is more in the nature of an investment.  The premiums are substantially higher because pay out is required.

Most commonly, there is not a fixed term. The  payment at the end of the term is effectively  the accumulated value of investments, less the part of the premium attributable to the risk premium (covering death), expenses and commission. Some endowment policies guarantee payment of a minimum amount at the end of the term.

Endowment policies were once commonly used as part of mortgage finance.  The objective was to build up funds to repay the principal / capital of a mortgage, at the end of the term.  Interest is paid in the meantime, together with the policy premium.  There was an expectation that the  amount available would be enough to both repay the principal due on the mortgage and pay a bonus.

However, in many cases, there were not sufficient monies available to repay the mortgage at the end of the term, with the result of the borrower/insured still retained a substantial liability.  Special compensation schemes were established in the UK to deal with claims for endowment policy misspelling, such was the scale.

Investment Policy

Many policies are linked to the value of investments in a unit trust / special investment fund, operated by the insurer.  The investments may be personalised in accordance with the insured’s preferences.  They are similar to unit fund investment and the saving products.

In the case of a with profits policy, the insurance company considers annually whether it is prudent to allocate a proportion of its profits to policyholders, by way of a bonus.  Most bonuses once declared, cannot be withdrawn.  There may be provision for a bonus annually or for a terminal bonus at the end of the term.

The more modern form of policy links the promise more directly to the underlying investments.  This may be linked through a unit trust or personal investment plan.

Use in Pensions

Money purchase pension scheme are now the most common form of policy.  PRSAs, retirement annuity contracts and defined contribution occupational pension schemes have the same broad characteristics.  They are broadly similar to endowment policies in that they involve the accumulation of savings in a tax-free entity. .

An annuity policy exchanges a lump sum for the payment of a steady sum, or a sum which may increase by a fixed percentage for inflation, during the life of the policy holder.  Where the person dies, no further benefit is usually paid to his estate (in the absence of insured death benefits).  There is, in effect,  a pooling of risk across policyholders.

Annuities are most commonly encountered on retirement, when pension funds purchase and   are  converted into annuities.  Where there is no right to transfer funds to an approved retirement fund, which is the case with many occupational pension schemes, an annuity must be purchased. Annuities may provide for payment for a period after death, to a spouse or dependents.  The rate of annuity payable to the primary insured, will be reduced to reflect the obligation to pay the annuity after his /her death.

Permanent Health Insurance

Permanent health insurance is sometimes called income protection or disability insurance.  The policy pays a specified annuity if a person suffers certain specified illness, sickness or infirmity.  The insured must satisfy medical criteria to show the requisite incapacity and entitlement to the benefit.  The purpose is to provide for replacement of income, usually until retirement age.

Permanent health insurance is different to private health insurance and it is unrelated to medical costs.  Permanent health insurance is classified as life insurance.  It qualifies for separate additional tax allowances, similar to those available in respect of pension contributions.  The rules for the allowance and the calculation of tax deductible amount, are similar to those for  pension contributions. A similar policy type provides critical illness cover.  This pays a one-off sum in the event of a person becoming incapacitated.  It may be an annuity element in addition.

Industrial assurance business is the business of effecting assurance on human life, where the premiums are payable at intervals of less than two months. The  policies were classically to cover funeral expenses and to accumulate modest savings. They were typically collected personally by agents. The premiums were relatively low and usually entered in a book. Industrial assurance is now rarely encountered.