Financial protection

In this chapter we will look at the diff...

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A whole of life plan is designed to pay out a lump sum benefit on death whenever this occurs, as long as the policy remains in place. It is a long-term insurance policy designed to last for the lifetime of the life assured.

Plans have traditionally included an investment component, which accumulates a cash value that the policyholder can withdraw or even borrow against; however, the value of most plans is very low in the first few years. Some newer plans now have no surrender value but offer the same flexibility of a whole of life plan. This can enable the insurer to offer lower premium rates and these policies are subject to the less onerous rules and guidance in the ICOBS section of the FCA Handbook, rather than the requirements of COBS.

Whole of life plans are usually very flexible, in that the amount of the sum assured can be incre...

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Plan review frequency will be written into the policy schedule at outset and both the premiums and sum assured can be increased or decreased during the life of the plan. The reviews are normally carried out after the first 10 years, then every five years and then annually as the life assured gets older. The factors that will be considered at plan reviews are mortality, expenses, investment returns and other relevant changes.

Whole of Life Assurance plans are available in several different formats, as discussed in the next sections.

What factors are considered at policy reviews for a whole of life plan?

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Generally marketed as ‘over-50s life cover’ but most plans are bought by those over...

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Suitable for older people who just want to provide for their funeral costs

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The taxation of non-qualifying policies is covered in Chapter 5.

How much is the typical difference between the offer and bid prices of units?

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Term assurance is a simpler form of life assurance, where a lump sum or series of payments are paid on the event of death within...

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There are many different types of term assurance as summarised in the next sections.

The simplest form of term cover, providing a level sum assured for a fixed term of the policy in return for payment of a fixed premium

There will be a mini...

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No surrender value or benefit payable on survival to maturity

Little or no policy flexibility

Sum assured reduces each year by a fixed or variable amount

Typically used to protect a decreasing debt. The decision on whether to use a fixed or variable decrease wil...

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Medical evidence and underwriting will generally be required

The sum assured increases throughout the term

Premiums usually increase at a similar rate

Annual increases in the...

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Medical evidence and underwriting will often be required

Convertible term assurance is a level term assurance with an option which enables the assured to convert it, at any time during the term, to a whole of life or endowment assurance without further...

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Medical evidence and underwriting will often be required at outset but not usually on any subsequent conversion

Product Structure

A term assurance with a short initial term of, for example, five years at the end of which the policy can be renewed for a further five years and again thereafter for an overall specified length of time

The po...

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The premiums on the new policy will depend on age at time of renewal. Holders of earlier policies may have difficulty renewing on similar terms

As with other life assurance, there is no surrender value if the policy is cancelled

Product Structure

Where an individual )a donor) makes a lifetime gift as a potentially exempt transfer (PET), the value of the PET in excess of the nil-rate band is assessed for inheritance tax (IHT) should they die during the following 7 years

If the donor outlives the gift by at lea...

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Sum assured need only cover the value of the PET which exceeds the donor’s nil-rate band – on death, any PETs are initially applied to / use up the donor’s nil-rate band

After what period of time does the initial sum assured start to decrease?

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Family income benefit is a type pf decreasing term assurance which, following the death of the life assured, pays the beneficiary the sum assured in income instalments, rather than as a lump sum

The instalments are paid to the beneficiary for the remainder of the policy term

The sum assured reflects the amount of income required for a specified term at outset

* For example, if the client wanted £10,000 per annum to be paid to their dependants for 20 years then the initial sum assured would be £200,000

* In the event...

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If, following death of the insured, a lump sum is needed, the policy may not allow this. Even if a lump sum is allowed, application of a commutation factor is likely to mean that the lump sum is less than the total value of future income payments being given up. If a lump sum is likely to be required, a level term assurance plan is more appropriate

Medical evidence and underwriting will generally be required

Where the sum assured under a family income benefit as a lump sum it is likely that:

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Before April 2006, and subject to certain conditions being met, it was possible to arrange term assurance through a pension scheme, with the term assurance premiums benefiting from tax relief in the same way as pension contributions

It has not been possible for a new pension term assurance to benefit from tax relief on premiums since April 2006, a few legacy arrangements remain in place

Tax relief on protection contributions is lost if the term is extended or premiums increased

If the policy benefits are increased or the term is extended, the tax relief is lost

It has not been possible to benefit from tax relief on premiums paid to a new pension term assurance policy since??

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Multiplan (or universal life/menu) policies act like an umbrella under ...

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Terminal illness benefit can be added to, is a ‘rider’ benefit on, a term assurance or whole of life plan and will pay out the sum assured prior to the death of the policy holder if they are diagnosed with a terminal illness. Essentially, terminal illness benefit allows for advance payment of the sum assured, whilst the life assured is alive and requires the funds, rather than on death. Some providers automatically include terminal illness on all policies at no extra charge, while others offer it for a small additional premium.

Terminal illness benefit should not be confused with critical illness cover (CIC), as although both...

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There are no specified illnesses (unlike critical illness cover)

The accelerated payment can help ease financial hardship caused due to the illness and provide a lump sum to contribute towards payment of care and allow the claimant some comfort in their final months

If the insured makes a claim and subsequently survives beyond the expiry date of the policy the terminal illness benefit does not have to be repaid but no further benefit is payable

It does not usually apply in the last 12 to 18 months of a policy

What is the main difference between critical illness and terminal illness benefit?

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In previous chapters, we have discussed why a need for life assurance may arise, such as paying off outstanding debts, enabling surviving family members to maintain their standard of living, covering the cost of caring for dependents and providing for the payment of inheritance tax.

It is important to establish who needs to be insured. Policies can be written in a variety of different ways depending on the individual needs of the client:

Own Life is where the life assured is insuring their own life for the benefit of others, e.g. a surviving spouse or other dependants

Life of another basis is where the life assured and the policyholder are two different people. It is suitable where an individual has an insurable interest in the life of another person, such as a divorced spouse insuring their former spouse to protect maintenance payments or where a business owner insures the life of a key individual within the business

Joint life first death will pay out the benefit ...

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Any surrender value cannot exceed the premiums referable to the unexpired risk under the policy

Only the sums and benefits in 1 to 3 above can be paid or conferred

Any benefits may only be paid to, or applied on behalf of, an individual or charity entitled to them

No benefit can be paid directly or indirectly to a life assured or a person connected to a life assured on the death of another life assured

Tax avoidance must not be the main or one of the purposes of the insurance

Important consideration also needs to be given to the destination of the benefits and whether the policy should be written in trust.

Neil and Heather are married and wish to make provision for an inheritance tax liability when their estate is passed on to their children. They have mutual wills leaving their respective assets to each other on first death and then to the children. On what basis should they set up a whole of life plan and why?

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As indicated in the previous topics, there are a wide range of policy types and options available and it is important to ensure that the plan selected contains the right options to meet the client’s needs and objectives.

Consideration should be given to the amount of flexibility that is required, both now and in the future. A client’s needs are unlikely to remain static throughout their lifetime and changes to their personal and financial circumstances will undoubtedly have an impact on their financial protection needs.

Whole of life plans are the most flexi...

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To benefit from the additional benefits included, it is important to ensure regular client reviews are undertaken. Some providers may only allow increases under guaranteed insurability options within a specified period after the trigger event has occurred, and failure to claim within the relevant timescale may mean that the option to increase is lost.

Name an event that could lead to an increase of the sum assured under a guaranteed insurability option.

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All premiums received from life assurance clients are paid into a common fund from which the insurer also pays out claims. When setting the premium rate, the insurer needs to be sure that the value of the fund is sufficient to pay out any claims, otherwise the insurer would have to sell assets to make up the difference.

The insurer’s actuaries use mortality tables to predict the number of claims an insurer is likely to have in a year and this information is then used to set an appropriate premium rate.

The mortality rate can also be described as “the proportion of deaths in a population or to a specific number of the population”. Current and previous mortality tables can be found on the National Statistics website or by typing  ’National Life Tables’ into a search engine. The most relevant information found in the mortality tables are the mortality rate (qx) and life expectancy listed (ex).

The natural premium is the cost of providing life cover for any given age. This is calculated by multiplying the mortality rate by the sum assured required. If everyone of the same age pays the premium, there should be sufficient in the pot to payout any claims, though leaving no excess. The cost for the following year will be higher as the probability of dying increases with age.

Example

The natural premiums for a female aged 30 over a four-year period

Age

Mortality Rate

Sum Assured

Premium

30

0.000361

£10,000

£3.61

31

0.000383

£10,000

£3.83

32

0.000457

£10,000 ...

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The premise of level premiums is that the cost of providing life cover over the whole term of the policy is considered and the cost is averaged out so that the same premium is charged throughout the term of the plan. In the early years this means that the premium paid is much higher that the natural premium that would be charged for that age, thereby creating an excess. The excess is paid into a reserve and this is then used to subsidise the higher natural premium cost later in the term.

Pure premiums calculated in this way do not consider any investment returns or interest that may accrue on the value of the reserves over time. When the premium paid by the policyholder is received by the life office, it is pooled with the premiums paid by others and the funds are invested until they are required to pay out claims. The actuary can use assumptions about future returns to discount the premium rate and thereby make the terms offered by the insurer more attractive.

The effect of interest will depend on the term of the policy. Interest would have little impact on a short term such as a year but would be effective over a longer term such as 25 years. The actuary would also have to make assumptions about future trends in interest rates and mortality.

What would be the natural premium for a female with a mortality rate of 0.000993 for a sum assured of £50,000?

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The pure premium as described above will solely provide the cost of expected claims; however, in calculating the actual premium to be charged the insurer will take account of expenses and other cost adjustments, as follows:

The main expenses incurred would include:

The cost of hiring and maintaining a workforce

The cost of offices/premises

IT, administration and regulatory costs

Underwriting ex...

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Some insurers approach this in a different way, quoting for a monthly premium and offering a discount if the whole annual premium is paid upfront. .

What are policy loadings?

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The role of the underwriter is to assess and measure the risk the life office is exposed to and determine whether that risk is acceptable to insure. Underwriters can either decline the risk or increase (i.e. load) the premium to reflect the higher risk. In addition, they may restrict the circumstances under which a claim would be paid by stipulating exclusions within the policy, conditions that are generally covered but are excluded from cover for a particular life assured.

Different types of policy are underwritten in different ways to reflect the specific risks, e.g. the factors which are relevant when assessing life cover are different to those ...

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It is important to note that this is the total cover, so includes all existing cover and any other concurrent applications

If the age of the life assured and/or the sum assured is more than these limits, the underwriter is likely to ask for a General Practitioner’s Report or a full Medical Examiner’s Report

What is the role of the underwriter?

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In some circumstances, additional evidence is required to assess the risks of a particular proposal. This might be because of answers given on the application form about health or lifestyle or may be required automatically due to the size of the sum assured or the age of the applicant.

General Practitioner’s (GP’s) Report

If further medical evidence is required, one of the most important pieces of information will be a GP’s Report

This will contain details from the applicant’s own doctor and detail their medical history. The life office may also request any additional information that may assist in assessing the risk of the application

The life office will pay a fee to the GP for supplying this information

Medical Examiner’s Report (MER)

Normal practice is for a life office to request a GP’s Report prior to asking for a medical examiner’s report

A medical examiner’s report may be reques...

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Hazardous sports and pastimes

Hobbies which have a high risk of accidental death as a side effect will also affect the underwriter’s decision. Obvious hazardous sports would include motor racing, motorbike racing, climbing, diving, boxing, kickboxing, karate, etc.

Financial underwriting

In addition to medical evidence the underwriter may also ask for financial information to assess the appropriateness of the suggested sum assured. This is usually when underwriting business protection cases, to ensure that the sum assured is not excessive but can also be relevant for personal protection not connected to a mortgage or loan or when underwriting a policy for the purpose of funding inheritance tax.

What are the two types of medical report that an underwriter may request?

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The main elements of the Act are:

General data processing ...

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Empowering the ICO to bring criminal proceedings for offences where a data controller or processor alters records with the intention of preventing disclosure following a Subject Access Request (SAR)

What amount of fine can be levied by the ICO for the most serious data breaches?

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Data protection legislation applies to data controllers and processors, the controller says how and why personal data is used and the processor acts on the controller’s behalf. Processors have specific legal obligations, for example, a firm must keep records of personal data and processing activities, and firms have legal liability if there are any breaches of the legislation. Controllers must also ensure that their contracts with processors meet the specified requirements.

 Data protection legislation applies to all personal...

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To restrict processing; if processing is restricted an organisation can store an individual’s data but cannot process it

To data portability; the right to transfer data from one organisation to another, making product / service transfers easier

To object to the processing of their data in certain circumstances

Firms are required to put into place comprehensive and proportionate governance measures and to report certain types of data breach to the relevant supervisory authority, the Information Commissioner’s Office (ICO) in the UK and the individuals affected. The transfer of data to a country outside of the EU is restricted, to ensure that individuals are not having their levels of protection decreased.

In the UK the main legislation governing the processing of personal data is?

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Once the underwriter has collected and assessed all the relevant information they will be able to make a decision on the proposal for insurance. They can:

Accept the application on standard terms

Accept the application on special terms. This would be done by increasing (or ‘loading’) the premium or by excluding...

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Decline. This option is only used in circumstances where the application is deemed unacceptable under any terms

Why would a decision on offering terms be postponed?

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An insurer cannot know all the facts about a proposer’s state of health unless the proposer declares all the facts to the insurer’s underwriters. Traditionally, applicants were under an obligation to act in utmost good faith, disclosing all ‘material’ facts that are relevant to their application regardless of whether they are specifically asked to provide that information or not.  

The obligation to act in utmost good faith resulted in many claims being declined because of non-disclosure of a material fact, especially in respect of critical illness cover. There were concerns that some claims were being declined as a person had innocently failed to disclose information that they weren’t asked which, at the point of a later claim, was deemed as a material fact by the insurance company.

Concerns about the application of utmost good faith led to the introduction of the Consumer In...

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The insurer can void the policy (decline the claim and cancel the policy from inception)

Source: ABI Guidance on Non-Disclosure and Treating Customers Fairly – January 2008

The Insurance Act 2015 came into force from August 2016 and introduced changes to the duty of disclosure in relation to commercial insurance contracts and in respect of the remedies available to insurers for fraudulent claims. The provisions of the Act now mean that employers taking out group policies have a duty to make a fair representation of the risk. The remedies available to insurers are now changed so that except where the breach of duty to make a fair representation is deliberate or reckless, proportionate remedies based on what the insurer would have done if full disclosure had been made will apply.

What are the three categories of non-disclosure?

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The legal principles of assignment

An assignment is the transfer of ownership of an asset from one person to another. It can be temporary or permanent and can confer an absolute or a limited interest. The ownership of life assurance policies is commonly changed by way of assignment and therefore it is important to understand the basic legal principles and how an assignment can affect claims and surrenders.

There are four main types of assignment:

Absolute assignment, including selling or gifting a policy

Assignment by way of mortgage

Assignment by operation of law on bankruptcy

Assignments by trustees (covered in Chapter 10)

Assignments can be made to a single or joint assignee(s) and where made on a joint basis it is important to ascertain whether it is on a joint tenancy or tenancy in common basis.

For joint tenants, on death of one tenant the ownership of the policy would automatical...

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To voluntary assignments, i.e. gifts or trusts

Between assignor and assignee based on the equitable principle that they are equally effected by the knowledge of the facts

Where there is evidence of blind wilfulness on the part of an assignee for value, where there is a suspicion that a prior notice of interest where the assignee deliberately refrains from making enquiries

It does not apply to mortgages for unlimited amounts. For example, where there is a second charge or further borrowing, the second mortgagee should make proper enquiries before taking a charge on the policy

Other provisions of the Act provide that assignments can be made by endorsements or by separate instruments.

What are the four main types of assignment?

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This is the complete transfer of a policy either by sale or gift. All interests are therefore vested in the assignee, which means that they effectively own the policy and are entitled to any claims made under the plan. Before completing an assignment, the assignee should contact the insurance company, check that premium payments are up-to-date and wheth...

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The whole policy must be assigned. Re McKerrell (1912)

The actual words used must be adequate to transfer the legal interest in the policy. Spencer v. Clarke (1878)

What is an absolute assignment?

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A lender may require a policy to be assigned to them in connection with a loan and used as additional security. The mortgage deed assigning the life policy will have the usual components in addition to:

A covenant by the mortgagor to pay premiums as they fall due and restore the policy if it lapses

A covenant that the policy is valid and that if it becomes invalid they will effe...

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To whom are the claim proceeds of a mortgaged life policy paid?

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Every life office will have their own claims procedures which will balance speed and efficiency in processing with due diligence. A claim will, in general, require:

Proof of title - producing the policy document and any deed of assignment. In the case of a death claim, a Grant of Probate (a grant of letters of administration in Scotland) is also required

Payment of all the premiums due - if some premiums have not been paid, a reduced claim might still be paid in some cases (e.g. where the policy has an investment element). In other cases, non-payment will cause the policy to lapse with no value (e.g. a term assurance policy)

Evidence of age and (if applicable) marital status - birth and marriage certificates will need to be produced if they were not supplied at the start of the policy

Death certificate - which should be the original document

Discharge form - duly completed and signed by the person with legal title

Maturity claims

These are fairly straightforward. If a policy has a value at the maturity date (e.g. an endowment plan) the life office will pay the maturity value to the policy owner on receipt of proof of title, policy documentation and completed discharge form.

The discharge form must be signed by the person with legal title and this is the only person that the insurer can legally pay the policy proceeds to.

Death claims

As mentioned above, proof of death and proof of title are essential before any claim can be considered.

Proof of Death

Proof of death is by way of an official Death Certificate, which is a copy of the entry on the Register of Deaths as per the Birth and D...

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This has been confirmed by a case taken to the House of Lords, Hickman v. Peacy (1945), where two brothers were killed in a basement during a bombing raid in London, payment would be made to estate of the younger brother.

Executors and administrators must also prove their right to make a claim and receive benefits. To do this, they should produce one of the following:

A grant of probate where there is a valid will or

A grant of letters of administration, where there is no valid will

In cases where the size of the estate and the sum assured are very small, e.g. a sum assured up to £5,000 and estate less than £10,000, the insurer may pay out the claim without a grant. However, this does expose them to a small risk that payment has not been made to the correct person.

Proof of Age

Proof of age can be proved on production of the original birth certificate. For married women, the marriage certificate is also required to link the married name to the birth name.

If the age of the claimant is incorrect, the premium charged will have been either too much or not enough. Where the age of the policyholder is older than previously advised, the insurer may reduce the claim accordingly (although practices vary between offices). Where the life is younger, the insurer may refund the difference between the premium paid and the actual cost, although again practices vary.

What documents can be used to prove title?

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It is a fundamental principle of insurance law that a person cannot benefit from their own criminal actor where, due to their own deliberate act, they cause the event they are insured against.

Where a policyholder took their own life while of sound mind, this caused a problem, because until the Suicide Act 1961, it was considered both a criminal and deliberate act and would have resulted in the non-payment of a claim. Most lif...

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It may not always be clear cut in either situation and therefore each case would have to be carefully considered. Where the claim is declined, the life office’s decision may also be legally challenged.

Why would an insurance company refuse a claim from a policyholder who has murdered the life assured?

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Where the policy document cannot be produced as proof of title, the life office will require a thorough search to be undertaken and if the policy document still can not be...

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Where a policyholder wishes to surrender or cash in a life policy, this would also be treated as a claim. The life office will have to go through all the steps of a claim regarding proof of title, to ensure that the surrender proceeds are paid to the correct party.

Where the policy is mortgaged, the discharge will need to be countersigned by the mortgagor unless the surrender is under ...

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What is an alternative option to the surrender of an endowment policy?

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A trust is a legal obligation where someone ( the settlor) gives away an asset to benefit others ( the beneficiaries) without passing over immediate full control to the beneficiaries. The asset  is instead legally owned by another person(s) ( the trustees) who hold the asset for the benefit of the beneficiaries in accordance with the specific terms set out in the trust.

There are three parties required to create a valid trust:

The settlor

The trustee(s)

The beneficiary or beneficiaries

Registration of trusts

When a trust is created, it has to be registered with HMRC’s Trust Registration Service (TRS). The information required depends on whether the trust is taxable or non-taxable.

Trusts of life policies are usually excluded from registration as express trusts during the lifetime of the life or lives assured. To qualify as exempt the policy (term or whole of life) must only pay out on death, terminal or critical illness or temporary or permanent disablement of the life/lives assured or to meet the costs of healthcare services.

If a policy has a surrender value, the trust could fall within the registration rules if it is surrendered and the cash is held within the trust. Trusts holding bonds will require registration if withdrawals are taken, as these payment represent pay-outs that do not fall within the above stated conditions. When an exempt policy pays out on death the trustees have two years from the date of death to distribute the funds to th...

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Trustees

The only basic requirements for trustees are that they are of sound mind and over 18. However, careful consideration should be given before appointing trustees, as they will in effect decide on the eventual destination of the trust benefits.

They should be aware of the settlor’s wishes. The settlor could leave the trustees a “letter of wishes”, non-binding guidance as to what they would like to happen after their death. Consideration should also be given to the age and state of health of the trustees as they would need to be capable of discharging their duties after the death of the settlor. Where all the trustees have died, their personal representatives can act as trustees or appoint replacements. However, this would add time and complication and is likely to delay the payment of any benefits.

Trustees should also be made aware of their legal obligations and the implications to them personally if these are not adhered to. Trustees can face criminal charges, fines and even imprisonment if their legal obligations are not met.

Trustees can resign or retire easily, but it is difficult to remove a trustee against their will. This could result in court action, time and expense.

What are the three parties required to create a valid trust?

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