UK Financial Services, regulations and ethics

In this section, we briefly discuss the importance of budgeting and how it affects an individual’s financial needs.

Within any financial planning scenario, considerat...

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...oid policies lapsing and vital protection being lost. It is better to recommend an affordable partial solution that can be sustained than a full solution that is unaffordable.

Expenditure should be considered under three headings:

Essential spending – rent/mortgage, utilities, etc

Everyday spending – food and travel costs

Non-essential spending – clothes, entertainment, holidays, etc

Where clients are struggling to make ends...

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...fit from the assistance of the Citizens Advice Bureau and debt counselling services.

If clients have borrowings but hold large cash reserves at the same time, the adviser should ask why it is that the client does not consider repaying some of their debt with their cash reserves.

Introduction

The term ‘mortgage’ refers to the security offered in exchange for a loan. When the security is signed over to the lender in exchange for the mortgage the transfer of ownership is known as the ‘assignment’ – a temporary assignment for the term of the loan. Often the term ‘mortgage loan’ refers to loans relating to residential properties although as we shall see it can relate also to commercial loans.

Buy-to-let

A buy-to-let mortgage is a loan taken out for a property purchase that will then be rented out to a tenant. Lenders consider this type of mortgage a higher risk and the amount the lender will be prepared to lend will depend on a number of factors:

The size of the deposit (it will need to be at least 25% of the property value and often a higher amount will be required)

Whether it is affordable to the purchaser (judged by an affordability calculator and credit score)

The expected annual rental income against the value of the property (normally this will need to be at least 125% of the annual mortgage repayments)

Second charge

These mortgages allow borrowers to use the equity they have in their home as security against another loan. They a...

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...ercial property and land for business purposes. The lender will have a claim over the property until the loan is fully repaid, like a residential mortgage.

Commercial loans typically run for shorter periods than residential mortgages, and for both interest-only and repayment mortgages borrowers may choose between fixed rate and variable interest rate options.

There are two main types of loan – structured and unstructured. Structured loans are normally for smaller purchases (e.g. cars) and have a fixed rate of interest and a fixed repayment structure, which does not change over the term. If these are repaid early there is normally a penalty. Unstructured loans are normally used for the purchase of commercial property and give the possibility to increase repayments, which reduces not only the capital outstanding but also the interest. They can also usually be repaid early without any penalty.

Overdrafts and some personal loans also fall into the unstructured category. The interest rate charged varies in line with the risk of default and is usually inked to the Bank of England base rate. 1% above the base rate is considered by the lender as a low risk of default whereas 4% would be considered a high default risk.

There are many factors that influence a client’s protection needs. Some major ones are:

Age

Variance in age will often highlight different protection needs (see life cycle of protection needs later).

Dependants

Number and age are very important. They will often be vital in determining the type of cover needed, how much and for how long. Adults as well as children could be dependants (e.g. elderly relative)...

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...h personal and business related protection needs.

Existing cover

Existing cover should always be taken into account when assessing client needs. Other areas to assess are accessibility to State benefits and any payments that may be made by an employer on death or illness. As already mentioned, there is no point in arranging more cover than is needed as this would also be a breach of the ‘suitability rules’.

Fewer households now conform to the previously accepted normal stages of life: - childhood, young single, young partnered, starting a family, family with older children, post-family/pre-retirement and retirement.

A simplified model is:

The ‘vulnerable years’ of early married life and starting a family, with relatively low incomes but high protection needs

The ‘relaxed years’ which start in the 40s, when children are independent and incomes are at a higher level, but protection needs are...

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...ckness – increasing age, increasing risk

Redundancy – if mortgage/loans in place

50-60

Death – less significant unless there is a second family. May need to protect assets against IHT liability

Sickness – long term care cover may be considered

Redundancy - if there is still a mortgage and/or loan(s) in place

Over 60

Death – protection of assets against IHT liability

Sickness – health protection and long term care

Redundancy – not usually significant

There are several types and variances of protection policies meeting a variety of different needs. Outlined below are some of the main ones and we list their individual features, benefits, limitations and tax treatment.

Term assurance

A term assurance pays a lump sum (sum assured) or series of lump sums (family income benefit) in the event of death of the life assured during a specified term. This amount can either be paid to the assured’s estate or it could automatically pass to someone else, e.g. through a trust or as a ‘life of another’ policy where the life assured is different from the individual setting u...

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...s - Can only be used to cover very specific needs due to the reducing nature of cover

Family Income Benefit

A special type of decreasing term assurance. On death of the life assured within the term, a series of annual payments will be made instead of a lump sum.

Gift inter vivos policy

Features – seven-year form of decreasing term assurance. Sum assured remains level for three years and reduces by 20% a year for remainder of the term

Benefits – Used to pay IHT liabilities arising as a result of lifetime gifts

Limitations – Designed to meet a specific need therefore very limited in its use elsewhere

A whole of life assurance pays a lump sum (sum assured) in the event of death of the life assured whenever that occurs during their life. This amount can either be paid to the assured’s estate or it could automatically pass to someone else, e.g. through a trust or as a ‘life of another’ policy where the life assured is different from the individual setting up the contract (the assured or policyholder).

These arrangements have an investment element. How extensive this will be depends on the type of policy. Outlined below are the features, benefits and limitations of the main different types of whole of life contract.

With profits whole of life

Features – Profi...

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...ed inflation. Also, wider investment choice is possible. Variety of additional benefits can help the client vary cover for protection needs throughout life stages under one policy.

Non-profit whole of life

Features – There is no investment value to this policy. Only sum assured payable on death.

Benefits – Protection throughout life.

Limitations of whole of life policies

Life cover is the main purpose. Surrender values may be low and hence an inefficient form of saving. Charges are unknown for with profits policies. Some policies can be inflexible in their structure and benefits on offer. For unit-linked policies, there is no guarantee of investment performance.

Endowment assurance policies will pay a lump sum to t...

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...rs the market for these policies has greatly reduced.

Sickness insurance comes in several...

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...wed as complementary to each other.

Income protection insurance (IPI) benefits:

Provide regular income payments in the event of incapacity (as defined in the policy) after a chosen deferred period

These payments will be linked to a percentage of the insured’s earnings subject to an overall maximum (e.g. 50-60%)

Benefits payable until the individual recovers, dies or the policy expires, whichever comes soone...

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...on is usually used with cover such as that available for house persons

First three definitions get used for people in work. First occupation definition will be most expensive but more likely to pay a claim. Last occupation definition will be cheapest but least likely to pay a claim. Activities of daily living definition usually used with cover such as that available for house persons

The benefits are:

Provides a lump sum on the diagnosis of a ‘critical illness’ as specified in the policy schedule. Common conditions include cancer, kidney failure, heart attacks, major organ transplants, multiple sclerosis, permanent ...

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...To Minimum Standards of Critical Illness Cover was published in September 2022 and applies to all new policies. Policies must cover at least cancer, heart attack and stroke and there are minimum definitions for each illness that insurers have to meet.

Personal Accident and Sickness policies pay benefits if the insured is unable to work due to accident or sickness, but there ar...

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... be cancelled by the insurer at the renewal date

Costs of policies are significantly less than Income Protection policies

Benefits – in the event of accident, sickness or unemployment, Mortgage Payment Protection Insurance (MPPI) provide...

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...ithout any link to a mortgage.

For both types of policy, benefits are tax free and premiums do not attract tax relief.

Payment protection insurance is designed to cover loan repayments if someone is unable to work due to ...

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...f a loan or credit and the sale of any form of payment protection insurance (including MPPI policies).