Life Insurance Basic Concept – United KingdomBy Avik Saha

Does not include reinsurance and annuities

Basic Terms Risk - Probability of loss Life Insurance - Insurance to cover the loss arising from

death Assured - Also called policy holder or proposer, the owner

of the life insurance policy Life Assured - Also called insured, the person whose life is

used to underwrite the life insurance policy Sum assured - Also called face amount, the amount of

money life insurance company pays if the risk materializes

Beneficiary - Also called claimant, whom the life insurance company pays the death benefit in the event of life assured’s death

Assured and Life Assured can be the same person. Life assured has to be a person; policyholder can be a

person or organization

Basic Product TypesTerm assurance – pays out if death

occurs within the specified term mentioned in the policy; policy does not have any cash value

Endowment assurance – Pays out on maturity or earlier death

Whole Life assurance – Pays out on death whenever it happens

Endowment and Whole life policies have cash values or investment components; they are called ‘substantive policies’

Term assurance (TA) – different variationsLevel (LTA) – the sum assured remains the same

throughout the termRenewable - the policyholder has the right to

take out a new policy on expiry of the existing contract

Convertible - the policyholder has the option to convert some or all of the sum assured to a whole of life or endowment policy

Decreasing (DTA)- the sum assured decreases over the term of the policy

Increasing - the sum assured increases over the term of the policy

Family income policies - an income is provided on death of the assured until the end of the policy

Endowment assurance – different variationsNon-profit - only the guaranteed sum assured is

payableWith-profits - the guaranteed sum assured and

any bonuses allocated at the time of claim are payable

Unit-linked - the sum assured is directly linked to the value of the underlying investments

Low-start - the initial premium is lower than an ordinary policy but it is increased over the term to ensure the full value of premiums are collected

Guaranteed bonds – ◦ Income Bond - only the income is guaranteed and not the

capital◦ Growth Bond - both the capital and growth are

guaranteed as it is set at the beginning

Whole life assurance – different variationsNon-profit - only the guaranteed sum assured is

payableWith-profits - the guaranteed sum assured and any

bonuses allocated at the time of claim are payableUnit Linked - the sum assured is directly linked to

the value of the underlying investmentsSingle premium – used primarily for investment

purposes as the death value is typically 101% of the policy value

Universal Life Policies – Regular premium unit-linked whole of life policies with a whole range of bolt-on extras (explained later) giving total flexibility. Policy holders pay in what they like, when they like and choose from a gamut of benefits

Bolt-on options Also called Riders; these are additional features which

can be added to the main life assurance policy for an extra charge

Some of the bolt-on options – ◦ Waiver of premium – premium for the policy is paid by the

life insurance company if insured is too ill to work◦ Disability benefit – policy proceeds paid on permanent

disability◦ Double Accident Benefit - sum assured doubled if death is

due to accident◦ Increasing cover option – increase cover on specific events

e.g. birth of a child◦ Critical Illness Cover – Payable on diagnosis of a critical

illness e.g. cancer, Alzheimer’s etc◦ Terminal Illness Cover – Payable on diagnosis of a terminal

illness (the life assured is expected to die within 12 months)

Income Protection Insurance (IPI)Previously know has PHI (Permanent Health

Insurance)Policy benefit payable if insured is too ill to

workDeferred Period – waiting period generally in

weeks (e.g. 4, 8, 13, 26, 52) before the payments begin. Longer the deferred period lower the premium.

Benefit limited to a percentage of earnings, typically 50 to 75% prior to illness to encourage claimants to return to work

Some exclusions are applicable to policiesIPI policies can not be assigned to another

Business assuranceBought to protect partners in a

partnership, shareholders/directors of a limited liability company or to protect company’s profits if a key person leaves or dies (Key Person Insurance)

Basis of writing Life assurance policies Life assurance policies can be written on the

following basis – ◦ Single Life – only one life assured◦ Own Life – policy holder is the life assured◦ Life of another – life assured is separate from the

policy holder◦ Joint life first death – two life assureds, death

benefit payable on death of the first life assured◦ Joint life second death - two life assureds, death

benefit payable on death of the second life assured

There is no limit on number of life assureds for a life insurance policy

Group life assuranceLife Assurance, IPI, Critical Illness

cover or Personal Accident Sickness (PAS) cover can be purchased by organizations for their ◦Employees (by employers)◦Borrowers (by lenders)◦Partners (by partnerships)◦Members (by clubs, trade unions etc)

Life insurance regulation in UK Erstwhile Financial Services Authority (FSA) is split

into PRA and FCA (“Twin Peaks”) from 1 April, 2013 Insurance companies are regulated by Prudential

Regulation Authority (PRA)◦ promotes the safety and soundness of insurers◦ protects policyholders

Financial Conduct Authority (FCA) – responsible for business conduct of all firms and prudential regulation of life insurance brokerages and advisory firms among others

Financial Policy Committee (FPC) – subsidiary of Bank of England responsible for ◦ horizon scanning for emerging risks to the financial system◦ providing strategic direction for the entire regulatory

regime

Underwriting

New Business

Policy Admin

Claims

Proposal Form

GP Report

Mortality Table

Insurable Interest

Premium

Declinature

Exclusion

Confirmation notice

Policy document

Policy set-up

Agent commission

Cooling off period

Alteration

Assignment

Renewal Premium

Policy Loan

Surrender

Withdrawal

Conversion

Death Claim

Maturity

Terminal Bonus

Claim Investigation

Policy Life Cycle

Underwriting - FinancialFinancial underwriting

◦Can be for individual or corporate◦Premium set based on mortality table,

assumed interest rate for premium invested, expense and frequency loading

◦Expense Loading: charge to cover the costs of setting up and running the policy

◦Frequency Loading: charge to cover the investment potential that is lost when premiums are not paid annually in advance

Underwriting - Medical Underwriter to consider –

◦ Medical factors (smoking habits, existing conditions etc)◦ Occupational Factors (nature of job)◦ Hazardous sports and pastime and◦ Residential factors

Underwriting procedure uses – ◦ Proposal form which the applicant fills-up◦ General practitioner’s (GP) report◦ Medical examiner’s report (in case needed)◦ Other questionnaires (in case needed)

Underwriting is based on utmost good faith◦ Applicant to take reasonable care not to make

misrepresentation [Consumer Insurance (Disclosure and Representation) Act 2012]

◦ Consumer must respond honestly and with reasonable care to questions asked

◦ Insurer can avoid contact in case of reckless misrepresentation

Underwriting …cont. The life assured can be either

◦ Preferred risk (low risk)◦ Standard risk (average or normal risk)◦ Sub-standard risk (high risk)

Strategy for sub-standard risk – ◦ limiting the policy e.g. by age◦ Exclusions (no coverage if death from a particular disease

or activity)◦ Extra premium◦ ‘Rating up’ by using a premium for an age that is older

than the life assured's actual age◦ debts on the sum assured◦ postponement of the policy for a defined period of time or

until certain events have occurred so that the risk reduces◦ Declinature i.e. refusing to issue policy

New Business ProcedureLegal requirements for valid life insurance contract

◦ Offer and acceptance◦ Consideration (premium)◦ Legal capacity to contract ◦ Insurable interest (policy holder shall suffer a loss if life

assured dies; unlimited interest in ‘self’)◦ consensus ad idem (Complete meeting of minds)

Policy can be owned singly or jointly (joint tenancy and tenancy in common). Under joint tenancy, if one joint tenant dies the interest automatically passes to the survivor(s). In case of tenancy in common, if a tenant dies their share passes to their estate and therefore, can be disposed of by will of the deceased

New Business Procedure Pre-sale regulatory requirement –

◦ Services and Cost Disclosure Document (SCDD) – mentions type of products sold by the firm, how cost of advice can be paid, how to complain, details of ownership etc.

◦ Key Features Document (KFD) – mentions nature of policy, risk factors, principal terms of the policy, definition of benefit, cancellation or withdrawal rights etc.

Post-sale regulatory requirement – ◦ Post-sale confirmation◦ Cancellation notice◦ Cooling off or free look period (period after policy issuance, normally 30

days during which policy owner can decide to return the policy and get the full premium back)

Premiums can be paid by – ◦ renewal notice sent by the insurer◦ Standing order ◦ direct debit◦ account collection or ◦ Cash, Cheques, Credit or Debit cards

Non-payment of premiums Consequences of non-payment of premiums can be –

◦ Lapse◦ Paid-up policy (policy with reduced sum-assured without requiring

further premium payment)◦ Surrender◦ Loan (automatic loan from cash value to pay premium)◦ Policy stays fully in force◦ Full cover ceases after a year ◦ Alternative premium payer and  ◦ Reinstatement of lapsed policy (subject to conditions)

Non-forfeiture Clause – ensures that policy is not lapsed due to non-payment of premium by effecting one of the above alternatives e.g. automatic loan

Grace period – time period after premium due date; if the policy holder pays the premium during this period policy does not lapse; typically 30 days for a annual premium-paying policy

Policy Administration Policy alteration – following changes can be requested

to a in-force policy◦ the premium◦ the type of policy e.g. converting a term policy to

endowment◦ the life assured◦ the fund the future premiums are invested in (known as redirection)or

◦ the fund that premiums that have already been paid could be moved to another fund (known as switching)

◦ the sum assured Alterations require –

◦ agreement of the life office unless it is an option in the policy◦ agreement of the policyholder◦ endorsement of the policy and ◦ a change to the office’s records

Policy Administration …cont.

Policy Assignment – changing the policy ownership can be of following types◦ Absolute – gift or sale◦ Mortgages (temporary assignment in connection with a

loan; reassigned to original owner once loan is repaid)◦ By operation of law e.g. in case of bankruptcy◦ To trustees

Policies of Assurance Act 1867 regulates assignments of life insurance policies

Request can also be made by the policy owner for Withdrawal, Surrender or Policy Loan

Policyholders are subject to surrender charge and tax penalty for premature withdrawal from certain policies

ClaimsCan be Maturity Claims or Death ClaimsClaim is subject to -

◦the payment of premiums◦production of the policy◦proof of title◦proof of death, for a death claim◦proof of age, for a death claim

Disability and Illness Claims – ◦Arises on IPI, Critical Illness, Terminal Illness

or Personal Accident and Sickness policies

With-Profit PoliciesPolicy value is indirectly linked to investment

performance Investment valuations happen annually; any

surplus is distributed to shareholders and with-profit policyholders

Smoothed investment returns as any bad year is compensated by surplus in good year

Bonus◦ Normal bonus – allocated annually following

valuations◦ Interim bonus - paid on claims and takes account of

any bonus that would have been accumulated since the last valuation

◦ Terminal bonus – paid on claims

Unit linked policiesPolicy value is directly linked to

investment performanceFunds are valued daily and reflected in

unit pricesPremium buys unitsUnits are cancelled for withdrawalUnit link funds include instruments such

as Equity, International, European, North American, Far Eastern, Fixed interest, property, cash, building society etc

Death Benefit/Maturity ValueDeath Benefit/Maturity value

payable is calculated as below – Death Benefit/Maturity Value = Sum Assured (or Unit value for unit linked policies) + Bonus (for with profit policies) + Advanced Premium Paid – Premium Due – Outstanding Loan plus interest – other charges

TrustAn equitable obligation binding the trustee to deal

with property over which he has control for the benefit of beneficiaries of whom he may be one, and any one of whom may enforce obligation

Trust can be of different types e.g. express, implied, resulting, bare, successive, fixed, discretionary, statutory etc.

Policies can be put in trust for favourable tax treatment of the proceeds and better estate planning

Acts governing trusts are – ◦ Trustee Act 1925◦ Trustee Delegation Act 1999 and ◦ Trustee Act 2000