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Life insurance basic concepts (United Kingdom)

This deck gives the reader a basic understanding of life insurance concepts. Terminologies and regulations are of UK region.

Life insurance basic concepts (United Kingdom)

  1. 1. Life Insurance Basic Concept – United Kingdom By Avik Saha Does not include reinsurance and annuities
  2. 2. 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
  3. 3. Basic Product Types     Term 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‟
  4. 4. Term assurance (TA) – different variations       Level (LTA) – the sum assured remains the same throughout the term Renewable - 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
  5. 5. Endowment assurance – different variations      Non-profit - only the guaranteed sum assured is payable With-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
  6. 6. Whole life assurance – different variations      Non-profit - only the guaranteed sum assured is payable With-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 Single premium – used primarily for investment purposes as the death value is typically 101% of the policy value Universal Life Policies – Regular premium unitlinked 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
  7. 7. 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)
  8. 8. Income Protection Insurance (IPI)       Previously know has PHI (Permanent Health Insurance) Policy benefit payable if insured is too ill to work Deferred 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 policies IPI policies can not be assigned to another
  9. 9. Business assurance  Bought 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)
  10. 10. 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
  11. 11. Group life assurance  Life 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)
  12. 12. 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
  13. 13. Insurable Interest Proposal Form Exclusion Policy Life Cycle GP Report Mortality Table Premium Declinature Cooling off period Underwriting Confirmation notice Policy document Policy set-up Agent commission New Business Conversion Alteration Surrender Assignment Renewal Premium Policy Loan Withdrawal Policy Admin Death Claim Terminal Bonus Maturity Claim Investigation Claims
  14. 14. Underwriting - Financial  Financial 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
  15. 15. Underwriting - Medical  Underwriter to consider – ◦ ◦ ◦ ◦  Underwriting procedure uses – ◦ ◦ ◦ ◦  Medical factors (smoking habits, existing conditions etc) Occupational Factors (nature of job) Hazardous sports and pastime and Residential factors 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
  16. 16. 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
  17. 17. New Business Procedure  Legal 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
  18. 18. 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
  19. 19. 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
  20. 20. 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
  21. 21. 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 
  22. 22. Claims Can be Maturity Claims or Death Claims  Claim 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
  23. 23. With-Profit Policies Policy value is indirectly linked to investment performance  Investment valuations happen annually; any surplus is distributed to shareholders and withprofit 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
  24. 24. Unit linked policies Policy value is directly linked to investment performance  Funds are valued daily and reflected in unit prices  Premium buys units  Units are cancelled for withdrawal  Unit link funds include instruments such as Equity, International, European, North American, Far Eastern, Fixed interest, property, cash, building society etc 
  25. 25. Death Benefit/Maturity Value  Death 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
  26. 26. Trust An 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

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