1 : 2 - The Role of Insurance

Question 1

What is the principal role of insurance?

Answer 1

To protect against the financial consequences arising from the occurrence of the insured event.

eg: theft, fire or accidental damage.

Question 2

What is the purpose of life assurance?

Answer 2

To ensure financial security for dependants on the death of the insured person(s) by providing a lump sum, a regular income, or both.

It is designed to meet several aims:
• paying final expenses (for example, funeral, legal)
• paying off outstanding debts (for example, mortgage, loans), and
• providing income to maintain the dependant(s) lifestyle.

Question 3

What are the 3 main types of life assurance policies?

Answer 3

1. Term Assurance.
2. Whole of Life Assurance.
3. Endowment Assurance.

Question 4

Terminology and definitions:

• The ‘proposer’
• The ‘life assured’
• The ‘assured’

Answer 4

• The ‘proposer’ is the person applying to the insurer for a policy.
• The ‘life assured’ is the person upon whose death the payment is triggered.
• The ‘assured’ is the person who effects the policy and is the original owner.

Question 5

What is an ‘own life policy’ ?

Answer 5

When the life assured and the assured are the same person. (happens frequently)

Question 6

What is it called when the ‘life assured’ and the ‘assured’ are different people?

Answer 6

‘Life of another policies’.

Question 7

Policies can also be written for two lives assured. Joint life policies are either:

(2)

Answer 7

• Joint life first death, paying out on the death of the first life assured
• Joint life second death policies pay out on the death of the second life assured

Question 8

What is the ‘Surrender or cash-in value’ ?

Answer 8

The amount of money the insurance company pays to the policyholder if the policy is voluntarily terminated before its maturity or a claim is made

Question 9

What is ‘term assurance’ ?

Answer 9

The most basic, and cheapest, form of life assurance that provides cover for a specified period of time. The sum assured will be paid out only if the life assured dies during the agreed term.

Question 10

What are the 5 types of five types of term assurance policies?

Answer 10

• Level-Term Assurance
• Increasing-Term Assurance
• Decreasing Term Assurance (DTA)
• Renewable-Term Assurance
• Convertible Term Assurance

Question 11

(Within Term Assurance):

What is Level-Term Assurance?

Answer 11

With this type of insurance, the sum assured and the premiums remain fixed over the period.

The advantage is that premiums will be predictable.

Question 12

What type of assurance is frequently
used to provide cover alongside an interest-only mortgage.
&
Why?

Answer 12

Level Term Assurance

A homeowner with an outstanding mortgage may consider level-term assurance useful as the lump sum
paid out upon death can be used to pay off a mortgage.

Question 13

(Within Term Assurance):

What is Increasing-Term Assurance?

Answer 13

Similar to level-term, except that the sum assured increases over the policy term.

Question 14

What is a ‘Guaranteed insurability option?

Answer 14

These allow the sum assured to be increased by
much more substantial amounts (for example, 50% of the original sum assured).

These increases are offered alongside key events in an assured’s life, such as marriage, the birth of a child or a remortgage for a higher sum.

Question 15

(Within Term Assurance):

What is Decreasing Term Assurance (DTA)?

Answer 15

These policies have a sum assured which reduces each year by a given amount, decreasing to zero at the end of the term.

The initial premium will be lower than that for level-term assurance as the overall liability to the insurer decreases over the term.

Question 16

What type of assurance would be used to cover reducing debts, such as a repayment mortgage?

Answer 16

Decreasing Term Assurance (DTA)

Question 17

Q:

Jayne has a repayment mortgage of £400,000 on her main residence with eight years remaining. She
is worried about how her family will repay this debt if she dies so asks for your advice with regard to
protecting this debt.

Answer 17

A DTA policy with Jayne as the life assured for an initial sum assured of £400,000 over an eight-year
period would satisfy this need.

The sum assured on the policy will decrease each year as it is designed to reduce in line with a typical repayment mortgage as the outstanding capital reduces.

Question 18

Q:

Stephen has an interest-only mortgage of £250,000 on his main residence with ten years remaining. He
is worried about how his family would repay this debt should he die and asks for your advice with regard
to protecting this debt. He plans on downsizing in ten years and repaying the mortgage at that time.

Answer 18

A level-term assurance policy with Stephen as the life assured for a sum assured of £250,000 over a ten year
period would satisfy this need.

Question 19

(Within Term Assurance):

What is Renewable-Term Assurance?

Answer 19

This is effectively term-assurance with a renewable option which provides the opportunity for the life assured to take out a further term assurance at ordinary rates, without requiring further evidence of health (known as guaranteed insurability).

Question 20

(Within Term Assurance):

What is Convertible Term Assurance?

Answer 20

This type of policy allows the policyholder to convert a term policy to a whole of life policy.

This conversion can take place at any time during the policy term or before the insured’s 70th birthday, and there will be no need to provide any further evidence of health.

Question 21

What is Family Income Benefit (FIB)?

Answer 21

This form of protection gives the beneficiaries a tax-free regular income, as opposed to a lump sum payment.

The income is paid for the remaining term of the policy, so the closer to the end of the policy the death occurs, the smaller the number of income payments received by the beneficiaries.

Question 22

What are the benefits of Family Income Benefit (FIB) assurance?

(3)

Answer 22

• a very low-cost method
• the income is tax-free
• there are no investment fees, charges or tax.

Question 23

What is the major drawback to Family Income Benefit (FIB) assurance?

Answer 23

The structure of the plan means that the total amount that can be paid out decreases each year, as the payments are only made until the end of the
policy term

Also, this type of policy will not allow the beneficiaries to pay off a debt such as a mortgage

Question 24

Life cover: key factors for a financial planner to consider:

6

Answer 24

• How much cover is actually required/how much will the children need per annum
• For what term will cover be required/when are they likely to be financially independent?
• How will inflation erode the cover over time?
• What level of life cover has she through her employer and how might this be used?
• Should the policy be placed into a trust from the outset to ensure the proceeds are payable to the
trust rather than to Margaret’s estate upon her death?
• What is her budget for this protection need?

Question 25

What is Whole of Life Assurance?

Answer 25

Whole of life assurance policies guarantee a payout of the sum assured on the death of a life assured, whenever that occurs.

Question 26

What are the 4 types of whole of life assurance policies?

Answer 26

1. Non-Profit Whole of Life Policies 2. With-Profits Whole of Life Policies 3. Low-Cost Whole of Life Policies 4. Unit-Linked Whole of Life Policies

Question 27

What are 'Non-profit whole of life' policies?

Answer 27

These have level or fixed premiums, payable throughout life. These policies pay out a fixed sum assured, whenever death occurs.

Question 28

What are 'With-Profits Whole of Life' Policies?

Answer 28

With-profits policies include an investment element and therefore, offer the opportunity for the sum assured to be increased by the addition of bonus payments, ie, profits from fund performance) These bonuses are not guaranteed but, once allocated, cannot be removed.

Question 29

What is a market value reduction (MVR) factor?

Answer 29

The MVR enables the life office to reduce the surrender or switch value, in an attempt to apply fairness across all with-profits members.

Question 30

What are 'Low-Cost Whole of Life' Policies?

Answer 30

These are products sold as one policy, but, in effect, are a combination of two policies we have already considered: * a with-profits whole of life policy element * a DTA element. The policy will pay out a full sum assured on death, based on the combined value of these two elements.

Question 31

What are 'Unit-Linked Whole of Life' Policies?

Answer 31

These policies incorporate an investment element – part of the monthly premiums paid are used to pay for the sum assured and the remainder is used by the life office to purchase units in a selected fund. Over time, as the number of units held increases, the policy’s value also increases. If, however, the fund performs poorly, premiums increase.

Question 32

What is Endowment Assurance?

Answer 32

Endowments combine life cover over a specific term (like term assurance), with the guarantee that there will be some form of payout upon death (like whole of life assurance). They provide a steady mix of protection and investment, and are the most expensive form of assurance.

Question 33

What are the 5 types of endowment assurance policies?

Answer 33

1. Non-Profit Endowment Policies 2. With-Profits Endowment Policies 3. Low-Cost Endowment Policies 4. Low-Start Endowment Policies 5. Unit-Linked Endowment Policies

Question 34

What are Non-Profit Endowment Policies?

Answer 34

The most basic form, with level premiums and a payout of a fixed sum assured on maturity or earlier death.

Question 35

What are With-Profits Endowment Policies?

Answer 35

These guarantee that the sum assured will be paid out on death or on maturity at the end of the term. In addition, there are likely to have been reversionary bonuses added during the term, and the possibility of a terminal bonus added at maturity.

Question 36

What are Low-Cost Endowment Policies?

Answer 36

These operate in much the same way as low-cost whole of life plans, with two different policies operating under the structure of one: * a with-profits endowment element or a unit-linked element, and * a DTA element. They guarantee to pay out the full sum assured on death.

Question 37

What are Low-Start Endowment Policies?

Answer 37

Low-start endowments are a development of low-cost endowments, but have a lower initial premium. That is because the premium rises, typically for the first five to ten years of the policy, and then settles at a higher figure than would have been the case under a low-cost endowment for the remainder of the term.

Question 38

What are Unit-Linked Endowment Policies?

Answer 38

These operate in a similar way to other unit-linked policies. The fund choice selection is often wider than for whole of life policies, as it is more of a pure investment product. The maturity value of the policy will always be the bid price of the units, so they are very transparent.

Question 39

Why have Traded endowment policies (TEPs) become attractive to investors?

Answer 39

Because, in buying a mid-term policy, the investor purchases a product with a guaranteed value which includes the basic sum assured, plus any bonuses already attached. A TEP also has the benefit that all initial charges have already been paid by the original policyholder.

Question 40

Why might a seller decide to sell a with-profits endowment policy prior to maturity?

Answer 40

A change in circumstances: such as divorce or change in mortgage requirements. Individuals have found that selling such a policy is more beneficial in terms of the sum received rather than surrendering it back to the insurance company.

Question 41

When is a gain made under a UK life assurance policy is subject to capital gains tax (CGT)?

Answer 41

If it has at any earlier time been acquired by any person for actual consideration (eg, policyholder may have sold the bond to someone wishing to buy it as an investment).

Question 42

When would a policy not be subject to IHT?

Answer 42

If the policy is written with a trust.