Life insurance is not a recent invention; it can be traced back to Roman times when a club called the Hornblowers was founded in Algeria in 203AD by a Roman garrison. In return for a regular payment into a central fund, a lump sum was paid in the event of death, promotion, transfer or becoming a veteran.
The earliest recorded life insurance in England was taken out in June 1583 on William Gibbons. It was payable if he died within 12 months, which he did, and the princely sum of £382.6s 8d was duly paid.
Whereas life assurance was originally available only to those who could afford to pay comparatively large premiums, the changing structure of society during the 18th and 19th centuries created an awareness that the ‘industrial classes’ needed some form of financial protection.
Before the end of the 18th century large numbers of Friendly Societies were providing some provision for sickness and funeral expenses. Out of the Friendly Societies grew the concept of ‘industrial’ life insurance, with companies providing assurance that was especially suited to the needs of the majority of the population.
As society has developed in sophistication, there has been an increased awareness that life insurance should provide more than an amount to pay for funeral expenses; it should provide a replacement for lost earnings.
Since 1774 every applicant for a plan must have an ‘insurable interest’ in the life assured.
Each individual has unlimited insurable interest in their own life and the life of their spouse. However, if someone wants to insure the life of anyone else they have to be able to show that they will suffer financially upon that person’s death. With their agreement they may then insure that person’s life up to that amount.
There is no automatic insurable interest between parent and child. Lenders would have insurable interest in the life of a borrower, but only to the amount of the debt.
Insurable interest must be shown only at the outset of a plan and it is the underwriter who needs to establish its existence.
A ‘term’ plan is designed to pay the benefit if the insured event occurs within a certain period of time (the term of the plan). Historically, the benefit has been the ‘guaranteed sum assured’ and has been paid by the life office in the event of the death of the life assured.
Some may offer renewability (where the original term selected may be extended) or convertibility (where the plan may be converted to a more permanent form of life assurance).
As term assurance is temporary cover, these plans are attractive to clients who need high levels of protection for a limited period and at the lowest cost. Types of term cover available in the market place are:
A level term plan is one where the sum assured remains the same throughout the term. The sum assured will only be paid should death occur during the term. At the end of the term the plan will cease. This plan is suitable where someone needs a fixed amount of money to pay a debt within the term.
A decreasing term plan is one where the sum assured reduces each year until, at the end of the plan, it decreases to zero. It is generally used in conjunction with a repayment mortgage (or similar loan) where the amount of debt is reducing, so, the amount of life cover needed to protect it is also reducing. It is often set up to reduce in line with such a debt.
A specific example of this would be a gift inter-vivos plan, which is designed to cover any outstanding inheritance tax payable by the donee on potentially exempt transfers which are above the nil rate band.
Although the sum assured reduces, an individual’s contribution remains the same. Some decreasing term plans offer a convertibility option. Where this is offered, the sum assured converted is the one at the time of the conversion (i.e. the decreased sum assured) and not the original sum assured. This plan is suitable where the amount of cover an individual needs decreases every year.
Family income benefit
On death, rather than the sum assured becoming payable as a one off lump sum, it is paid out in instalments. These instalments can be paid monthly, quarterly or annually. The instalments would be paid until the end of the original term of the plan. For example, if the plan was set up to run for 10 years and the life assured died after 4 years, the instalments would be paid for a further 6 years.
A lump sum commutation option can allow the remaining sum assured to be paid out in one go, less a penalty charge. They can be set up on a single or joint life basis and can include indexation.
The income is free of income tax because it is regarded as instalments of a sum assured. This plan is suitable where individuals want their dependants to receive a regular income on their death, rather than a lump sum (maybe because they aren’t used to handling capital sums).
A convertible term plan allows an individual to “convert” the plan, without any further underwriting, into a plan offering a more permanent form of life cover, at any time during the term (normally whole of life plans but can also be an endowment). They are more expensive than non-convertible term plans.
On conversion, an individual will have to pay the contributions for the new plan. This will normally be based on the age and sex of an individual at the time of conversion.
The benefit of this type of plan lies in the guaranteed insurability, which allows an individual to extend their life cover from a specific term to a whole of life basis no matter what their state of health in the future.
The sum assured on the new plan will be limited to what it was on the original plan. This plan is suitable for clients who want the flexibility to convert to a more permanent solution in the future, maybe because they cannot afford permanent cover at this moment in time.
A renewable term plan allows an individual to extend their plan for a further term, once they reach the end of the original term. Again, this is allowed without further underwriting, so is particularly useful to those individuals whose health deteriorates. Again, the sum assured will be limited to what it was on the original term and an individual’s contribution will reflect their age and sex at renewal.
This is also useful in business situations, where the business wishes to protect a loan. Frequently, at the end of the term of the loan, it is re-financed and further life cover is needed. The option allows this to happen even if an individual’s health is no longer good.
Renewable term assurance can also be offered as an option alongside convertible term assurance (renewable and convertible term assurance). This plan is suitable for clients who want the flexibility to extend the term of their plan as the need may still exist at the end of the original term.
These are term assurance plans where the sum assured increases automatically during the term of the plan, for example, on every plan anniversary.
There are various options as to how much the sum assured can increase by, for example, in line with the Retail Prices Index or the Average Earnings Index, or by a fixed amount, for example 5%.
An individual’s contribution will increase each year based on their age, sex and the amount the sum assured has increased by.
The benefit of an increasing term assurance plan is that they help protect the sum assured against the effects of inflation and maintain it’s real buying power.
Whole of Life policies
Offered by Life Offices, Composite Offices and Friendly Societies, whole of life plans pay the guaranteed sum assured whenever the life assured dies (or, in some cases, in the event of a critical or terminal illness). They contain an investment element, but it forms a smaller percentage of the total contribution than is the case of, say, an endowment plan and should not be sold as an investment plan.
Whole of life plans are ‘permanent’, i.e. they pay out the benefit whenever the life assured dies rather than within a specific term. Terminal illness benefit means that an accelerated payment will be made if the client is diagnosed with a terminal illness and will enable the life assured to save a number of contributions and see that the money is correctly administered for the beneficiaries.
A life insurer has to assume that every plan owner will continue their plan until they die (or suffer a critical or terminal illness), a plan reserve has to build up within every plan to cover part and, eventually, all of the guaranteed sum assured.
Once the plan has attained a surrender value, the owner may cash it in. However, as a whole of life plan is not designed to be a savings plan, in the early year’s cash values will be low. Predominantly, the key uses for whole of life plans are inheritance tax planning and estate creation.