10 - Life Assurance Products

Question 1

Life Assurance Products

What are the three basic types of life assurance product?

Answer 1

• Single Premium Bonds (aka investment bonds, onshore bonds)
• Regular Premium Policies (aka savings policies)
• Offshore Bonds

Question 2

Life Assurance Products

What’s the difference between an investment bond and an investment fund?

Answer 2

The investment bond is the product you invest in (like an OEIC or an ETF).

The investment fund is the underlying fund that the money goes into and gets invested to achieve the return.

They are NOT two different products.

Question 3

The premiums of life assurance products are split between which two aspects?

Answer 3

• Life assurance element
• Investment element

The higher the level of life assurance, the more of the premium is directed towards that and the lower the investment performance/return.

Question 4

With Profits

Are these single payment or regular premium products?

Answer 4

With Profits can be single premium or regular premium

Question 5

With Profits

What is the modern type of WP product that has replaced the traditional WP?

Answer 5

Unitised With Profits contracts

Question 6

With Profits

What is the difference between the bonus calculations for traditional and unitised WP plans?

Answer 6

Bonuses for unitised plans are calculated in advance by actuaries projections of the long term future performance of the fund. This makes the investment much more transparent and is the main reason unitised plans are more popular and have replaced traditional plans.

Question 7

With Profits

What is the return of the product based upon?

Answer 7

The return of the product is based on both the performance of the underlying fund investments AND the activites of the life assurance provider.

Note that the return is not DIRECTLY based on investment peformance (e.g. fund goes up 5% so you get a 5% bonus), but the actuaries estimates of future performance take into account the investment performance, so it does have an impact.

Question 8

With Profits

What is the key benefit of WP funds compared to other investments, in terms of protection?

Answer 8

Unit prices of with profits funds are guaranteed not to go down.

Question 9

With Profits

How do fixed price and variable price WP funds work?

Answer 9

The price of fixed price funds stays the same. Bonuses involve additional units being given to existing unit holders.

Variable price units on the other hand reflect bonuses by increasing the value of existing units.

Question 10

With Profits

How does free asset ratio relate to WP investments?

Answer 10

The free asset ratio is an indication of the financial strength of the life assurance company. If this is not at a healthy level it indicates a risk that they will have issues maintaining the WP performance in the future.

Question 11

With Profits

What is the MVR?

Any issues with it?

Answer 11

MVR is Market Value Reduction

This is a penalty applied to people exiting the fund to protect the people left in it.

There are “MVR free dates” when people can exit without paying an MVR, which is a potential issue for people left in the fund. Closed funds are likely to hold a lot of fixed interest (low risk) and the pot is getting smaller as people exit on MVR free days.

Question 12

What is pound cost averaging and what investments does it relate to?

Answer 12

Pound cost averaging relates to regular premium investments (i.e. not lump sum investments).

It relates to the fact that you invest a little bit over time so your “start price” is spread out over the year. The idea is it reduces your risk of investing on one date that happens to be a high point.

Question 13

With Profits

Two advantages to WP in terms of investment flexibility (vs collective investment funds)

Answer 13

• Switching between funds is very low cost
• All the usual funds available to OEICs (etc) are available in WP funds, but there are also guaranteed growth and guaranteed income funds, and property or mixed/managed funds

Question 14

With Profits

Any return other than the regular annual bonuses?

Answer 14

There will be a terminal bonus on death/maturity.

If the product is life assurance focused the death bonus might be higher than the maturity bonus.

Question 15

With Profits Savings Plans

What are they?

Restrictions?

Answer 15

Basically a WP investment with regular level investments.

Still get annual bonus, terminal bonus

Limited to £3,600 per year

Question 16

With Profits Savings Plans

What are the features of low cost plans?

Answer 16

Low cost plans might have increasing premiums (so early premiums are cheap but have to get more expensive later to make up for it) or have lower terminal bonus than death bonus.

These aren’t very popular now.

Question 17

With Profits

Early encashment issues

Answer 17

May be a surrender penalty.

Might be better off selling.

Unlikely to get your terminal bonus (unless very close to maturity).

Question 18

With Profits Lump Sum Investments

What are they?

Answer 18

Just a WP invesment with a single lump sum investment instead of regular premiums (savings plans/endowments).

Usually written with whole of life cover.

Question 19

With Profits

What are the typical charges

Answer 19

5% bid offer spread

1% AMC

Question 20

With Profits

What are the 6 types of investment bond?

Answer 20

1. Guaranteed Income
2. High Income
3. Guaranteed Growth
4. Unit Linked
5. Distribution
6. Guaranteed/Protected Equity

Question 21

With Profits

Features of:

1. Guaranteed income bonds

Answer 21

1. Guaranteed income bonds

• Up to 5 year maturity
• Income guaranteed and paid in arrears annually
• Capital returned at maturity

So they’re similar to fixed income/bonds.

Question 22

With Profits

Features of:

2. High income bonds

Answer 22

2. High income bonds

• Give up the capital guarantee to achieve higher level of income
• Based on derivatives
• Capital only returned if stock index meets pre-set targets

Question 23

With Profits

Features of:

3. Guaranteed Growth bonds

Answer 23

3. Guaranteed Growth bonds

• Capital guaranteed
• No income
• Various maturity dates and possibility to roll-over

Question 24

With Profits

Features of:

4. Unit Linked bonds

Answer 24

4. Unit Linked bonds

• Income doesn’t get paid, rolled up and paid out at maturity as capital
• So better for high rate tax payers (CGT better than tax on income)
• Get 5% tax deferred withdrawals
• Can be encashed at any time

Question 25

_With Profits_ Features of: 5. Distribution bonds

Answer 25

5. Distribution bonds * Capital guaranteed * Income paid depending on income generated by the fund

Question 26

_With Profits_ Features of: 6. Guranteed/Protected Equity bonds

Answer 26

6. Guranteed/Protected Equity bonds * Fixed maturity * Based on derivatives, a bond plus a call option * So capital is guaranteed with extra return if the index goes up

Question 27

_Investment Bonds_ Why are investment bonds good investments for trusts?

Answer 27

Trusts pay very high tax on income but investment bonds don't generate taxable income. Bonds can get assigned to the beneficiaries with no tax charge. 5% withdrawal tax deferral feature

Question 28

_Investment Bonds_ What are the implications of offshore bonds (compared to onshore investment bonds)?

Answer 28

Offshore bonds usually have higher costs Income is rolled up and investors pay income tax on everything at maturity. For onshore investment bonds they would pay as capital (CGT) so the rate is lower and they get the exempt amount each year. They still get the 5% tax deferred withdrawal benefit and can be useful for high rate taxpayers in some cases (invest now when you're high rate, get the gain later when you're retired).

Question 29

What is a personal portfolio bond?

Answer 29

This is when you wrap your personal investment fund up in a bond. HMRC don't like it so slap you with a big tax rate (as if you earned a 15% return).

Question 30

_Friendly Society Policies_ Benefits Limits

Answer 30

Benefits are no gains or income tax Limited to £270 per annum Need to hold for at least 7.5 years

Question 31

_Life Assurance Tax_ What is the internal tax treatment of the life assurance fund?

Answer 31

Similar to other entities, 20% corporate tax on most items. No tax on UK (franked) dividends but do pay tax on gains. Gilts and corporate bonds don't get taxed (same as for individual investors).

Question 32

_Taxation of Life Assurance_ Implication of being a qualifying policy Requirements for a qualifying policy

Answer 32

No tax at maturity on qualifying policies * At least 10 years * Premiums at least annually * Must have paid at least 75% of the premiums * Premiums in any 1 year never more than twice any other year * £3,600 annual premium limit

Question 33

_Taxation of Life Assurance_ Tax implications of early enchasment

Answer 33

If the policy becomes non-qualifying (less than 10 years, haven't paid 75% of premiums) it loses the tax protection and becomes a chargeable event

Question 34

_Taxation of Life Assurance_ Tax on non-qualifying policies

Answer 34

Don't have the qualifying protection so the gain is taxable. Not taxed on CGT, use top-slicing and pay income tax. So split the final gain across the number of years you held the policy, and stick that gain on top of your income in each of those years. The extra income tax payable in each year is the tax you pay.

Question 35

_Taxation of Life Assurance_ What is segmentation?

Answer 35

Segmentation is splitting your investment bonds into clusters of smaller bonds. It gives you some flexibilit and tax benefits.

Question 36

_Selling Policies_ What are the regulatory rules regarding the ability to sell policies?

Answer 36

* IFAs must avise clients that selling is an alternative to encashment * Life funds must also advice clients that selling might be better than enchashment * IFA must make sure the client understands the tax position

Question 37

_Selling Policies_ Tax implications for the seller

Answer 37

No special implications, same as encashment. If the policy is qualifying (\>10 years, 75% premiums paid etc) you pay no tax on the gain. Otherwise pay top-slicing tax on the gain.

Question 38

_Selling Policies_ Tax implications for the buyer

Answer 38

If it's a qualifying policy and they hold to maturity/death there is no tax on the gain. Othewise they pay tax, but normal CGT instead of the tax slicing rule, since they just bought an asset and realised a gain.