1. Certificate for Introduction to Securities & Investment (Cert.ISI) Unit 1 Lesson 51:  Life assurance  Investment bonds 51cis

2. Life assurance Life assurance is a form of insurance where the event insured is a death. Death can be due to an accident, or illness Few people want to think about what would happen if they died. When she woke up on 13 th October 2009, this woman had no idea she would be run over by a double-decker bus whilst on her way to work that morning. Although seriously injured, the victim did not die and made a full recovery.  We tend to make light of such discussions by starting with the words: “if I went under a bus tomorrow…”  But life assurance is an essential part of financial planning Factoid: Life assurance cannot be called life “insurance” because you cannot insure against something that you know is definitely going to happen.  Everyone is going to die

3. Life assurance Life assurance policies involve the payment of premiums (i.e. fees) in exchange for life cover. Life cover means that in the event of your death, the life assurance company will pay a lump sum, the size of which is normally fixed at the time the policy is started. The assured person can nominate his/her dependants to receive the lump sum… …or, for instance, the mortgage lender, to pay off the outstanding loan on a house

4. Different kinds of life assurance policy There are two kinds of life assurance policy:  Term assurance  Whole-of-life assurance A term assurance policy is for a fixed period. Typical terms are 20, or 25 years.  If the assured dies during the term of the policy, then the descendants receive the lump sum for the assurance company  If the assured ides after the end of the term, the descendants receive no pay out from the assurance company

5. Term assurance premiums The amount of premiums paid for term assurance will depend on a number of factors. These include:  The amount payable in the event of death  Personal profile of the policy-holder  Age o The older you are, statistically the more likely to die within the term  Sex o Women have longer life expectancy than men  Family history o Certain diseases are hereditary

6. Term assurance premiums (cont.) The life assurance company will also take into account:  The length of the term for life cover  Other risk factors  State of the policy-holder’s health  Occupation  Dangerous sports o In the UK, only about half of long-term smokers live past the age of 70 o Deep-sea fishermen are 50x more likely to die at work compare with other jobs o BASE jumping has a risk of death in one out of every 2,300 jumps

7. Term assurance pay-outs The amount paid out by a term life assurance policy will vary according to the requirements of the policy-holder  Level term  The same amount of cover over the term of the policy  Cover and premium rise each year o e.g. £250,000 paid out whether assured dies in Year 1 or Year 19 o Often linked to a repayment mortgage where the principal sum is being repaid steadily  Decreasing term  Increasing term Policies can either pay a lump sum on death or a regular monthly amount over the remaining term (this is known as a “family income benefit policy”).  The amount of pay-out decreases over time o Perhaps in line with inflation or house prices Source: Nationwide

8. Whole-of-life assurance policies Whole-of-life assurance policies pay out on the death of the policy-holder, regardless of when that might occur.  Non-profit  With-profit Whole-of-life policies are usually linked in with investment plans. There are three main types of policy:  Unit-linked Life assurance companies invest the premiums paid by their policy-holders. How much the policy-holder participates in the returns from that investment depends on the type of policy.

9. Non-profit whole-of-life assurance policies A non-profit policy guarantees a set amount of life cover (i.e. pay-out) on the death of the person, regardless of when that might occur. Because the pay-out does not depend in any way on the investment returns from the premiums, the life assurance company is facing higher risk… Therefore the premiums for non-profit whole-of-life assurance policies can often be very high A quotation for whole-of-life non-profit policy for a male non-smoker, aged 54 (statistically likely to live another 25 years). 25 years worth of premiums at £50 per month makes a total of £15,000. Invested in gilts at 4%, those premiums would provide a nominal return of over £25,000

10. With-profit whole-of-life assurance policies A with-profit policy usually pays a minimum amount of life cover which increases each year by the addition of annual bonuses. The bonuses are based on the performance of the underlying investment portfolio and are spread out over a number of years to smooth the effect of volatile stock market returns. The annual bonuses permanently increase the basic guaranteed sum  However, in the event of severe falls in investment markets, the need to make sure the with profits fund can meet its guarantees might lead to more of the assets being held in more secure investments.  If this happens it can reduce investment returns for policyholders.

11. Unit-linked whole-of-life assurance policies A unit-linked policy uses the part of the premiums to buy units in the insurance company’s investment fund The remaining part of the premiums are used to pay for the life assurance cover. These plans originally appeared about 25 years ago and have developed substantially since. These are now the most popular whole life policies.  As with with-profits policies, investment returns of unit-linked policies are usually smoothed to reduce volatility

12. Investment bonds An investment bond is a single-premium life assurance policy whose main purpose is investment. They are normally designed to produce long term capital growth, but can also be used to generate an income. Their main attraction is tax avoidance Up to 5% of the original investment can be taken each year as income from the investment bond without incurring an immediate tax liability. The tax is paid when the bond is encashed – usually when the investor has retired and paying the basic rate of tax  If the 5% is not taken, it can be rolled up on a cumulative basis and taken at a later stage  When the bond is encashed, the profits are taxed as income rather than capital gains.  The reduction of Capital Gains Tax to a flat rate of 18% in 2008 reduced the relative attractiveness of the tax treatment of investment bonds

13. Investment bonds (cont.) Investment bond returns are taxed as income at source at the basic rate of 20%. If the investor becomes a basic-rate tax-payer at retirement, no further tax liability will arise. Although taxed as income, investment bonds can be structured to provide capital growth, or regular income, or a mixture of the two. Investment bonds are available in a variety of structures, providing differing levels of risk, geographic coverage and investment style:  With-profit investment bonds  Distribution bonds  Guaranteed equity bonds  Unit-linked bonds There are two basic charging structures:  Initial charge structure  Establishment charge structure  All costs taken in up-front  Costs spread over the first five years There may also be charges for exiting the scheme early