Be assured about life assurance

Last week&#39s column focused on an area of CeMAP paper one that gives many candidates particular difficulty – taxation. Another part of the syllabus that also presents problems is that of life assurance. Much of the difficulty can arise from not having a clear understanding of the various types of life assurance policy and how each of them works.

There are just three fundamental forms of life cover, although there are variations on each. Term assurance is the most basic form of life assurance. It provides protection only and will pay out if the life assured dies within the term of the policy. An endowment policy will pay out on death during the term or on survival to the end of the term of the policy. A whole-of-life policy will pay out on the death of the life assured provided, of course, that the policy remains in force up to that point.

There are various forms of term assurance including increasing, decreasing, level, renewable and convertible. The operation of each is straightforward and must be clearly understood by candidates, who should also be able to recognise the main uses of each form.

As far as mortgage advisers are concerned, the decreasing term policy (sometimes referred to as a mortgage protection policy) will be familiar as a form of life cover used in connection with a repayment mortgage. Candidates should remember that a family income benefit policy is also a form of decreasing term assurance in that the policy pays out a regular income from the date of death of the life assured until the end of the chosen term. The later the date of death, the less will be paid out under the policy.

Whole-of-life policies can be taken out on a variety of bases including, for example, non-profit, with-profit and unit-linked. These are often used to provide financial protection for dependents and to protect the value of an estate on death from inheritance tax. When used for these purposes the policies would generally be written in trust to enable the policy benefits to be paid to the trustees whose legal duty it is to deal with the proceeds in accordance with the terms of the trust deed. As the policy benefits do not form part of the deceased&#39s estate there are two advantages of writing a policy in trust. First, the proceeds can normally be paid out quickly as it is not necessary to wait for grant of probate or letters of administration. Secondly, there is no inheritance tax payable on the proceeds.

Endowment policies, like whole-of-life policies, can be effected using one of a range of underpinning investment bases such as non-profit, with-profit and unit-linked. Candidates must understand how each type of policy works and what will be paid on death during the policy term or on the maturity of the policy. This is particularly the case if a policy is also being used as a capital repayment vehicle in connection with an interest-only mortgage. Only a non-profit and full with-profit endowment will guarantee to repay the outstanding debt on an interest-only mortgage at the end of the term (assuming that no arrears had accrued) because the sum assured would be equivalent to the mortgage debt. The sum assured would be payable on death during the term or on maturity. In the case of a low-cost with-profit endowment, the mortgage debt would be repaid on death during the policy term as this would equate to the guaranteed death benefit. However, as the sum assured is lower than the guaranteed death benefit and mortgage debt, the sum payable on maturity depends on the addition of bonuses which may or may not be sufficient to repay the mortgage.

Unit-linked policies, on the other hand, have a guaranteed death benefit which would repay the mortgage debt on death during the term. However, they do not have a sum assured. The value of the policy at the end of the policy term is simply the value of the accumulated units sold at the bid price.

Candidates must have a sound understanding of the difference between the sum assured, which is payable on death during the term or on maturity, and the guaranteed death benefit which is only payable on death during the term.

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