Life Insurance
Life insurance or life
assurance is a contract between
the policy owner and the insurer,
where the insurer agrees to pay a designated beneficiary a sum of money upon the
occurrence of the insured individual’s or individuals’ death or
other event, such as terminal illness or critical illness. In return, the policy
owner agrees to pay a stipulated amount at regular intervals or in lump sums.
There may be designs in some countries where bills and death expenses plus
catering for after funeral expenses should be included in Policy Premium. In the
United States, the predominant form simply specifies a lump sum to be paid on
the insured’s demise.
As with most insurance policies,
life insurance is a contract between the insurer and the policy
owner whereby a benefit is paid
to the designated beneficiaries if
an insured event occurs
which is covered by the policy.
The value for the policyholder is derived, not from an actual claim event,
rather it is the value derived from the ‘peace of mind’ experienced by the
policyholder, due to the negating of adverse financial consequences caused by
the death of the Life Assured.
To be a life policy the insured
event must be based upon the
lives of the people named in the policy.
Insured events that may be
covered include:
- Serious illness
Life policies are legal contracts and the terms of the contract describe the
limitations of the insured events. Specific exclusions are often written into
the contract to limit the liability of the insurer; for example claims relating
to suicide, fraud, war, riot and civil commotion.
Life-based contracts tend to fall into two major categories:
- Protection policies -
designed to provide a benefit in the event of specified event, typically a
lump sum payment. A common form of this design is term insurance. - Investment policies – where
the main objective is to facilitate the growth of capital by regular or
single premiums. Common forms (in the US anyway) are whole
life, universal
life and variable
life policies.
[Oroma]Overview
[Oroma]Parties
to contract
There is a difference between the insured and the policy owner (policy holder),
although the owner and the insured are often the same person. For example, if
Joe buys a policy on his own life, he is both the owner and the insured. But if
Jane, his wife, buys a policy on Joe’s life, she is the owner and he is the
insured. The policy owner is the guarantee and he or she will be the person who
will pay for the policy. The insured is a participant in the contract, but not
necessarily a party to it. However, “insurable
interest” is required to limit an unrelated party from taking life insurance
on, for example, Jane or Joe.
The beneficiary receives policy proceeds upon the insured’s death. The owner
designates the beneficiary, but the beneficiary is not a party to the policy.
The owner can change the beneficiary unless the policy has an irrevocable
beneficiary designation. With an irrevocable beneficiary, that beneficiary must
agree to any beneficiary changes, policy assignments, or cash value borrowing.
In cases where the policy owner is not the insured (also referred to as the celui
qui vit or CQV), insurance
companies have sought to limit policy purchases to those with an “insurable
interest” in the CQV. For life insurance policies, close family members and
business partners will usually be found to have an insurable interest. The
“insurable interest” requirement usually demonstrates that the purchaser will
actually suffer some kind of loss if the CQV dies. Such a requirement prevents
people from benefiting from the purchase of purely speculative policies on
people they expect to die. With no insurable interest requirement, the risk that
a purchaser would murder the CQV for insurance proceeds would be great. In at
least one case, an insurance company which sold a policy to a purchaser with no
insurable interest (who later murdered the CQV for the proceeds), was found
liable in court for contributing to the wrongful
death of the victim (Liberty
National Life v. Weldon, 267 Ala.171 (1957)).
[Oroma]Contract
terms
Special provisions may apply, such as suicide clauses wherein the policy becomes
null if the insured commits suicide within
a specified time (usually two years after the purchase date; some states provide
a statutory one-year suicide clause). Any misrepresentations by the insured on
the application is also grounds for nullification. Most US states specify that
the contestability period cannot be longer than two years; only if the insured
dies within this period will the insurer have a legal right to contest the claim
on the basis of misrepresentation and request additional information before
deciding to pay or deny the claim.
The face amount on the policy is the initial amount that the policy will pay at
the death of the insured or when the policy matures,
although the actual death benefit can provide for greater or lesser than the
face amount. The policy matures when the insured dies or reaches a specified age
(such as 100 years old).
[Oroma]Costs,
insurability, and underwriting
The insurer (the life insurance company) calculates the policy prices with
intent to fund claims to be paid and administrative costs, and to make a profit.
The cost of insurance is determined using mortality tables calculated by actuaries.
Actuaries are professionals who employ actuarial science, which is based in
mathematics (primarily probability and statistics). Mortality tables are
statistically-based tables showing expected annual mortality rates. It is
possible to derive life expectancy estimates from these mortality assumptions.
Such estimates can be important in taxation regulation.[1][2]
The three main variables in a mortality table have been age, gender, and use of tobacco.
More recently in the US, preferred class specific tables were introduced. The
mortality tables provide a baseline for the cost of insurance. In practice,
these mortality tables are used in conjunction with the health and family
history of the individual applying for a policy in order to determine premiums
and insurability. Mortality tables currently in use by life insurance companies
in the United States are individually modified by each company using pooled
industry experience studies as a starting point. In the 1980s and 90′s the SOA
1975-80 Basic Select & Ultimate tables were the typical reference points, while
the 2001 VBT and 2001 CSO tables were published more recently. The newer tables
include separate mortality tables forsmokers and
non-smokers and the CSO tables include separate tables for preferred classes. [3]
Recent US select mortality tables predict that roughly 0.35 in 1,000 non-smoking
males aged 25 will die during the first year of coverage after underwriting.[2] Mortality
approximately doubles for every extra ten years of age so that the mortality
rate in the first year for underwritten non-smoking men is about 2.5 in 1,000
people at age 65.[3] Compare
this with the US population male mortality rates of 1.3 per 1,000 at age 25 and
19.3 at age 65 (without regard to health or smoking status).[4]
The mortality of underwritten persons rises much more quickly than the general
population. At the end of 10 years the mortality of that 25 year-old,
non-smoking male is 0.66/1000/year. Consequently, in a group of one thousand 25
year old males with a $100,000 policy, all of average health, a life insurance
company would have to collect approximately $50 a year from each of a large
group to cover the relatively few expected claims. (0.35 to 0.66 expected deaths
in each year x $100,000 payout per death = $35 per policy). Administrative and
sales commissions need to be accounted for in order for this to make business
sense. A 10 year policy for a 25 year old non-smoking male person with preferred
medical history may get offers as low as $90 per year for a $100,000 policy in
the competitive US life insurance market.
The insurance company receives the premiums from the policy owner and invests
them to create a pool of money from which it can pay claims and finance the
insurance company’s operations. Contrary to popular belief, the majority of the
money that insurance companies make comes directly from premiums paid, as money
gained through investment of premiums can never, in even the most ideal market
conditions, vest enough money per year to pay out claims.[citation
needed] Rates charged
for life insurance increase with the insurer’s age because, statistically,
people are more likely to die as they get older.
Given that adverse selection can have a negative impact on the insurer’s
financial situation, the insurer investigates each proposed insured individual
unless the policy is below a company-established minimum amount, beginning with
the application process. Group
Insurancepolicies are an exception.
This investigation and resulting evaluation of the risk is termed underwriting. Health and
lifestyle questions are asked. Certain responses or information received may
merit further investigation. Life insurance companies in the United States
support the Medical Information Bureau (MIB) [4],
which is a clearinghouse of information on persons who have applied for life
insurance with participating companies in the last seven years. As part of the
application, the insurer receives permission to obtain information from the
proposed insured’s physicians.[5]
Underwriters will determine the purpose of insurance. The most common is to
protect the owner’s family or financial interests in the event of the insurer’s
demise. Other purposes include estate planning or, in the case of cash-value
contracts, investment for retirement planning. Bank loans or buy-sell provisions
of business agreements are another acceptable purpose.
Life insurance companies are never required by law to underwrite or to provide
coverage to anyone, with the exception of Civil
Rights Actcompliance requirements. Insurance companies alone determine
insurability, and some people, for their own health or lifestyle reasons, are
deemed uninsurable. The policy can be declined (turned down) or rated.[citation
needed] Rating
increases the premiums to provide for additional risks relative to the
particular insured.[citation
needed]
Many companies use four general health categories for those evaluated for a life
insurance policy. These categories are Preferred Best, Preferred, Standard, and
Tobacco.[citation
needed] Preferred Best
is reserved only for the healthiest individuals in the general population. This
means, for instance, that the proposed insured has no adverse medical history,
is not under medication for any condition, and his family (immediate and
extended) have no history of early cancer, diabetes,
or other conditions.[5] Preferred
means that the proposed insured is currently under medication for a medical
condition and has a family history of particular illnesses.[citation
needed] Most people are
in the Standard category.[citation
needed] Profession,
travel, and lifestyle factor into whether the proposed insured will be granted a
policy, and which category the insured falls. For example, a person who would
otherwise be classified as Preferred Best may be denied a policy if he or she
travels to a high risk country.[citation
needed] Underwriting
practices can vary from insurer to insurer which provide for more competitive
offers in certain circumstances.
[Oroma]Death
proceeds
Upon the insured’s death, the insurer requires acceptable proof of death before
it pays the claim. The normal minimum proof required is adeath
certificate and the insurer’s
claim form completed, signed (and typically notarized).[citation
needed] If the
insured’s death is suspicious and the policy amount is large, the insurer may
investigate the circumstances surrounding the death before deciding whether it
has an obligation to pay the claim.
Proceeds from the policy may be paid as a lump sum or as an annuity,
which is paid over time in regular recurring payments for either a specified
period or for
a beneficiary’s lifetime.[citation
needed]
[Oroma]Insurance
vs Assurance
The specific uses of the terms “insurance” and “assurance” are sometimes
confused. In general, in these jurisdictions “insurance” refers to providing
cover for an event that might happen (fire, theft, flood, etc.), while
“assurance” is the provision of cover for an event that is certain to happen.
“Insurance” is the generally accepted term, but people using this description
are liable to be corrected. In the United States both forms of coverage are
called “insurance”, principally due to many companies offering both types of
policy, and rather than refer to themselves using both insurance and assurance
titles, they instead use just one.
[Oroma]Types
of life insurance
Life insurance may be divided into two basic classes – temporary and permanent
or following subclasses – term, universal, whole life and endowment life
insurance.
[Oroma]Term
Insurance
Term assurance provides life insurance coverage for a specified term of
years in exchange for a specified premium.
The policy does not accumulate cash value. Term is generally considered
“pure” insurance, where the premium buys protection in the event of death
and nothing else.
There are three key factors to be considered in term insurance:
- Face amount (protection or death
benefit), - Premium to be paid (cost to the insured),
and - Length of coverage (term).
Various insurance companies sell term insurance with many different combinations
of these three parameters. The face amount can remain constant or decline. The
term can be for one or more years. The premium can remain level or increase.
Common types of term insurance include Level, Annual Renewable and Mortgage
insurance.
Level Term policy has the premium fixed for a period of time longer than a year.
These terms are commonly 5, 10, 15, 20, 25, 30 and even 35 years. Level term is
often used for long term planning and asset management because premiums remain
consistent year to year and can be budgeted long term. At the end of the term,
some policies contain a renewal or conversion option. Guaranteed Renewal, the
insurance company guarantees it will issue a policy of equal or lesser amount
without regard to the insurability of the insured and with a premium set for the
insured’s age at that time. Some companies however do not guarantee renewal, and
require proof of insurability to mitigate their risk and decline renewing higher
risk clients (for instance those that may be terminal). Renewal that requires
proof of insurability often includes a conversion options that allows the
insured to convert the term program to a permanent one that the insurance
company makes available. This can force clients into a more expensive permanent
program because of anti selection if they need to continue coverage. Renewal and
conversion options can be very important when selecting a program.
Annual renewable term is a one year policy but the insurance company guarantees
it will issue a policy of equal or lesser amount without regard to the
insurability of the insured and with a premium set for the insured’s age at that
time.
Another common type of term insurance is mortgage
insurance, which is usually a level premium, declining face value policy.
The face amount is intended to equal the amount of the mortgage on the policy
owner’s residence so the mortgage will be paid if the insured dies.
A policy holder insures his life for a specified term. If he dies before that
specified term is up (with the exception of suicide see below), his estate or
named beneficiary receives a payout. If he does not die before the term is up,
he receives nothing. However, in some European countries (notably Serbia),
insurance policy is such that the policy holder receives the amount he has
insured himself to, or the amount he has paid to the insurance company in the
past years. Suicide used to be excluded from ALL insurance policies[when?],
however, after a number of court judgments against the industry, payouts do
occur on death by suicide (presumably except for in the unlikely case that it
can be shown that the suicide was just to benefit from the policy). Generally,
if an insured person commits suicide within the first two policy years, the
insurer will return the premiums paid. However, a death benefit will usually be
paid if the suicide occurs after the two year period
[Oroma]Permanent
Life Insurance
Permanent life insurance is life
insurance that remains in force (in-line) until the policy matures (pays out),
unless the owner fails to pay the premium when due (the policy expires OR
policies lapse). The policy cannot be canceled by the insurer for any reason
except fraud in the application, and that cancellation must occur within a
period of time defined by law (usually two years). Permanent insurance builds a
cash value that reduces the amount at risk to the insurance company and thus the
insurance expense over time. This means that a policy with a million dollar face
value can be relatively expensive to a 70 year old. The owner can access the
money in the cash value by withdrawing money, borrowing the cash value, or
surrendering the policy and receiving the surrender value.
The four basic types of permanent insurance are whole
life, universal life, limited
pay and endowment.
[Oroma]Whole
life coverage
Whole life insurance provides for
a level premium, and a cash value table included in the policy guaranteed by the
company. The primary advantages of whole life are guaranteed death benefits,
guaranteed cash values, fixed and known annual premiums, and mortality and
expense charges will not reduce the cash value shown in the policy. The primary
disadvantages of whole life are premium inflexibility, and the internal rate of
return in the policy may not be competitive with other savings alternatives.
Also, the cash values are generally kept by the insurance company at the time of
death, the death benefit only to the beneficiaries. Riders are available that
can allow one to increase the death benefit by paying additional premium. The
death benefit can also be increased through the use of policy dividends.
Dividends cannot be guaranteed and may be higher or lower than historical rates
over time. Premiums are much higher than term insurance in the short-term, but
cumulative premiums are roughly equal if policies are kept in force until
average life expectancy.
Cash value can be accessed at any time through policy “loans” and are received
“income-tax free”. Since these loans decrease the death benefit if not paid
back, payback is optional. Cash values support the death benefit so only the
death benefit is paid out.
Dividends can be utilized in many ways. First, if Paid up additions is elected,
dividend cash values will purchase additional death benefit which will increase
the death benefit of the policy to the named beneficiary. Another alternative is
to opt in for ‘reduced premiums’ on some policies. This reduces the owed
premiums by the unguaranteed dividends amount. A third option allows the owner
to take the dividends as they are paid out. (Although some policies provide
other/different/less options than these – it depends on the company for some
cases)
[Oroma]Universal
life coverage
Universal life insurance (UL) is
a relatively new insurance product intended to provide permanent insurance
coverage with greater flexibility in premium payment and the potential for a
higher internal rate of return. There are several types of universal life
insurance policies which include “interest sensitive” (also known as
“traditional fixed universal life insurance”), variable universal life
insurance, and equity indexed universal life insurance.
A universal life insurance policy includes a cash account but the cash decreases
over time. Premiums increase the cash account, but, the cost of interest
increases each year so the cash deteriorates over time. Interest is paid within
the policy (crOromaed) on the account at a rate specified by the company, but
then mortality charges and administrative costs are then charged against
(reduce) the cash account. The surrender value of the policy is the amount
remaining in the cash account less applicable surrender charges, if any.
Universal Life does not work in a recession or low interest rate environment.
With all life insurance, there are basically two functions that make it work.
There’s a mortality function and a cash function. The mortality function would
be the classical notion of pooling risk where the premiums paid by everybody
else would cover the death benefit for the one or two who will die for a given
period of time. The cash function inherent in all life insurance says that if a
person is to reach age 95 to 100 (the age varies depending on state and
company), then the policy matures and endows the face value of the policy.
Actuarially, it is reasoned that out of a group of 1000 people, if even 10 of
them live to age 95, then the mortality function alone will not be able to cover
the cash function. So in order to cover the cash function, a minimum rate of
investment return on the premiums will be required in the event that a policy
matures.
Universal life insurance addresses the perceived disadvantages of whole life.
Premiums are flexible. Depending on how interest is crOromaed, the internal rate
of return can be higher because it moves with prevailing interest rates
(interest-sensitive) or the financial markets (Equity Indexed Universal Life and
Variable Universal Life). Mortality costs and administrative charges are known.
And cash value may be considered more easily attainable because the owner can
discontinue premiums if the cash value allows it. And universal life has a more
flexible death benefit because the owner can select one of two death benefit
options, Option A and Option B.
Option A pays the face amount at death as it’s designed to have the cash value
equal the death benefit at maturity (usually at age 95 or 100). With each
premium payment, the policy owner is reducing the cost of insurance until the
cash value reaches the face amount upon maturity. But, it does not perform like
a whole life policy when each year the costs increase and never stop. In whole
life, the costs are complete within the first few years of the policy.
Option B pays the face amount plus the cash value, as it’s designed to increase
the net death benefit as cash values accumulate. Option B offers the benefit of
an increasing death benefit every year that the policy stays in force. The
drawback to option B is that because the cash value is accumulated “on top of”
the death benefit, the cost of insurance never decreases as premium payments are
made. Thus, as the insured gets older, the policy owner is faced with an ever
increasing cost of insurance (it costs more money to provide the same initial
face amount of insurance as the insured gets older).
[Oroma]Limited-pay
Another type of permanent insurance is Limited-pay
life insurance, in which all the premiums are paid over a specified period
after which no additional premiums are due to keep the policy in force. Common
limited pay periods include 10-year, 20-year, and paid-up at age 65.
[Oroma]Endowments
policy
Endowments are policies in which
the cash value built up inside the policy, equals the death benefit (face
amount) at a certain age. The age this commences is known as the endowment age.
Endowments are considerably more expensive (in terms of annual premiums) than
either whole life or universal life because the premium paying period is
shortened and the endowment date is earlier.
In the United States, the Technical
Corrections Act of 1988 tightened
the rules on tax shelters (creating modified
endowments). These follow tax rules as annuities and
IRAs do.
Endowment Insurance is paid out whether the insured lives or dies, after a
specific period (e.g. 15 years) or a specific age (e.g. 65).
[Oroma]Accidental
Death
Accidental death is a limited life insurance that is designed to cover the
insured when they pass away due to an accident. Accidents include anything from
an injury, but do not typically cover any deaths resulting from health problems
or suicide. Because they only cover accidents, these policies are much less
expensive than other life insurances.
It is also very commonly offered as “accidental
death and dismemberment insurance”, also known as an AD&D policy.
In an AD&D policy,
benefits are available not only for accidental death, but also for loss of limbs
or bodily functions such as sight and hearing, etc.
Accidental death and AD&D policies very
rarely pay a benefit; either the
cause of death is not covered, or the coverage is not maintained after the
accident until death occurs. To be aware of what coverage they have, an insured
should always review their policy for what it covers and what it excludes.
Often, it does not cover an insured who puts themselves at risk in activities
such as: parachuting, flying an airplane, professional sports, or involvement in
a war (military or not). Also, some insurers will exclude death and injury
caused by proximate causes due to (but not limited to) racing on wheels and
mountaineering.
Accidental death benefits can also be added to a standard life insurance policy
as a rider. If this rider is purchased, the policy will generally pay double the
face amount if the insured dies due to an accident. This used to be commonly
referred to as a double
indemnity coverage. In some
cases, some companies may even offer a triple indemnity cover.
[Oroma]Related
Life Insurance Products
Riders are modifications to the insurance policy added at the same time the
policy is issued. These riders change the basic policy to provide some feature
desired by the policy owner. A common rider is accidental death, which used to
be commonly referred to as “double indemnity”, which pays twice the amount of
the policy face value if death results from accidental causes, as if both a full
coverage policy and an accidental death policy were in effect on the insured.
Another common rider is premium waiver, which waives future premiums if the
insured becomes disabled.
Joint life insurance is either a term or permanent policy insuring two or more
lives with the proceeds payable on the first death or second death.
Survivorship life: is a whole life policy insuring two lives with the proceeds
payable on the second (later) death.
Single premium whole life: is a policy with only one premium which is payable at
the time the policy is issued.
Modified whole life: is a whole life policy that charges smaller premiums for a
specified period of time after which the premiums increase for the remainder of
the policy.
Group life insurance: is term insurance covering a group of people, usually
employees of a company or members of a union or association. Individual proof of
insurability is not normally a consideration in the underwriting. Rather, the
underwriter considers the size and turnover of the group, and the financial
strength of the group. Contract provisions will attempt to exclude the
possibility of adverse selection. Group life insurance often has a provision
that a member exiting the group has the right to buy individual insurance
coverage.
Senior and preneed products: Insurance companies have in recent years developed
products to offer to niche markets, most notably targeting the senior market
to address needs of an aging population. Many companies offer policies tailored
to the needs of senior applicants. These are often low to moderate face value
whole life insurance policies, to allow a senior citizen purchasing insurance at
an older issue age an opportunity to buy affordable insurance. This may also be
marketed as final expense
insurance, and an agent or company may suggest (but not require) that the
policy proceeds could be used for end-of-life expenses.
Preneed (or prepaid) insurance policies: are whole life policies that, although
available at any age, are usually offered to older applicants as well. This type
of insurance is designed specifically to cover funeral expenses
when the insured person dies. In many cases, the applicant signs a prefunded
funeral arrangement with a funeral
home at the time the policy is
applied for. The death proceeds are then guaranteed to be directed first to the
funeral services provider for payment of services rendered. Most contracts
dictate that any excess proceeds will go either to the insured’s estate or a
designated beneficiary.
[Oroma]Investment
policies
With-profits policies:
policy
Some policies allow the policyholder to participate in the profits of the
insurance company these are with-profits
policies. Other policies have no rights to participate in the profits of the
company, these are non-profit policies.
With-profits policies are used as a form of collective
investment to achieve capital
growth. Other policies offer a guaranteed return not dependent on the company’s
underlying investment performance; these are often referred to as without-profit policies
which may be construed as a misnomer.
Investment Bonds
bond
Pensions: Pensions are a form of life assurance. However, whilst basic life
assurance, permanent
health insurance and non-pensions
annuity business includes an amount of mortality or morbidity
risk for the insurer, for
pensions there is a longevity
risk.
A pension fund will be built up throughout a person’s working life. When the
person retires, the pension will become in
payment, and at some stage the
pensioner will buy an annuity contract, which will guarantee a certain pay-out
each month until death.
[Oroma]Annuities
An annuity is a contract with an insurance company whereby the insured pays an
initial premium or premiums into a tax-deferred account, which pays out a sum at
pre-determined intervals. There are two periods: the accumulation (when payments
are paid into the account) and the annuitization (when the insurance company
pays out). IRS rules restrict how you take money out of an annuity.
Distributions may betaxable and/or penalized
[Oroma]Tax
and life insurance
[Oroma]Taxation
of life insurance in the United States
Premiums paid by the policy owner are normally not deductible for federal and
state income
tax purposes.
Proceeds paid by the insurer upon death of the insured are not included in gross
income for federal and state income tax purposes;[6]however,
if the proceeds are included in the “estate” of the deceased, it is likely they
will be subject to federal and state estate
and inheritance tax.
Cash value increases within the policy are not subject to income taxes unless
certain events occur. For this reason, insurance policies can be a legal and
legitimate tax
shelter wherein savings can
increase without taxation until the owner withdraws the money from the policy.
On flexible-premium policies, large deposits of premium could cause the contract
to be considered a “Modified Endowment Contract” by theInternal
Revenue Service (IRS), which
negates many of the tax advantages associated with life insurance. The insurance
company, in most cases, will inform the policy owner of this danger before
applying their premium.
The tax ramifications of life insurance are complex. The policy owner would be
well advised to carefully consider them. As always, the United
States Congress or the state
legislatures can change the tax laws at any time.
[Oroma]Taxation
of life assurance in the United Kingdom
Premiums are not usually allowable against income
tax or corporation
tax, however qualifying policies issued prior to 14 March 1984 do still
attract LAPR (Life
Assurance Premium Relief) at 15% (with the net premium being collected from
the policyholder).
Non-investment life policies do not normally attract either income tax or capital
gains tax on claim. If the policy
has as investment element such as an endowment policy, whole of life policy or
an investment bond then the tax treatment is determined by the qualifying status
of the policy.
Qualifying status is determined at the outset of the policy if the contract
meets certain criteria. Essentially, long term contracts (10 years plus) tend to
be qualifying policies and the proceeds are free from income
tax and capital
gains tax. Single premium contracts and those run for a short term are
subject to income tax depending upon your marginal rate in the year you make a
gain. All (UK) insurers pay a special rate of corporation
tax on the profits from their
life book; this is deemed as meeting the lower rate (20% in 2005-06) liability
for policyholders. Therefore a policyholder who is a higher rate taxpayer (40%
in 2005-06), or becomes one through the transaction, must pay tax on the gain at
the difference between the higher and the lower rate. This gain is reduced by
applying a calculation called top-slicing based
on the number of years the policy has been held. Although this is complicated,
the taxation of life assurance based investment contracts may be beneficial
compared to alternative equity-based collective investment schemes (unit
trusts, investment
trusts and OEICs).
One feature which especially favors investment bonds is the ’5% cumulative
allowance’ – the ability to draw 5% of the original investment amount each
policy year without being subject to any taxation on the amount withdrawn. If
not used in one year, the 5% allowance can roll over into future years, subject
to a maximum tax deferred withdrawal of 100% of the premiums payable. The
withdrawal is deemed by the HMRC (Her
Majesty’s Revenue and Customs) to be a payment of capital and therefore the tax
liability is deferred until maturity or surrender of the policy. This is an
especially useful tax planning tool for higher rate taxpayers who expect to
become basic rate taxpayers at some predictable point in the future (e.g.
retirement), as at this point the deferred tax liability will not result in tax
being due.
The proceeds of a life policy will be included in the estate for death
duty (in the UK, inheritance
tax (IHT)) purposes, except that
policies written in trust may
fall outside the estate. Trust law and taxation of trusts can be complicated, so
any individual intending to use trusts for tax planning would usually seek
professional advice from an Independent
Financial Adviser (IFA) and/or a solicitor.
[Oroma]Pension
Term Assurance
Although available before April 2006, from this date pension
term assurance became widely
available in the UK. Most UK product providers adopted the name “life insurance
with tax relief” for the product. Pension
term assurance is effectively
normal term life assurance with tax relief on the premiums. All premiums are
paid net of basic rate tax at 22%, and higher rate tax payers can gain an extra
18% tax relief via their tax return. Although not suitable for all, PTA briefly
became one of the most common forms of life assurance sold in the UK until the
Chancellor, Gordon
Brown, announced the withdrawal of the scheme in his pre-budget announcement
on 6 December 2006. The tax relief ceased to be available to new policies
transacted after 6 December 2006, however, existing policies have been allowed
to enjoy tax relief so far.
[Oroma]History
of insurance
Insurance began as a way of reducing the risk of traders, as early as 5000 BC in China and
4500 BC in Babylon.
Life insurance dates only to ancient Rome; “burial clubs” covered the cost of
members’ funeral expenses and helped survivors monetarily. Modern life insurance
started in 17th century England,
originally as insurance for traders[7] :
merchants, ship owners and underwriters met to discuss deals at Lloyd’s Coffee
House, predecessor to the famous Lloyd’s
of London.
The first insurance company in the United
States was formed in Charleston,
South Carolina in 1732, but it
provided only fire insurance. The sale of life insurance in the U.S. began in
the late 1760s. The Presbyterian Synods
in Philadelphia and New
York created the Corporation for
Relief of Poor and Distressed Widows and Children of Presbyterian Ministers in
1759; Episcopalian priests
organized a similar fund in 1769. Between 1787 and 1837 more than two dozen life
insurance companies were started, but fewer than half a dozen survived.
Prior to the American
Civil War, many insurance companies in the United States insured
the lives of slaves for their
owners. In response to bills passed in California in
2001 and in Illinois in
2003, the companies have been required to search their records for such
policies. New
York Life for example reported
that Nautilus sold 485 slaveholder life insurance policies during a two-year
period in the 1840s; they added that their trustees voted to end the sale of
such policies 15 years before the Emancipation
Proclamation.
Stranger Originated Life Insurance
Stranger Originated Life Insurance or STOLI is
a life insurance policy that is held or financed by a person who has no
relationship to the insured person. Generally, the purpose of life insurance is
to provide peace of mind by assuring that financial loss or hardship will be
lessened or eliminated in the event of the insured person’s death. STOLI has
often been used as an investment technique whereby investors will encourage
someone (usually an elderly person) to purchase life insurance and name the
investors as the beneficiary of the policy. This undermines the primary purpose
of life insurance as the investors have no financial loss that would occur if
the insured person were to die. In some jurisdictions, there are laws to
discourage or prevent STOLI.
[Oroma]Criticism
Although some aspects of the application process (such as underwriting and
insurable interest provisions) make it difficult, life insurance policies have
been used in cases of exploitation and fraud. In the case of life insurance,
there is a motivation to purchase a life insurance policy, particularly if the
face value is substantial, and then kill the insured. Usually, the larger the
claim, and/or the more serious the incident, the larger and more intense will be
the number of investigative lawyers, consisting in police and insurer
investigation, eventually also loss
adjusters hired by the insurers
to work independently.[8]
The television
series Forensic
Files has included episodes
that feature this scenario. There was also a documented case in 2006, where two
elderly women are accused of taking in homeless men and assisting them. As part
of their assistance, they took out life insurance on the men. After the
contestability period ended on the policies (most life contracts have a standard
contestability period of two years), the women are alleged to have had the men
killed via hit-and-run car crashes.[9]
Recently, viatical
settlements have created problems
for life insurance carriers. A viatical settlement involves the purchase of a
life insurance policy from an elderly or terminally ill policy holder. The
policy holder sells the policy (including the right to name the beneficiary) to
a purchaser for a price discounted from the policy value. The seller has cash in
hand, and the purchaser will realize a profit when the seller dies and the
proceeds are delivered to the purchaser. In the meantime, the purchaser
continues to pay the premiums. Although both parties have reached an agreeable
settlement, insurers are troubled by this trend. Insurers calculate their rates
with the assumption that a certain portion of policy holders will seek to redeem
the cash value of their insurance policies before death. They also expect that a
certain portion will stop paying premiums and forfeit their policies. However,
viatical settlements ensure that such policies will with absolute certainty be
paid out. Some purchasers, in order to take advantage of the potentially large
profits, have even actively sought to collude with uninsured elderly and
terminally ill patients, and created policies that would have not otherwise been
purchased. Likewise, these policies are guaranteed losses from the insurers’
perspective.
