CLASSES OF LIFE INSURANCE

INTRODUCTION

Until recently, the term “assurance” was used when referring to the life sector of insurance. The terms “life insurance” and “life insured” are now commonly used.

Life insurance or life assurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a sum of money upon the occurrence of the insured's death. In return, the policy owner (or policy payor) agrees to pay a stipulated amount called a premium at regular intervals.

As with most insurance polices, life assurance is a contract between the insurer and the policy owner (policyholder) whereby a benefit is paid to the designated beneficiary (or beneficiaries) if an insured event occurs which is covered by the policy. To be a life policy the insured event must be based upon life (or lives) of the people named in the policy. Insured events that may be covered include:

1.  death, 
2. diagnosis of a terminal illness 
3. diagnosis of a critical illness 
4. disability due to ill health 
5. permanent disability 
6. accidental death 
7. requirement for long term care 

There are four basic life assurance contracts. These are stated and explained below.

At the end of this unit you should be able to name all types of life assurance contracts, their uses and benefits.

Term Assurance

In this type of contract, a fixed term of years is decided upon at the outset. The benefit i.e. sum assured is only payable if death should occur during the chosen term. Nothing is payable if the life assured survives to the end of the term. The premiums for this contract are low because the majority of term assurance contracts do not result in payment.

Uses – Term Assurance policies are used to cover period in a person’s life when the consequences of an early death would be particularly serves, for example:

1. When a young family is growing up 
2. When a house mortgage or other loan is being repaid. 
3. When an income for dependents may be required. 

These requirements give rise to variations in the basics for assurance contract; for example, when a loan or mortgage is being repaid a “decreasing term assurance” may be used. In decreasing term assurance, the sum assured payable decreases each year so that it is equal to the amount of loan outstanding at any given time during the term.

Also, a decreasing term assurance may be used when an income is required on the death of a breadwinner.

Whole Life Assurance

There are several types of whole life insurance policies. The six traditional forms: non-participating (aka "non par"), participating, indeterminate premium, economic, limited pay, and single premium. It should be noted that there are as many types of insurance policies as can be written in their contracts while staying within the law's guidelines.

Non-Participating Policy

Under this policy, all values related to the policy (death benefits, cash surrender values, premiums) are usually determined at policy issue, for the life of the contract, and usually cannot be altered after issue.

This means that the insurance company assumes all risk of future performance versus the actuaries' estimates. If future claims are underestimated, the insurance company makes up the difference. On the other hand, if the actuaries' estimates on future death claims are high, the insurance company will retain the difference.

Participating Policy

In a participating policy (also par in the, and known as a with-profits policy), the insurance company shares the excess profits (variously called dividends or refunds or bonus) with the policyholder. In this policy, the greater the success of the company's performance, the greater the dividend. For a mutual life insurance company, participation also implies a degree of ownership of the mutuality.

 Indeterminate Premium

It is similar to the non-participating policy, except that the premium may vary year to year. However, the premium will never exceed the maximum premium guaranteed in the policy.

 Economic Policy

It is a blending of participating and term life insurance, wherein a portion of the dividends is used to purchase additional term insurance. This can generally yield a higher death benefit, at a cost to long term cash value. In some policy years the dividends may be below projections, causing the death benefit in those years to decrease.

 Limited Pay

It is similar to a participating policy, but instead of paying annual premiums for life, they are only due for a certain number of years, such as 20. The policy may also be set up to be fully paid up at a certain age, such as 65 or 80. The policy itself continues for the life of the insured. These policies would typically cost more up front, since the insurance company needs to build up sufficient cash value within the policy during the payment years to fund the policy for the remainder of the insured's life

Single Premium

It is a form of limited pay, where the pay period is a single large payment up front. These policies typically have fees during early policy years should the policyholder cash it in.

Interest Sensitive

This type is fairly new, and is also known as either excess interest or current assumption whole life. The policies are a mixture of traditional whole life and universal life. Instead of using dividends to augment guaranteed cash value accumulation, the interest on the policy's cash value varies with current market conditions. Like whole life, death benefit remains constant for life. Like universal life, the premium payment might vary, but not above the maximum premium guaranteed within the policy.

In a whole life assurance contract, there is no fixed term. Premiums are paid up to the date of death, when the sum assured becomes payable. The premiums charged are higher than for term assurance because claims would definitely be made on the policy.

Whole life assurance is used as a means of obtaining relatively inexpensive cover and to cover the event of early death over lengthy periods.

Identify and explain the various types of whole life assurance policy. 

Endowment Assurance

An endowment policy is a life assurance contract designed to pay a lump sum after a specified term (on its “maturity”) or on earlier death. Typical maturities are ten, fifteen or twenty years up to a certain age limit. Some policies also pay out in the case of critical illness.

Endowment assurance has a fixed term of years decided upon at the outset. The benefit under the policy is payable either on death during the chosen term or at the end of the term if the life assured survives until then.

Endowments can be cashed in early (or “surrendered”) and the holder then receives the surrender value which is determined by the insurance company depending on how long the policy has been running and how

much has been paid in to it. During adverse investment conditions, the encashment value or surrender value may be reduced by a “Market Value Adjuster” to allow for the need to cash in units at a time when investment conditions are not ideal. This means that the investor would receive the surrender value less the market value adjuster.

Various types of endowment policy are as outlined and explained below: 1. Traditional With Profits Endowments

There is an amount guaranteed to be paid out called the sum assured and this can be increased on the basis of investment performance through the addition of periodic (for example annual) bonuses. Regular bonuses (sometimes referred to as reversionary bonuses) are guaranteed at maturity and a further non-guaranteed bonus may be paid at the end known as a terminal bonus

 Unit-linked Endowment

Unit-linked endowments are investments where the premium is invested in units of a unitized insurance fund. Units are encashed to cover the cost of the life assurance. Policyholders can often choose which funds their premiums are invested in and in what proportion. Unit prices are published on a regular basis and the encashment value of the policy is the current value of the units. This is the simplest definition.

 Full Endowments

A full endowment is a with-profits endowment where the basic sum assured is equal to the death benefit at start of policy and, assuming growth the final payout would be much higher than the sum assured 4. Low Cost Endowment (LCE)

A low cost endowment is a combination of an endowment where an estimated future growth rate will meet a target amount and a decreasing life insurance element to ensure that the target amount will be paid out as a minimum if death occurs (or a critical illness is diagnosed if included).

The main purpose of a low cost endowment has been for endowment mortgages to pay off interest only mortgage at maturity or earlier death in favour of full endowment with the required premium would be much

Traded Endowments

Traded endowment policies (TEPs) or second hand endowment policies (SHEPs) are traditional with-profits endowments that have been sold to a new owner part way through their term. The TEP market enables buyers (investors) to buy unwanted endowment policies for more than the surrender value offered by the insurance company. Investors will pay more than the surrender value because the policy has greater value if it is kept in force than if it is terminated early.

When a policy is sold, all beneficial rights on the policy are transferred to the new owner. The new owner takes on responsibility for future premium payments and collects the maturity value when the policy matures or the death benefit when the original life assured dies. Policyholders who sell their policies, no longer benefit from the life cover and should consider whether to take out alternative cover.

The TEP market deals exclusively with traditional with profits policies. The easiest way of determining whether an endowment policy is in this category is to check to see whether it mentions units, indicating it is a unitized with profits or unit linked policy, if bonuses are in sterling and there is no mention of units then it is probably a traditional with profits. The other types of policies - “Unit Linked” and “Unitized With Profits” have a performance factor which is dependent directly on current investment market conditions. These are not tradable as the guarantees on the policy are much lower and there is no gap between the surrender value and the market value.

Modified Endowments

Modified endowments were created in response to single- premium life (endowments) being used as tax shelters. They are contracts with fewer than 7-level annual premiums, and are subject to more stringent tax regulations. They are also subject to annuity rules (such as penalties for pre-death proceeds before age 59½). If a life insurance policy is changed and then fits the seven-pay rules, it may then be redefined as a modified endowment.  

 Annuities

An annuity is a financial contract written by an insurance company that provides for a series of guaranteed payments, either for a specific period of time or for the lifetime of one or more individuals. Although an annuity is essentially a life insurance product, there are important differences between the two. For example, under the terms of a life insurance policy the insurer will generally make a payment upon the death of the insured. Under the terms of an annuity, however, the insurance company makes its payments during the lifetime of the individual. In addition, unless the annuity contract specifies a beneficiary, most annuity payments cease upon the death of the recipient.

Investors purchase annuities for many reasons, the most common being the tax deferral of earnings and the guarantee of a lifelong annual income. Annuities have become much more attractive investment options for retirement savings in recent years. This has been due in large part to innovation within the industry, as providers have introduced reasonably priced products with greater flexibility, as well as a variety of investment options. The key benefits of annuities include the following:



Earnings grow tax-deferred until withdrawal. Annuity holders receive a specified amount of annual income during retirement.
Investors are allowed to switch between investments in their annuity tax-free.
Investors can contribute as much as they want during the accumulation phase of an annuity.


There are two basic types of annuities: Immediate and Deferred.


Immediate annuities are usually purchased at retirement age, with benefits that begin immediately (within one year of purchase).

Deferred annuities offer benefit payments that begin at some future date. Interest usually accrues on a tax-deferred basis in the interim.

Annuities are also classified as either “Qualified” or “Non-Qualified” based on the type of funds that an investor uses to purchase the annuity contract (or to contribute to it).

Qualified annuities are annuities that an investor funds with either pre-tax funds or tax-deductible contributions.

Non-qualified annuities are those contracts funded with after-tax funds.

Annuities may also be Fixed or Variable.

A fixed annuity is a personal retirement account in which the earnings are based on a fixed rate set by the insurance company. Fixed annuities are susceptible to inflation risk due to the fact that there is no adjustment provided for runaway inflation.

A variable annuity is a personal retirement account in which the investment grows tax-deferred until the investor is ready to withdraw the assets. Unlike an IRA, there are no restrictions on the amount of the annual investment. In addition, variable annuities offer the potential for greater returns and the opportunity for the investor to make his/her own decisions regarding how the assets are invested. Another important feature of the variable annuity is the family protection, or death benefit that often comes along with such contracts. This guarantees that, should the investor die during the accumulation phase of the variable annuity, the account owner’s beneficiary will receive at least the amount of the investor’s contributions minus withdrawals, or the current market value of the account.

An annuity is designed to provide a regular income or what is known as pension from a fixed date i.e. on retirement until the policyholder dies. Premiums are paid for a number of years before the income payments start. This is known as deterred annuity or one large single premium is paid and the income payments start immediately. This is known as immediate annuity.

The Pension Reform Act 2004 requires retirees to use part of their retirement benefit to purchase immediate annuities from any approved life assurance company. One important thing in annuities polices is that the amount of each payment is guaranteed.

CONCLUSION

We have explained classes of life insurance policy such as term assurance policy, whole life assurance, endowment assurance and annuities.

SUMMARY

Life insurance or life assurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a sum of money upon the occurrence of the insured's death. In return, the policy owner (or policy payor) agrees to pay a stipulated amount called a premium at regular intervals.

As with most insurance polices, life assurance is a contract between the insurer and the policy owner (policyholder) whereby a benefit is paid to the designated Beneficiary (or Beneficiaries) if an insured event occurs which is covered by the policy. To be a life policy the insured event must be based upon life (or lives) of the people name in the policy. Insured events that may be covered include: death, diagnosis of a terminal illness, diagnosis of a critical illness, disability due to ill health, permanent disability, accident and death, among others.