Life Cover Listings

Some unit-linked plans have, however, introduced guarantees. Normally these involve a special fund which allows the company to guarantee a value at retirement age and hence an actual pension. Such guarantees are no different from the non­profit ones discussed earlier, and may be useful at ages close to retirement.

The unit-linked plans involve charges expressed slightly differently from unit-linked life insurance policies. The initial charge on units is normally 5% but may be higher, and the annual charge is between 1.5 % and 1 %. Many plans, however, also involve the allocation of capital units in the first one, two or three years, embodying an extra management charge of 3% or more.

As previously mentioned, this is not a once-for-all charge; it is an annual charge and means that 3% (or whatever) of the value of the relevant units will be deducted by the company each year the plan is in force. This can add up to a substantial amount over a long-term pension plan. The reason capital units are used is that under a personal pension plan the company is unable to make deductions from the fund if the plan is stopped by the plan holder (in the case of the life insurance contract it can do so via the surrender value). So to take account of “lapses” the company has to build into its charges an element that will recoup its costs. Nevertheless, some companies do not use capital units on personal pension plans, and their plans can often offer better value (capital units are not allocated when unit-linked funds are used on a single-premium basis).

At maturity, the unit-linked plan holder has the option of converting all his units into an annuity, in which case he gets a fixed level income for life (though he may also, if he takes a slightly lower annuity, have a guarantee that it will be payable for a minimum of 5 or 10 years whether he lives or not) or of keeping the units and drawing off an annual pension by selling some each year.

Generally, unit-linked policies are aimed at producing investment gains and are designed for the investor who wants to accumulate capital over a period of several years. The level of life insurance cover per £ of premium is so much lower than that on term assurance that unit-linked policies are not suitable for providing family protection. Salesmen sometimes present packages con­sisting of a unit-linked policy and term assurance, which they try to sell on the basis of security and investment. Such packages should be examined carefully, both from the point of view of how the benefits compare with your needs and from the cost angle.

The investment attractions of the unit-linked life insurance policy can easily be demonstrated. Imagine you agree to pay a £l0 - a ­month premium on a unit-linked policy. The life insurance company may deduct £1 to provide life insurance cover to meet its expenses. The other £9 is invested in units. The price of these units embodies a further charge because there is a disparity of about 5% between the offer price and the bid price (the price at which the company will buy back the units when the policy matures). So the amount actually invested in the fund on your behalf would be £8.55. You can get tax relief on each premium at 17.5%, so that the net cost of each £10 premium is only £8.25. Your £10 a month is therefore buying you more investments than your net monthly outlay.

Most life insurance policies incorporate a more complicated charges structure. However charges are levied, the final value of the life insurance policy at maturity is determined by the growth in the value of the units. This depends partly on the skill of the investment managers but is determined to a larger extent by trends in the economy and the financial markets. Estimates of growth in unit value are always used in estimating maturity values for unit-linked insurance; it is important to remember that, just as reversionary bonus rates are never guaranteed, so neither are estimated growth rates.

The actual operation of a modern life insurance company is extremely complex, involving all the aids of modern technology and especially, of course, the computer. But the essential principle is simple. Let us assume that we were planning a scheme whereby 1,000 men all aged 45 would agree to pay into a common fund each year of their lives enough to pay out £1,000 to the dependants of any of them who died during any year. It is possible to determine fairly precisely just how many of the 1,000 will die in any year. To provide the £4,000 necessary to meet the claims of the dependants that are each of the original 1,000 would have to pay £4.

But if we continue in this way, deriving the premium from the year’s actual mortality each of them will have to pay in over £21 to meet the outgoings, since their income would quite probably be falling just as the contributions rose, such a scheme would be extremely unattractive.

What the founders of life insurance discovered, however, was that with a lot of mathematical calculation and a little guesswork, they could work out a premium rate which each of the 1,000 would agree to pay throughout their lives in return for the guarantee that all claims would be met when they fall due. The annual premium is far higher than the payments required in the early years of the “pay-as-you-go” scheme, because a reserve is being accumulated in the early years which will cover the excess of claims over premiums in the later ones. The fund is investing the surplus of the early years at interest to build up reserves which will meet future claims.

To devise such a system requires two principle calculations:

•1.      The mortality rate

The mortality rate determines how much it is likely to be required each year to meet claims.

•2.      The interest rate

The interest rate is needed to work out how much the premium can be reduced to allow for the effect of accumulation or reserves ands interest.