One company may regard a minor thrombosis lightly and require no extra premium, while another may take it much more seriously. Although most offices today adopt a reasonable attitude to underwriting requirements, anyone with an impairment needs the advice of someone familiar with the attitudes of different life offices and capable of selecting the one that is suitable.
The occupation of the critical illness insurance proposer normally has no bearing on the rate of premium, but there are a few occupations which through experience companies have found to have a higher mortality rate and for which a higher premium may be charged. These include miners, deep-sea divers, publicans, steeplechase jockeys and steeplejacks. (In peacetime, members of the armed forces are normally accepted at standard rates unless they are, say, aircrew, bomb disposal squad, or are likely to be posted to a political troublespot.) The extra premium charged in any of the above cases varies from company to company. The loading will amount to a substantial percentage on pure critical illness-protection policies but to a much smaller one on with-profit policies.
It should be added, however, that if a critical illness insurance policy is taken out while the proposer is in a non-risky occupation then the office has no power to raise the premium if he later moves to a risky one. Leisure activities pursued by the proposer may also add to the risk involved for the critical insurance office. Flying, gliding, rally driving and mountaineering are among those that some offices will regard as requiring an addition to the normal premium.
As an alternative to an extra premium, an office may agree to apply a “debt” to a policy and this means that in the event of death they will deduct an amount from the sum assured; this amount may be fixed or it may reduce year by year over a fixed term. In effect, a proposer backs himself against the underwriter’s judgement. While this solution may be practicable under an investment contract, it is not to be recommended under a critical illness insurance policy.
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A point that must be noted is the effect of the final encashment of income bonds on age allowance. The age allowance is an extra personal allowance granted to those aged over 65. For the fiscal year 1978/79 a married couple (over 65) will be allowed personal allowances free of income tax of £2,075 (instead of the normal £1,535) provided that their taxable income does not exceed £4,000. (If it does, the extra allowance is reduced by £2 for every extra £3 of taxable income.)
The bulk of the income from guaranteed bonds is not taxable and therefore does not count towards the limit: thus if £10,000 is invested in a guaranteed income bond yielding 8% net, only the “excess” of 3%, i.e. £300 a year, is regarded as part of taxable income for age allowance income limit purposes. Income bonds are often, therefore, a more efficient source of income for the retired than, say, building societies, since in the latter case all the grossed-up equivalent of the net income is taken into account.
However, in the year of encashment of an income bond, there will be a gain (on the capital portion) which will be subject (normally) to higher rates of income tax and investment income surcharge. For the purpose of these two taxes, the gain is “sliced” over the period for which the bond has been held, and normally this will mean that any tax payable is small except for very high rate taxpayers.
However, for the purposes of the age allowance income limit, no top slicing is allowed and the whole of the taxable gain is regarded as part of the income in that tax year. This will very often mean that age allowance is restricted in the year of encashment, which means the individual will pay more income tax. However, this tax liability in an encashment year should not be looked at in isolation but related to the tax savings in the previous years. Most investors will achieve an overall gain in net income from income bonds over the holding period.
Inevitably efforts are made to compare critical illness insurance policies with conventional policies in terms of actual results. A couple of qualifications are in order before even attempting this. The first is that the aims are different. Conventional critical illness insurance is designed to produce a steady, non-fluctuating up trend in maturity values. The investment risks are spread across a wide spectrum of assets and also over time. Critical illness insurance is designed to enable the investor to take whatever risk he wishes, and in whatever market, using the umbrella of critical illness insurance to add to the investment benefits through tax concessions (this is the principle; in practice, many contracts offered by conventional life offices reduce the risks and otherwise alter the system, for example by providing much larger life cover).
The second qualification is that conventional critical illness insurance has been going a lot longer than others. The oldest critical policy has not yet run for a full 20 years and some of the largest insurance companies have been selling policies for less than 10 years. The newer types of policy involving investment in property and managed funds have been available for even shorter periods. So the basis for comparison is somehow limited.
Comparisons are possible between conventional policies and newer policies involving investment only in shares. As one might expect, the results fluctuate much in line with the stock market. Thus, an equity-linked policy maturing in 1972 when the stock market was at a peak produced 40% more than the best conventional policy over a period of 10 years; one maturing in 1974 when the market was at a low produced 35% less. The variation in maturity values can be enormous even over short periods, though as we have seen the policyholder has the option to defer taking the proceeds.
The experience to date of property-linked and managed fund-linked policies is that they produce results somewhat less volatile than those of pure equity-linked ones, though still, of course, more volatile than the values of conventional with-profit critical illness insurance policies.
The average acquisition cost of units is determined by market movements and a principle called pound-cost averaging applies. This means that, because a given premium buys more units when prices are low than when they are high, over a period the investor acquires more units at lower than at higher prices and therefore his average acquisition cost per unit will be below the average unit price over that period. Pound-cost averaging is simply a mathematical fact of life, and, though it is comforting to know that it is working on one’s behalf in any regular investment plan, it does not alter the fact that it is the difference between the average acquisition cost and the unit price on encashment that determines the profit one receives.
The final unit price is subject to the fluctuations of the market, and as we have seen in recent years these fluctuations can be large and sudden. For this reason the majority of unit-linked life insurance policies contain one of two options: either the investor may defer taking the policy proceeds for a year or more (i.e. the policy continues in force with no more premiums payable) or he may take the units his premiums have acquired instead of the cash value. Either way, the intention is to allow the investor to ride out any fall in market prices so that he may encash his units at a better price. The ability to defer taking the proceeds is the better option, since the sum paid out will still be the proceeds of a policy and thus free of tax, whereas if the investor takes the units as the policy proceeds then any increase in their value from that point on creates a gain liable to capital gains tax.
To return to the theme of investment management, it is today widely recognized that to better the average trend in prices in any investment sector by a consistent 1-2% p.a. is a considerable challenge for any fund manager. Of course, most funds do achieve short-term bursts of performance.
A solution often suggested for the younger person is the combination of other insurances to critical illness insurance. The advantage of the whole-life policy added to critical illness insurance in this context is its flexibility. The policy may be used as collateral to raise a loan; critical illness insurance companies themselves will usually lend up to 85 – 90% of the surrender value to the policyholder, interest being paid only on the loan with the capital being repaid out of the maturity proceeds (or repayable earlier at the policyholder’s option). Or the policy may be made ‘paid-up’; this means that the policyholder stops paying premiums, and the company keeps the policy in force with a reduced sum assured (bonuses already earned would not be reduced). The policy then continues to share in bonuses in the normal way (though a few companies still do not allow paid-up policies to earn any more bonuses). The disadvantage of the critical illness insurance policy is its slow build-up in value, and for most young people, whose needs, say, 10 to 20 years ahead are uncertain, this is a considerable drawback.
Generally, therefore, critical illness insurance may be of more use and relevance to those in the lower age groups, who can use it for pure protection or investment, or both, and whose needs and incomes are more closely related to the cost and benefits provided. One unfortunate phenomenon in the critical illness insurance business in recent years has been the sale of policies to older people by some advisers motivated solely by commission, which until 1976 was far higher on this type of policy than any other for the same amount of annual premium.
Non-profit critical illness insurance polices are not, as such advisers sometimes claim, of any use whatsoever in obtaining a mortgage nor in providing for its repayment (taking out a non-profit critical illness insurance policy may be the price an adviser demands to obtain someone a mortgage, but that is another and more unpleasant subject). Students are in most cases ill advised to buy such policies.
The disparity between the cost of protection and investment-oriented contracts mentioned will be reiterated. Since the vast proportion of the premiums on any participating, or even non-participating life insurance policy aimed at producing a capital sum will be devoted to investment rather than to providing life insurance coverage, the cost of a given sum assured for an endowment policy of a given term does not vary greatly according to age. For example, a with-profit life insurance endowment policy for a given sum assured over 15 years would cost the same at 30 as at 20, only 2 or 3% more at 40 and about 7% more at 50.
So long as you are in reasonable health, therefore, you will lose very little, in terms of premium rates, by delaying taking out an investment-oriented contract until you are older (though of course the longer the period of saving, the larger the return will be). However, if we look at protection by itself, the picture is completely different. A 45-year-old man will pay up to four times as much for a 10-year term assurance policy as a 30-year-old; and a man of 55 will pay up to three times what the 45-year-old pays. Another way of seeing the difference is to look at the relationship between whole life insurance premium rates (premiums are payable throughout life) and term assurance rates.
The 30-year-old man would pay about £90 a year for a £10,000 whole-life insurance policy. A 15-year term assurance with the same sum assured would cost him about £17 a year. For a man of 55, the cost of the whole-life insurance policy has more than trebled to just over £300. But the cost of the 15-year term assurance has multiplied tenfold to £170.
The conclusion, inevitably, is that pure protective life insurance is best bought young, when it is so cheap as to be insignificant (at least by comparison with what you have to pay later). The sharp rise in the mortality curve after 30 is reflected in a steep increase in insurance premium rates.