What is life insurance?
Life insurance offers valuable financial protection in the event of your early death and makes a payment to your beneficiaries, heirs or family members dependent on your selected sum assured and earnings. But it may also be a means of saving. This combination of protection and saving makes life insurance unlike any other financial product. Some policies protect, some help you to save and some do both.
In Gibraltar there is the added benefit of having premiums (provided they do not exceed 1/6 of assessable income or 7% of the capital sum assured at death) fully tax deductible as also are pension contributions to approved occupational pension schemes. Your insurance intermediary or tax adviser will be able to provide further guidance on this matter.
A life insurance is a long term contract which may mean that for a number of years, you have to pay a periodic premium to your life insurance company and it was not 'annually renewable'. When you take out a life policy, you have to be sure that you would be able to meet your obligations of premium payments on time and in full. In certain circumstances, you may not be able to obtain the full value of your insurance premium paid over the years if you surrender your policy before its maturity or if you have missed premium payments.
Paying for your life insurance policy usually takes two basic forms:
- Single Premium: a lump sum is paid at the beginning of the policy. No other payments are made for the whole duration of the policy. Some policies may allow you to "top-up" the amount at particular specified intervals during the policy term.
- Periodic Premium: this can be annual or in instalments e.g. monthly or quarterly. An instalment premium would normally incur charges made to the policyholder as a result of higher administration for the insurance company.
Remember that if you decide to change any aspect of your policy at any time during the duration of the policy, the insurance company may reserve the right to charge you a fee to cover administrative expenses.
How can life insurance protect my family?
Loss of the head of the family's income and problems paying debts or meeting tax liabilities can result from loss of life. To help with these costs there are three basic types of life policy - term insurance, whole life insurance and endowment insurance. All these provide you with protection by paying a lump sum on death. People on a limited income may find that term insurance is the best buy. The term (period of cover) can be chosen to cover the time when children are growing up and family expenses are high.
Term insurance (or "temporary insurance") gives you financial protection if you die within a specified period known as "the term". This period might be 10, 15 or 20 years although you can arrange policies to cover you for periods as short as one month or as long as 40 years. If you stop paying the premiums the cover ceases and there is no refund of premiums paid.
An endowment policy gives both protection and saving. Although more expensive than term or whole life insurance because part of the premium are invested it will help your family's finances should you die during the policy term, while at the same time it is a method of long-term saving because it also pays a sum of money which depends on the successful investment of the funds paid in as premiums. If you do not survive the term then the policy pay the sum assured plus investment accrued to date (bonuses).
Whole life insurance gives more extensive protection. You know your family is financially protected whenever you should die and the policy will pay a fixed sum on the date of your death.
Can you give me more information on term insurance?
Term insurance is the cheapest form of protection and it can offer high life insurance cover for a low premium. This can be ideal if you have a limited income or only need cover for a relatively short period of time. Cover is usually arranged for just one person, but in some cases cover will also be available for spouses/partners on the same policy.
There are different types of term insurance:
1. Level Term
You are insured for the same amount throughout the agreed term.
2. Renewable Term
You have the option, after a specified period (usually 5 years) to take out a further term policy without the need for any further evidence of health, providing the policy does will not continue beyond a certain age (often 65 or more) but premiums may well increase on the renewal date.
3. Convertible Term
You can convert the policy to a whole life (see below) or endowment (see below) insurance without giving further evidence of your state of health. If you decide to convert, the new policy will usually cost the same as a normal whole life or endowment policy based on your age at the date when you exercise the option. If you have a young family and a limited income these policies might be best. Not only do they provide cheap life cover at the outset, but they give you valuable options in later years if your income has risen or your health has declined.
4. Decreasing Term
The sum insured reduces by a fixed amount each year, decreasing to nil at the end of the term. The premium will normally stay the same throughout the term. These policies are usually used to cover a home loan or other loan as they are calculated to pay any outstanding balance of the debt if you die early. Remember, though, at the end of the term nothing is payable and there is no surrender value. These policies may be combined with endowment policies to provide a payment to you at the end of the term.
5. Increasing Term
The sum insured and premium increase each year by a fixed percentage of the original sum insured. These policies are designed to increase your insurance protection as your earnings increase.
How can I save with a life insurance policy?
The long-term nature of life insurance allows you to make clear plans for long-term saving. Life insurance companies have long and wide experience of investment as well as providing protection in the event of your early death.
1. Endowment Insurance
This both protects your family and saves for the future. Endowment policies can be issued with or without profits or can be unit-linked (see below). You pay premiums for an agreed number of years - say 10, 15, 20 or even up to 40 years. At the end of this time you receive a lump sum, which is made up of the amount saved plus bonuses accumulated during the policy term in the case of a with-profits policy, or - in the case of unit-linked endowments - the lump sum is the return of all money invested together with the investment growth attained by the units or funds chosen. If you die before the maturity date the insurance company will pay the sum assured plus any bonuses accumulated to date or increase in the unit value at that date.
2. With and Without Profits
- A with-profits policy lets you share in the profits made by the insurance company from the investment it makes. These profits are usually added to your policy as an annual bonus and once they have been added they cannot be taken away.
The amount of bonuses allocated to your policy depends on the investment returns made by the company. These bonuses cannot be guaranteed in advance but it is likely that bonuses will add to your sum invested. The with-profits endowment policy is a means of long-term saving with a lower risk than direct investment in shares, and the potential for a good return. It smoothes out fluctuations in the value of investments, although there is no guarantee of the final (maturity) value of the policy. In addition a terminal bonus may be paid on maturity. Historically with-profits policies were used to fund the repayment of mortgages. However recent low returns on such policies have resulted in shortfalls between the monetary value and the sum required to repay the loan. Therefore the use of such policies for mortgage repayment purposes should only be done with great care and suitable advice.
Market Value Adjuster (MVA) – the term used to describe the exit penalty imposed on policyholders who surrender their policies early. It is normally only applied if a policyholder surrenders their policy during a period of poor performance on the stock market. The main reason for the application of MVA's is to ensure that payouts on maturing policies reflect the returns actually earned on the underlying assets.
- Without profits policies do not share in profits made by the insurance company. The amount paid out on death or maturity will be the basic sum assured only.
What is "whole life" insurance?
This pays the sum insured whenever your death occurs. Whole life insurance is not limited to a specific period like term insurance. Premiums are usually more expensive because it is certain that the insurance company will eventually pay the sum assured. With some policies you will have to pay the premiums until you die, but with others you may not have to pay premiums any more once you reach a chosen age - say 65 or 80 - but the insurer will pay the sum insured when you die. Whole life insurance can be arranged with or without profits or can be unit-linked.
What is a reversionary bonus?
This is a bonus declared by the insurance company reflecting investment returns from year to year and which will be added to the policy and paid to the insured on maturity or early surrender of the policy or on the death of the life assured.
The insurer will add a declared percentage to the sum assured payable under your policy. This addition is in proportion to the invested premium and accumulated bonuses, and can apply to a with-profits policy. Usually, bonuses are declared net of tax to the policy holder as any tax liability is borne by the company.
What is a terminal bonus?
This is an extra bonus payable on with profits or endowment policies that become payable upon claims which are made upon maturity or death of the policyholder. Normally the policy would have to be in force for a minimum number of years to qualify for such a bonus. This is also usually expressed as a rate per cent of the sum assured and any attaching bonuses at the date of the claim. The insurer may reduce or discontinue granting a terminal bonus according to its investment performance. Read the wording carefully.
What are unit-linked policies?
With a "unit-linked" insurance policy there is no guaranteed sum insured payable except in the case of death. The investment element of the annual premium is invested by the insurance company in your choice of funds. Each fund has various degrees of risks and rewards, depending on its respective investment objectives. Some companies offer a choice of managed funds whereby the insurance company or fund manager manages these investments on your behalf. The value of your policy at maturity is based on the market value of the accumulated units in your selected funds.
Insurance companies offer a range of different funds to which your policy can be linked. You should ask for an explanation of the different funds so that you understand the different risks and opportunities. There is no guarantee on the value of the sum to be paid at maturity or early surrender.
The potential benefit from a unit-linked policy can be much greater than from a with-profits endowment policy. But of course there is also a risk that the eventual benefit could be lower since these are directly linked to investment returns. Unit-linked policies are designed for long term investment and as such carry early surrender penalties. These penalties are usually confined to the first five years of the contract, but you should ask as these early surrender penalties vary from company to company.
The value of investments can fall as well as rise and past performance may not be a guide to future performance.
Do life insurance policies come with any "extras"?
Some life policies have optional benefits that may be subject to additional premiums:
1. Waiver of premium
If you suffer from a temporary total disablement because of illness or injury, the insurance company will continue to pay your premiums to maintain the benefits under the policy. There are usually time limits stated in the policy normally reflecting the duration of the disablement.
2. Critical Illness
This provides cover against the risk of you having a serious illness such as a heart attack or cancer. If you develop one of the illnesses listed in the policy, part of the maturity will be paid as a lump sum. Some insurers offer a regular income for a set period as an alternative to a lump sum payment. This type of insurance can be bought on its own or as an addition to whole life, endowment or term insurance.
3. Accidental Death Benefit
This benefit provides additional cover so that if you were to die as a direct result of an accident the insurance company will pay this benefit in addition to the main benefit. The amount of cover under this accidental death benefit can be up to the same amount payable under the main benefit thus doubling the amount payable in the event of death as a result of an accident.
4. Permanent Total Disability
Total Disability arising solely out of an accident or sickness and which having lasted 24 months is permanent, continuous and beyond hope of improvement.
These "extras" are sometimes called Rider benefits because they run alongside the main policy cover which could be a whole life or endowment. You should always check with your insurance representative about these "extras" and whether they are suitable for you.
How do I decide upon a life insurance policy?
It takes careful planning to choose the right life insurance policy for yourself, family or business. It is also important to review regularly your life insurance needs to make sure that they keep up with changing personal and economic circumstances.
Also you will need to ensure that you can afford to pay the premium now and in the future.
When you have decided on a policy you will have to complete and sign a proposal form. This form asks about such matters as your age, occupation and health. You must answer all questions truthfully. If you fail to do so, it can, in some circumstances, mean that you would have made false declarations and as a result your policy will not pay out the sum assured on maturity.
A life insurance policy is a long-term commitment. It is not designed for you to cash in early. If cashed in early the probability is that you might not get back what you have invested in the policy. Insurance companies and financial intermediaries can help you decide what products are suitable for you. Never surrender a life insurance policy without taking expert advice as this would mean a breach of contractual obligations and therefore may be subject to penalties.
What if I change my mind?
Every effort is made to ensure that your application for life insurance is made in the full knowledge of all its terms and conditions, but most of these policies have a "cooling off" period (maximum 15 days). It allows you to reconsider your decision to buy the long term cover. During this time you can tell the insurer you do not want the policy and receive a full refund of any initial premiums you have already paid. With unit-linked policies it may not be the full amount you originally paid if the value of the units has decreased since purchase.
What should I expect when purchasing a life insurance product (or any other long term insurance policy)?
BEFORE YOU BUY
- Obtain information about the insurance company issuing the policy. Get the name, address of its head office, whether it is established locally or abroad, and if it is a foreign company, the entity which represents it in Gibraltar.
- Make sure you know the difference between the types of TERM, ENDOWMENT, WHOLE LIFE or UNIT-LINKED policies. Know which type is suitable for you and why. Ask your insurer or insurance intermediary for a clear explanation of how it works.
- Obtain whatever explanation of the benefits and options of the policy you require. Keep copies of any written information regarding the product you are purchasing.
- Understand the duration of the policy (i.e. when the policy matures) and how you can terminate it prior to maturity. Note that you may incur extra charges if you decide to terminate your policy before its maturity.
- Know how much premium you need to pay, and when you need to pay it. Ask clearly what charges, if any, are imposed on the policy and take note of them. Ask how much is allocated to the savings part of your policy (sometimes referred to as the "Investment Premium"). When such amount is expressed as a percentage (such as 95%), it indicates that 95% is actually allocated to your policy (5% is to cover expenses by the insurance company).
- Understand how bonuses are calculated and distributed. Obtain an explanation of different types of bonuses: REVERSIONARY or TERMINAL, and the difference between such bonuses. Understand the manner in which they are calculated. Ask if any are guaranteed or not even if the word guaranteed is written on the information.
- Clarify and understand your policy's surrender values - that is, the amount of money which you may get after over specific periods of time if you surrender your policy. Make sure you establish whether the surrender values are guaranteed or not. If they are only meant to give you an indication of what you might get you are NOT guaranteed that you will receive the amounts shown. Remember that illustrations given on the future returns from your policy are merely forecasts based on given returns which may not reflect the same returns in the future.
- If the policy allows for supplementary benefits, you may have to pay additional premium. Check with your insurer or insurance intermediary the amount and purpose of each additional charge which will be added to your premium.
- Make sure you are given advice of any 'cooling-off' periods you are entitled to as well as being provided with the following two documents, where applicable:
- Statutory Notice: this document explains your right to withdraw your decision to purchase a long term policy within 15 days from the date on which you sign this notice.
- Cancellation Notice: You have to sign this within 15 days from signing the Statutory Notice in order to get your money back in the case you have decided to cancel. If the insurance company gave you some gift with the policy, you also have to return it (unless otherwise stated in the policy).
- If you are given information about past performance, remember that what happened in the past may not necessarily happen in the future. Returns on investments can fall substantially. Ask your insurer or insurance intermediary to give you a pessimistic scenario and not only optimistic. Make sure the returns quoted are realistic in the existing market conditions when you are purchasing the policy.
Your adviser will ask you for details of your personal and financial circumstances so that they have a sufficient basis for any advice they give. These details will include: -
- Attitude to risk
- Future plans
- Career prospects etc.
If you decide to make changes to your policy in the future, your adviser may ask you for these details again in order to update their records.
Based on the information that you provide, your adviser may then recommend a number of products.
'Reason Why' Letters
Your adviser will set out the recommendation in writing. This document is called a 'reason why' letter or 'report'.
This letter/report should include:
- an assessment of your individual situation and needs and how the recommendations made follow from this;
- a description of the products recommended.
You may be asked to sign and return a copy of this letter/report to your adviser.
You should then be able to make a final decision.
AFTER YOU BUY
- The insurance company may declare reversionary bonuses - which once declared cannot be withdrawn. A company may choose not to declare profits in any particular year if investment returns are not favourable during that year.
- When an insurance company declares a bonus, you should receive a statement with the amount of bonus declared. You should also be given a statement of the total value of benefits (plus bonuses) which have accrued to your policy. Remember your policy will only participate in profits if it is a "with-profits" policy.
- This statement also includes information which explains the contents of such document. If in doubt, check it out!
What happens if I forget to pay my renewal premium?
One of the conditions on your life policy is the Days of Grace condition. This condition normally allows 30 days' grace for payment of your renewal premium. If death should occur during these days of grace the claim would still be met and the insurer would deduct the outstanding premium from the sum payable. If the premium is paid on a monthly basis, the days of grace may be reduced to 15 days or none at all. Ask your insurer or insurance intermediary. In some cases, and this applies for with-profits policies, such premiums may be deducted from your policy account. The policy continues to be in force until there is enough balance in this account to pay this premium. In such cases, these will be deducted from any claim made on death, maturity or surrender.
What if I need to surrender my life policy before maturity?
If you see no alternative but to surrender your life policy, you should first discuss the problem with your insurer or insurance intermediary who may give you advice on how you may avoid surrender.
Always get a written quotation of the surrender value from the insurance company before you make a final decision.
Think twice if someone suggests you surrender a policy with one insurance company and take one out with another company. This is called "churning" and usually involves you in some financial loss on your existing policy (which would either have to be surrendered or made paid up).
If you surrender, your insurance company has to cover all the initial costs of issuing your policy. These costs include payment of commission, office administration costs, policy documentation costs and other expenses connected with issuing your policy. These costs have to be met whether you continue your policy for the full period or discontinue it after only a short time because the insurance company would have incurred these expenses anyway. Remember the administration costs of the insurer under a long term cover are highest at the beginning and therefore the earlier the surrender, the greater the deduction for costs in proportion to the premiums already paid.
So if you surrender your policy, the insurance company has to keep enough money from the premiums you have paid so far to cover all these costs. In addition, allowance also has to be made for the cost of providing you with life cover for your full sum insured. This must not be overlooked as the full sum would have been payable in the event of your early death before deciding to surrender.
A surrender in the early years of the policy means you will get back a little or a lot less than the premiums you have paid. Very often, nothing at all is payable if you surrender the policy within the first year or so.
Ask about surrender terms when purchasing your policy.
What should I do if I am having trouble settling my claim?
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Points to remember
- Some contracts - such as term insurance or policies which are not with-profits - do not as a rule ever attain surrender values. This is because these are life policies without a savings element - they provide protection only. They can be compared to household or motor insurance policies which pay out only if a claim arises.
- If your policy is intended to repay a loan - for example an endowment policy taken out in conjunction with a mortgage loan - you should not surrender it unless you have made other arrangements to repay the loan.
- When taking out or changing a home loan, it may be in your interest to use your existing policies as backing for the new loan. A top-up policy may be required if the new home loan is more than your previous one. The cash value of policies linked to investments (such as collective investment schemes) is dependent on the value of your holding in the fund at the time of surrender.