Traditional life assurance policies in Australia
The Australian Life Insurance Industry was once largely made up of traditional permanent plan life assurance policies. While these options may still prove popular for certain business insurance options, Whole of Life plans are no longer offered as personal insurance and have been replaced by Term Life Insurance.
There are two main types of traditional policies that were widely used in previous years:
- Whole of Life Policies: Provide a lump-sum payment upon the insured's death. The policy applicant does not elect the term of cover in comparison to modern term policies.
- Endowment Insurance: Provide a lump-sum payment once the policy has reached the maturity age that has been nominated by the applicant or upon death (if before date nominated).
Life assurance policies are no longer offered
- What are the key features of a life assurance policy
- What is surrender or cash value when it comes to 'whole of life' policies
In comparison to widely used term insurance policies of today, the features of traditional policies are quite simple in nature.
- Level premium structure: Premium payments on both whole of life policies and endowment policies are generally level and are usually paid monthly.
- Premium Quite High at Policy Commencement: In comparison to stepped premiums of most term insurance plans, the level premium structure of traditional policies start out quite high but will generally be cheaper than stepped premiums at the end of the policy.
- Option for Cash in or Surrender Value: In comparison to term insurance policies, traditional whole of life policies have the option for cash in or surrender value.
- Benefit Paid: The amount payable at death or policy maturity for endowment policies can increase annually after the insured declares bonuses.
What is a Surrender Cash Value?
- The surrender cash value is the sum of money that a life insurance company will give to the policyholder in the event that the insured terminate their policy or upon their death. The cash value is the savings that has accumulated in the traditional policy.
How Does Surrender Cash Value Work?
- A portion of the premiums paid each year under traditional policies is required to account for claims and expenses each year. The life company invests this part of the premium to accumulate funds that can be used to cover claims as they occur.
- It can take some time for this portion of the premium to cover the initial costs of the policy activating so there may not be equity for a few years. As the funds do eventually build over the life of the policy, the policy accumulates cash value (this is the savings element).
- This equity is not the value of the premium paid but what is left after the necessary expenses and actual insurance is covered. It will take quite a long time for the cash value to equal that of the premiums paid.
What does this mean for policyholders of traditional plans?
- Cash value enables the policyholder to borrow against the contract with the savings that have accumulated in the fund while still remaining covered.
- Another key feature of permanent plan contracts is the non-forfeiture principle, which will allow the insured to borrow funds to cover the premium if they are unable to make the payment to ensure that cover is maintained. This facility continues until the policy owner has borrowed more than what has accumulated in their fund.
The profit earned annually on traditional life contracts on top of the sum-insured is called a reversionary bonus. This bonus is declared annually and is guaranteed to be paid at the maturity of the policy. That added bonus could help protect the policyholder against ongoing inflation by keeping up with the original value of the sum-insured.
The payment provided when a reversionary bonus is actually cashed is significantly smaller to the perceived value due to the time value of the money till the actual date a claim would be expected. The bonus is subject to variance according to the actual companies financial performance and premium (a higher premium will yield a higher bonus). This makes the process of comparing different permanent contracts extremely important.
Terminal bonuses have also been added on permanent policies to represent the profit that has grown out of capital gains on investment. This bonus is not guaranteed and will fluctuate subject to the investment market. In comparison to reversionary bonuses, terminal bonuses cannot be cashed in until the policy has reached maturity.
Not all traditional policies offered bonus features. While these were more affordable, they did not offer the policy owners any defence over inflation, as the sum-insured remained constant over the life of the policy.
While investment-linked policies still prove to be popular for some businesses, the rate of inflation on personal policies saw them become less and less popular. Without the benefit of being able to predict how inflation will change into the future, what initially looks to be a strong source of retirement funds is quickly eroded by inflation. This was coupled by the fact that the investment of life insurance company funds used generally be in fixed interest securities which did not perform well in an economy experiencing rising inflation and interest rates.
The decline of popularity of whole life policies for personal cover gave rise to unbundled contracts where the insurance, investment components of policies were now separate and more visible to the traditional policies.
The benefit of unbundled policies is both through their flexibility and ability to have all key features visible;
- The Charges
- The Cost of Life Cover
- The Savings Component of the Plan
- The Investment Component of the Plan
With the features now unbundled, applicants now have a range of different combinations of how the investment and insurance of the policy is managed.
Investment account policies are policies where a portion of the life insurance premium is directed into a linked investment account, earning an interest rate declared by the life office. This rate will have to take into account the performance of the fund and the amount of capital required for capital guaranteed. Applicants should be aware that these types of policies will often come with an exit fee on funds which will be deducted from the policy sum-insured once the policy expires or is terminated. This exit fee will be quite high in early years but will level off further into the life of the policy.
The return on Investment Account Policies is guaranteed to policyholders.
NOTE: Applicants must be made aware of this exit fee at the time of application.
In comparison to investment account life insurance policies, investment linked policies invests the premium to purchase units in different investment portfolios including capital stable, equity, property, mortgage and discretionary units.
It is up to the policyholder to decide what kind of portfolio their funds go into and as such, the savings will fluctuate according to those investment units. As the investment return is not guaranteed to policyholders, they are taking a risk on the performance on the unity.
Similarly to Whole of Life policies, an investment-linked insurance policy will not lapse until all of the equity (funds accumulated after exit fees) has been used to pay the charges and costs of the policy.
Variable life insurance is a type of permanent life insurance that provides ongoing protection to the policy owners beneficiary following their death. Also known as “Variable Universal Life Insurance” it is a form of unbundled life insurance where there are flexible terms and investment options to the policyholder that can be taken out within the company’s portfolio. The cash value that accumulates can be invested by the policy owner into a variety of accounts offered by the insurer including stocks, bonds, bond funds, equity funds and money market funds. This type of insurance is no longer available in Australia.
Note: Variable life insurance is no longer available in Australia
The key difference in variable life insurance to other types of permanent life insurance options is that the policyholder has far greater flexibility in how they are able to manage their policy and invest their cover.
- Adjustment of Sum-Insured: In comparison to whole of life and endowment insurance, the policy owner is able adjust their sum-insured throughout the life of the policy.
- Adjustment of Premium: In addition, policy owners have the power to adjust the premium frequency and how much is paid in premiums, allowing them to both increase or decrease the premium within defined limits on the policy. Policy owners may have the option to invest nothing in a given month to a maximum that has been specified. This is in comparison to traditional whole of life policies where premium payments are fixed and skipping payments will result in the policy being lapsed.
- Ability to Choose Investments: In comparison to other endowment plans, Variable Life Insurance gives policy owners the ability to choose how their premium will be invested across the different options available in the insurer's investment portfolio.
- Risk of Loss with Variable Life Insurance: The increased flexibility of Variable Life Insurance policies also means that there is a greater risk of loss possible. The cash value of the policy and the sum-insured is subject to fluctuate based on the performance of the funds that the premiums have been invested into. As is the nature of investment linked policies, there is potential of capital loss if looking to receive cash value with the policy. Similarly, skipping premium payments lead to the policy owner having to increase their premium payments in future years to account for any loss in cash value.
A traded policy is a life insurance contract that is purchased from the original owner for a small margin premium over the policy surrender value. These policies are generally purchased by settlement brokers to sell to large investors. A settlement broker will have a set of criteria required for the policy to be accepted for trade.
What is surrender value?
The surrender value is the amount of money that the life insurance company will pay to the policyholder when they voluntarily terminate the policy before it reaches maturity or the event they are insured for occurs. This value is the savings component that has accumulated in the fund.
Characteristics of Traded Policies
- Whole of life or endowment policies
- Generally already completed a period of its terms to maturity when it is traded (usually five years)
- Policies will generally have between five and ten years left in their policy term
Quite simply, traded life insurance policies are a secure investment available at a discount price.
Whole of life and endowment policies generally come with quite high establishment fees that level off later into the life of the policy. An investor looking to purchase a traded policy will not be weighed down by these charges and is purchasing the policy when it will increase in value greatly over the remainder of the term.
- Sum Insured: Upon the policies maturity or death of the life insured, the life insurance company will pay the new policy owner the sum-insured.
- Reversionary Future Bonuses: Upon the maturity of the policy, the policy owner will be provided with the payment of funds that have accrued over the policies life. Reversionary bonuses are guaranteed and attached to the fund at time of purchase.
- Terminal Bonus: The terminal bonus will be paid upon the maturity date. The terminal bonus is not guaranteed as it will depend on how much capital is in the life insurance company’s fund at the time of maturity.
- Premiums: Once the investor has purchased the life insurance policy, it is their responsibility to now maintain premium payments. They can elect to make premium payments on annual or lump sum basis.
While the primary purpose of providing a benefit payment in the event that the policy owner dies or suffers a terminal illness remains the same for both Life Assurance and Life Insurance policies, the two types of cover are significantly different from one another. Here are some key differences between traditional life assurance policies and life insurance of today;
Are the premiums in
|Term life insurance||Life assurance|
|Are my premiums invested?||No||A portion may be invested|
|Is there a cash value accrued when the policy expires||No||Yes|
|Is is possible to borrow from the cash value to pay premiums?||No||Yes|
|Are premiums expensive?||Generally cost less than life assurance||Generally costed more than a term life insurance policy|
- No investment linked component for life insurance policies. No portion of the premium of current term life policies is directed towards investment. The policy owner is not able to control how their premium is used. They must simply make ongoing premium payments.
- No cash value. Term life policies do not accrue a cash value that can be accessed by the policyholder while the policy is active or if it expires or is cancelled.
- Not possible to borrow cash value. With no cash value provided to policyholders on current term life policies, it is not possible for them to borrow against this amount to fund premium payments. In the event that policyholders are unable to make consecutive premium payments, the policy will lapse.
- Expensive. Premium payments on life assurance policies were generally much higher than on current term policies.