Read Aloud the Text Content

This audio was created by Woord's Text to Speech service by content creators from all around the world.

Text Content or SSML code:

15 Investment types Each contract type described in the previous sections is likely to be available in one or more of the following investment types withoutprofit, withprofit, unitlinked, or indexlinked. 15.1 Withoutprofit nonparticipating contracts A life insurance contract is withoutprofit if the life insurance company has no discretion over the amount of benefit payable, ie the policy document will specify at outset either the amount of the benefits under the contract or how they will be calculated. So, the key feature of withoutprofit business is its guaranteed, nondiscretionary nature. A customer knows, at outset, what both their premiums and benefits will be. Strictly, only the main benefits may be fixed, for example the death and maturity benefits may be fixed but the surrender value may be at the discretion of the life insurance company. Withoutprofit contracts tend to be most appropriate when the primary customer need is protection. Broadly, this certainty means less risk for the policyholder than on a withprofit or unitlinked contract. An individual might decide to take out a withprofit or unitlinked contract, despite withoutprofit contracts being less risky for policyholders. This is because the expected returns from a withprofit or unitlinked contract will be higher. However, because they are more risky, the actual returns may or may not be higher than those from a withoutprofit contract. 15.2 Withprofit participating contracts A life insurance contract is withprofit if the policyholder is entitled to receive part of the surplus of the company or of a subfund within the company. The extent of the entitlement is usually at the discretion of the company. Withoutprofit contracts do not have this profit participation feature. Under a withprofit contract, the insurer and the policyholder share the profits and hence the risks. A wide range of withprofit contracts is available. They tend to be most appropriate when the customer need that the contract is addressing is saving. Savings contracts will tend to have premiums invested in riskier assets than do withoutprofit contracts, with higher expected returns that are used to form the basis of the discretionary benefit entitlement. It is typical for a withprofit contract to involve some guaranteed benefits and some discretionary. There are a variety of ways of applying the discretionary benefit including the additions to benefit approach. The factors that come into play, when setting levels of bonus include the wish to smooth benefits from year to year, so keeping back some of the profit from the good years, to help in the bad years, policyholder expectations, eg based on past bonus distributions by the company, looking at what competitors are doing adhering to regulatory limits on payouts. Exam Tip The above four bullet points represent good word association ideas to have for the word withprofit in the exam. 15.3 Unitlinked contracts Unitlinked contracts are unitised contracts whose value of units is directly attributable to the underlying value of the invested assets. Unitlinked contracts operate by paying policyholder premiums into pooled investment funds. Often the policyholder has a choice of funds. The policyholders share of the fund is represented by units. Any of the types of contract can be written in a unitlinked form, although normally only contracts with a significant investment element are written in this way. The benefit payable at maturity depends on the performance of the underlying assets and the level of charges levied by the insurance company. This is the investment, or savings, element of the contract. A protection element of the contract may also exist. For example, the benefit on death might be a fixed sum eg £50,000, or, the value of units, or, some percentage eg 120 of the value of units. This makes unitlinked policies very versatile if the first option is chosen, with a very high sum assured relative to the premium, then the contract can be almost entirely protection in nature. The policyholder will typically be charged for this protection cover via regular charge deductions eg a monthly mortality charge from their unit fund. From the insurers perspective, the profit comes from the expense charges less the actual expenses, and the mortality charge less the cost of providing any guaranteed death benefit. Therefore, the key risk to the life insurer is that the charges do not match the expenses cost of guarantee in terms of nature, timing and amount. A unitlinked contract enables consumers either to obtain a higher expected level of benefit for a given premium or to pay a lower expected level of premium for a given level of benefit, than under a comparable nonlinked version of the contract. This occurs because the consumer accepts a significant element of risk, mostly investment risk. By accepting greater risk, the consumer gains a higher expected return, at the expense of a possibility that the return will be lower than might have been achieved from a nonlinked contract. The word expected is important here. While the expected maturity value might be higher under a unitlinked contract, the actual maturity value could be lower. This is what is meant by the policyholder taking more risk. Under a typical unitlinked contract, all the investment risk lies with the consumer, as investment performance directly affects the value of the unit fund and hence the main benefit. In contrast, under a typical withprofit contract, less investment risk lies with the consumer because There is still a guaranteed element to the benefit that the insurance company must meet. Policyholder expectations may limit the scope and speed of bonus reductions. These are at the discretion of the company rather than being ‘automatic as with the value of the unitlinked contract. It is possible that shareholders where there are any share in the investment losses as well as profits of the company. In addition, a unitlinked contract can offer flexibility in the types and levels of cover included and the ability to vary premiums according to need. 15.4 Indexlinked contracts An indexlinked contract enables the consumer to obtain a benefit that is guaranteed to move in line with the performance of an index specified in the contract. Normally the index will be an investment or economic one. Premiums may move in line with the same index, or may be fixed in monetary terms. Suitable investment indices might be the major domestic equity market indices of any country, or more broadly based international equity indices. Also links might be made to other asset classes such as fixed interest. Typical economic indices that might be used include retail or other appropriate price indices.