Underwritten whole of life plans provide attractive returns for people wanting to leave funds to beneficiaries, invariably exceeding those available from pensioner bonds and gilts. The only requirement is not to lapse the plan. These products should be considered in a balanced portfolio, particularly for clients looking to mitigate inheritance tax.
I first came across the hidden opportunities of whole of life in the 1990s. Canada and Ireland were seeing rapid sales growth from a product called Term 100 and when I did the maths it was clear that, for customers who did not surrender, the effective returns (for beneficiaries) were phenomenal. Advisers quickly wised up and soon insurers realised the actual lapse rates were far less than assumed and the products were re-priced or withdrawn.
Whole of life insurance is already attractive because it is excluded from means testing and, when written in trust, is not subject to IHT. It can be a good solution to cover a beneficiary’s IHT liabilities.
Advisers may incorrectly assume underwritten whole of life only makes sense for policyholder’s who die within a relatively short period from purchase. This is not the case. The returns on premiums can be significant, even for those living many years past their life expectancy.
For example, in analysing the effective net returns for a 65-year-old non-smoker, the following points can be highlighted:
- It takes 42 years for the premiums paid to exceed the sum assured. Even with dramatic improvements in life expectancy, very few 65-year-old non-smokers would be alive aged 107.
- It takes 27 years before the premiums rolled-up at 3 per cent per annum exceed the sum assured.
- Where the policyholder dies after 20 years the net returns would be 6.9 per cent per annum.
- Where the policyholder dies after 30 years the net returns would be 2.1 percent per annum.
In summary, the overall returns on this low risk product are attractive and even with an extended life expectancy are not unacceptable.
The returns would be significantly more favourable where premiums are paid from funds subject to IHT. For comparison purposes the premiums should be reduced by the expected marginal IHT rate on the funds they were drawn from. This would increase the returns on death after 20 and 30 years to 11.3 per cent and 5.1 per cent per annum net.
Clearly the prerequisites to make this work are writing the policy in trust and not lapsing the plan. The latter is critical. However, in comparison with pension annuities, for which Steve Webb has argued for a secondhand market, for life assurance there is already a small viaticals market.
Some insurers looking to enter the market have mentioned they may include a long-term care drawdown facility. I am in two minds about the value this adds. While it ensures the policyholder has access to funds, it would be more tax efficient to first draw from funds potentially subject to IHT. In addition, the long-term care benefit would increase premiums and, for those who do not claim, it would diminish the attractive returns.
Martin Werth is chief executive officer at UnderwriteMe