The spotlight is again on protection. Why? The need for protection products has not changed. Life cover and critical illness continue to be key elements in any client recommendation. Nevertheless, many of the traditional players, who left to chase the spoils in the fund management and investment business, are now returning to try to recapture a share of an old but rapidly expanding market.
Critical-illness contracts now cover more illnesses and offer bolt-on benefits including serious accident cover and cover reinstatement. Products are developing beyond just paying out cash, with access to medical specialists also provided at times of need.
There is also the possibility of more than one claim under any plan. It is this last point that I want to focus on.
What is the problem in structuring a plan to provide multiple benefits? Tax, if you set it up wrongly. The chargeable event legislation has often presented financial planners with the opportunity to create tax-efficient investments or planning structures which lessen any tax payable. For example, the success of the single-premium investment bond can be credited partially to its construction. The ability to divide a bond into separate policies has helped to increase tax-efficiency, both in providing regular payments and for inheritance tax purposes.
Is this not equally true about protection contracts? It is. However, some providers have shrugged their shoulders metaphorically and walked away from this reality. The result has been a limit on client choice.
Consider the example of Janet and John, who need critical-illness and life cover. They are looking for flexibility in both options and cover and the ability for the plan to change with their lifestyle and needs. They buy a non-qualifying term insurance plan that simply provides life cover of £100,000 on each of their lives and, in addition, critical-illness cover of £150,000 on each of their lives.
If the provider built this plan as a single policy, then using it would be tantamount to recommending your clients play Russian roulette to improve their health.
Imagine John dies in an unexpected accident. Janet receives £100,000 and the critical-illness cover on John ends. There would be a chargeable event but there would be no tax liability as the surrender value (nil) would not exceed premiums paid.
Suppose Janet lives for a further 10 years. She then dies and £100,000 is paid out. Again there would be a chargeable event. However, the gain this time will be the excess of the surrender value and any relevant capital payments over premiums paid. S541(5)(a) ICTA 1988 states that “relevant capital payments means any sum or other benefit of a capital nature, other than one attributable to a person's disability, paid or conferred under the policy before the occurrence of the chargeable event”. Thus, the sum paid on John's death is a relevant capital payment.
The gain equals the surrender value plus relevant capital payments minus premiums paid. So, nil plus £100,000 minus £12,000 (say) equals £88,000. Therefore, higher-rate tax (at 18 per cent) is £15,840. Oh dear! That was the chamber containing the bullet.
There are two solutions that will prevent this from happening. First, the provider can simply refuse to allow a contract where there could be two death claims. This reduces client choice and advisers would see this as an unreasonable approach. Alternatively, the provider can structure their plan as a series of individual policies. This is an innovative solution that creates a gun with six empty chambers.
As you should now understand clearly, how a provider sets up its products will affect how the benefits are taxed. Innovation has led providers to develop multiple benefits for more than one individual under one product. If the benefits are not clearly identified as separate policies under a product, your clients will be playing Russian roulette.
In summary, when looking at multiple benefit policies and multiple life proposals under one product, the price of any particular product structure could be much higher than you might expect. Understanding the distinction between the product and the policies comprised in it is as important as the price your client eventually pays.
Make sure you recommend a provider that delivers a flexible solution which meets all the needs that you and your clients demand.