Article from HM Revenue & Customs
A unit linked (or investment linked) policy is one in which the benefits are determined by reference to the value of a collection of investments which are broadly identified and to whose fortunes the return is linked. Typically, this will comprise a portfolio of equities, bonds and, perhaps, real property. Investment linked policies’ returns may also be determined by reference to a specified investment, or to an index.
This arrangement might be thought of as similar to owning units in unit trusts or shares as direct investments, but legally the position is quite different and this is reflected in the tax treatment. There is a contractual relationship between the policyholder and the insurer. The policyholder’s entitlement is governed by that contract, according to such events - death, maturity or surrender whole or partial - as the terms provide for. The sum payable may, subject to the nature of the event, depend on the value of the linked investments, but their nature and value is not directly relevant to the tax charged on the policyholder.
IPTM1410 - Types of insurance policy used for investment: with-profits and without-profits policies
With-profits
Traditionally, the most common form of investment-type life policy is the with-profits policy commonly used for endowment policies, including mortgage endowments. There is a minimum ‘sum assured’ that is augmented through the declaration of ’bonuses’, reflected in policyholders’ reasonable expectation to share in profits and the insurers’ duty of fairness.
’Sum assured’ is the cash benefit guaranteed by the insurer. It is different from the ’surrender value’. This is the cash value of a whole life or endowment insurance when discontinued, and can be small in the early years of a policy when expenses are high but there has been time for little growth.
’Reversionary’ or annual bonuses are generally declared year by year. They are guaranteed additions to the sum assured and payable in the same circumstances. Additionally, a ’terminal bonus’ may be declared at maturity or surrender, at the discretion of the insurer. Benefits may therefore comprise sum assured, accrued reversionary bonuses and a terminal bonus. The insurer determines the amount of bonuses following an actuarial assessment of its obligations to policyholders and the value of its with-profits funds.
The popularity of with-profits policies has declined somewhat following, amongst other things, adverse stock market conditions that resulted in some insurers making ’market value reductions’ to the value of the reversionary bonuses. These may be applied if the value of the fund assets falls and the viability of the fund is threatened. There has also been criticism of the opacity of the valuation and award process. The advantage lies in the smoothing of returns that protects in some measure against adverse stock market movements.
Unitised with-profits
Some insurers offer ‘unitised’ as well as conventional with-profits policies. Here a with-profits fund is notionally split into units. This is purely an internal bookkeeping exercise and the units are not like the units in unit trusts. The ‘units’ are backed by a pool of assets, or fund, into which the premium is paid. But the bid price, or value of units to the investor, is not directly linked with asset movement, as it would be if the policy were unit-linked. Instead, the insurer controls the price of units, or sometimes the number of them, by allocating bonuses to the tranche of policies to which the units relate. The fund in question is often a specified sub-fund rather than a whole with-profits fund.
Sometimes the term may be applied to with-profits and investment-linked funds comprised in the same policy with the choice of switching between the two.
Without-profits
In this case there is a fixed sum assured. It may refer to a variety of products
term insurance - pure protection
unit-linked policies, where there is no smoothing, see IPTM1400
guaranteed and indexed bonds, see IPTM1420
fixed return.
Article from HM Revenue & Customs
