Insurance Products

What has Insurance got to do with Investment?

Well, nothing actually, except that both involve financial decisions balancing risk and reward. But it goes like this:

  • Insurance involves collecting premiums as reward for risking a future payout.
  • .... so the money comes in before it goes out - the reverse of normal business practice.
  • .... so insurance companies have funds they need to manage - they are in the fund management business on their own behalf.
  • .... so it's a small step to be in the fund management business on behalf of others.

But there's more:

  • An important sector of the insurance business is life assurance.
  • The longer an insured person lives the more premiums the company collects, and the longer it earns a return on these premiums. 
  • .... so life-assurance companies want you to live longer- in the jargon they are said to be 'long of longevity' - in the same sense that a currency trader who has euros in the bank is said to be 'long of euros'.
  • .... so life assurance companies are looking for activities where they want us to die quickly - to be 'short longevity' - so that they can offset the longevity risk in their life business..
  • ....and they have found one: pensions. 
  • When a company grants you a regular pension in exchange for a capital sum or a set of prepaid premiums it wants you to die as quickly as possible - it is 'short longevity'.

This combination of businesses has encouraged the industry to offer a whole range of products combining features of life-assurance, investment and retirement planning. These products can be more complex than they look. They may be heavily marketed (and therefore costly, with high charges), inflexible and out of your control. They can have reassuringly comfortable names: with-profit bonds, unit-linked bonds, insurance bonds, whole-of-life plans, maximum investment plans. No point in trying to list them all. As fast as one is rumbled a new variant is launched.

Annuities are a special case and deserve their own page. If you want one you more or less have to go to an insurance company.

With-profit bonds

With-profit investment bonds (sometimes called single-premium investment bonds or distribution bonds) have their fans, because 5% may be distributed every year for 20 years tax free.

We've never understood why this matters. So, you get your own money back without it being taxed. Big deal! You get the same effect by putting your money under the mattress and spending 5% each year. Or invest in equities and use your ISA and annual CGT allowances for proper tax planning.

OK, tax is never that simple. But these bonds pay initial commissions of up to 9% and have opaque management fee structures.

What else about tax?

Unscrupulous advisers might imply that insurance funds are tax-free. They are not.

You pay no more (standard rate) tax on distributions from insurance funds. But that is because the funds themselves have already been taxed. This is in contrast to unit trusts and investment trusts which are not taxed. So you pay tax on distribution.

You pay much the same total tax in both cases. More at Tax Free?

In general, taxation of insurance products is an extremely complex matter. You need to know about taxation of all the alternatives to make the right decision for you. Would you prefer to get that advice from a decent adviser or from the man who's selling you the product?

Other things to watch

The industry's big claim is that insurance funds offers the benefit of smoothing investment returns. It's a mirage. We explain why in The Smoothing Illusion.

Some insurance companies have proved to be slow and/or inefficient in paying out when old insurance products are cashed in. This is particularly true if the products were originally marketed by other companies or under defunct brand names. Nothing you can do about it. You have no leverage.

Sometimes companies 'guarantee' that no exit penalties will be applied during the life of the fund. However they still apply a Market Value Adjuster (see The Smoothing Illusion again). There is a word for this. It is called 'lying'.

Above all, insurance products can be opaque. You can't see what initial commission has been paid, what annual commission has been paid, what management and other charges have been paid or what the performance of the underling fund has been. The industry does not do enough to counter the charge that it is a high-cost producer of poor financial products that relies on commission-driven sales and product opacity to exploit consumer ignorance.