Life Insurance Guide | Insurance Help Product Information | With Profits Policies

Every year, the life office carries out a valuation of the assets and liabilities of its life fund. This will normally reveal a surplus, part of which can be allocated to the with-profits policyholders, in the form of an addition to the sum assured. This addition, called a bonus or a profit, is usually ‘reversionary’ which means that it is only payable at the same time as the sum assured, for example, on death or maturity. Any unallocated surplus can be ploughed into the reserves or paid out to the office’s shareholders as a dividend.

The bonus systems of the various life offices vary considerably, and it is not possible to describe all the methods within the confines of this guide. However, one fundamental distinction is between a ‘normal bonus’ and a ‘terminal bonus’. A normal bonus is usually declared annually and increases the value of the policy year by year, as it gets older. The bonus is usually expressed as a percentage of the sum assured, and thus the higher the sum assured, the greater the bonus, It can be either simple, based purely on the original sum assured; or compound, based on the sum assured plus previous bonuses. Once allocated, normal bonuses cannot be removed or reduced.

A terminal bonus is different in concept. This is only added when a policy becomes a claim and is not normally payable on surrender. It is usually expressed as a percentage of the total normal bonuses and will vary in accordance with market conditions.

Most offices operate a system using both normal and terminal bonuses and the eventual amount payable will comprise three elements – the sum assured, normal bonus and terminal bonus. Only the sum assured is guaranteed at outset.

Premiums for with-profits contracts are always higher than those for the corresponding non-profit contracts for the same sum assured, since they reflect the higher benefits that will be paid out.

Under a with-profits policy, the policyholder does benefit in some measure from the investment performance of the life fund, but the link is not direct. It depends on annual valuations of the fund’s assets and liabilities, where a multitude of factors are taken into consideration, as well as the decision of the directors as to how to allocate any surplus. Because of this, the bonuses added to policies only follow investment performance in a very cushioned and distant fashion, smoothing out investment returns. Allowance must be made for the guarantees underlying the basic sum assured, and so the bonus structure cannot directly reflect the value of the underlying assets of the life funds. IN addition, bonuses are only declared yearly, and so cannot possibly match the daily fluctuations in the value of the assets.

Many offices have now pulled out of writing new conventional with-profits life insurance in favour of writing unitised with-profits business, though there are a great many traditional with-profits policies still in force.