Review Critical Illness Cover

Once the proposal form is filled in, the proposer has to wait until the company has assessed it, obtained (in some cases) a medical report from the proposer’s doctor, and decided whether or not to accept the risk. If it does, it will generally send a letter saying so and asking for the first premium; it is only after this first premium has been paid, or more exactly after it has been received by the company or its agent, that the cover commences. (A few offices now allow the first premium to accompany the proposal form on simple types of critical illness insurance policies, in which case cover commences as soon as the company accepts the proposal.)

Only after it has received the first premium does the company prepare and send out the policy document, setting out the terms of the contract. The policy document should be kept with care as it will be required (a) for a claim and/or (b) if the policyholder wants to borrow against the policy. If it is lost, the company may for a fee issue a duplicate, but before doing so will require the policyholder to sign a form of indemnity. In the large majority of cases where people think they have lost their policy document, a thorough search will normally uncover it, perhaps in the hands of a bank manager, solicitor or accountant.

The policyholder can often choose whether to pay premiums annually, or at six-monthly, quarterly or monthly intervals. Premiums are normally calculated on the basis that they are paid annually in advance, so that the payment at shorter intervals means the company receives less interest and incurs more expenses than on the annual basis. Monthly premiums therefore carry a loading of 2-5% over annual premiums.

Monthly premiums may be on a “true” or an “installment” basis. In the latter case, if the assured claims between two policy anniversaries the balance of a year’s premiums will be deducted from the policy proceeds. No such deduction is made if the policy is subject to “true” monthly premiums.

Since the late 1960s, a different type of linked critical illness insurance policy has been available. Here the investment is in a building society: a different medium with its own attractions. The critical illness insurance policies are not “unitised” but operate on a similar principle to those we have already discussed. The advantage of using a critical illness insurance policy to invest in a building society is that tax relief on the premiums increases the return from a given rate of interest, while critical illness cover is provided as is a preferential position in the mortgage queue. Finally, some critical illness insurance policies, unlike the vast majority of regular premium contracts, may be encashed without surrender penalties from the fourth year onwards and are therefore suitable for people whose saving needs are strictly short-term ones.

The number of building society-linked plans now runs to 60 or more and every large society and several large insurance companies are involved. The plans are very simple. You pay your premium each month to the insurance company. The company deducts a small amount to pay for critical illness cover (usually at a level of 100 times the monthly premium) and its expenses. The rest is then invested in a specified building society at a slightly lower rate of interest than is payable on normal share accounts.

The critical illness insurance policies are in theory for 10 years, but after the fourth year the policyholder can surrender the policy without penalties and achieve an attractive investment return. The actual return will depend on the interest rate paid by the society over the period, and this may vary quite substantially, as it has in recent years. But the return to the critical illness insurance policyholder will be net of tax (except for the higher-rate taxpayer who may have to pay extra tax if he surrenders within the first 7% years of the l0-year term) and will always be higher than he could have got by putting the money directly into a building society, because of the tax relief on the premiums.

Insurance companies’ investment management can be described as the adjustment of the proportions of the total fund invested in different sectors in accordance with their view of prospects at the time. Since most companies have a substantial excess of income over critical illness claims (that is, they are expanding, taking in more money from new policies each year than they are paying out on old ones), they have always got money to invest.

By choosing the right sector to invest their new money in each year, they can therefore over a period of years improve on the average performance of anyone of the three main investment sectors. Since fixed-interest investments (largely consisting of Government securities) can, unlike shares or property, easily be bought and sold in large quantities, they also have considerable scope for manoeuvre in taking advantage of fluctuations in interest rates. They may sell their fixed interest stocks when a rise in interest rates looks probable, take temporary advantage of high short-term interest rates on deposits, and reinvest in longer-term when a fall in interest rates appears imminent.

Down the numerous years, these decisions, like compound interest, add up. They can easily account for a disparity of 3% compound per annum in overall fund performance. Over a period of 10 years, for example, the disparity might be between growth at an average 5.5% p.a. and growth at an average 8.5% p.a.: £1,000 invested at the start of the period would be worth £1,708 and £2,261 respectively at the end of it.

The other main factor is the proportion of the company’s income that is taken by expenses. Head office staff, invest­ment managers, marketing and commission, regional offices and salesmen are all costs that have to be met out of the income obtained by way of critical illness insurance premiums and income from investments. The higher the proportion of income taken by expenses, the less there is to invest for critical illness insurance policyholders, and so maintaining efficiency and keeping expenses down is a major factor in producing good results.