PSI20.3.21 - Funding and Surpluses: Insured Schemes - General - Types of Policy

(This archived guidance relates to HMRC discretionary practice before the 6th April 2006. For current guidance on Registered Pension Schemes see the Registered Pension Schemes Manual)

Many different types of policy are used to provide benefits for members of retirement benefits schemes. The most common are described at a., b., d., f. and g. below. Those described at c. and e. may be encountered on long-standing schemes but are not generally issued nowadays.

1. Deferred Annuity. At maturity, which will usually be the employee’s normal retirement date, the policy provides an annuity (part of which may be commutable for a lump sum) which is paid to the scheme member. The policy may provide for premiums to be refunded if the member dies before the maturity date (this is known as a “with return” policy) but if not, no benefits are payable on death in service.

Deferred annuities are the most common type of policy used for providing retirement benefits, usually in conjunction with term life policies to provide death in service benefits. In the case of the latter the requirements of PSI20.1.44. must be satisfied.

[PN13.13]

1. Term Life or Term Assurance. This type of policy provides a capital sum payable on the member’s death during a particular period or “term”. Term life policies generally provide life assurance cover for a single year only and are renewable annually (the premium increases as the member grows older because of the higher mortality risk). The sum assured under the policy may, subject to Revenue limits (see Part 11), be paid in lump sum form or as pensions for a widow/widower and dependants (or a combination of both). Because the policy is renewed annually, the capital sum assured can be adjusted so that it does not exceed the amounts needed to pay the death in service benefits which would be due for payment in the event of the member’s death in the coming year, having regard to the funds available on death under retirement benefit policy(ies) for that member. Sometimes the term life and deferred annuity elements are combined in a single policy document.
2. Pure Endowment. Like the deferred annuity this policy provides benefits on the member’s retirement but instead of retirement benefits it produces a capital sum. Unless a scheme provides lump sums only the policy must satisfy “correspondence” requirements (section 431 (4)(b) ICTA 1988) by providing for conversion of the proceeds into pension at a guaranteed annuity rate. As with a deferred annuity policy, no benefits will be payable on death in service unless it is “with return” and allows for premiums to be refunded. Pure endowment policies are also used in conjunction with term life policies.
3. Endowment Assurance. This policy is in effect a combination of pure endowment and term life. It provides a capital sum payable either on a member’s retirement or on earlier death. This can lead to problems with excessive benefits on early death and the requirements of PSI20.1.45must be satisfied. At retirement the sum assured must be converted into pension form except to the extent that cash is required to provide the member’s lump sum retirement benefits. On death in service the benefits may (subject to the usual limits) be paid as a lump sum or as a widow’s/widower’s or dependant’s pensions (or a combination of both). This type of policy has declined in popularity because of the inflexibility of the link between the retirement and death benefits and we generally discourage their use (see PSI1.3.49). Most schemes use policies which provide these benefits independently of each other so that each can be tailored to meet the scheme’s needs.

[PN11.6]

1. Whole Life. This differs from the term life policy in that it provides a capital sum on the member’s death whenever that occurs (there is no time limit or “term”). In practice these policies are only suitable for schemes providing death in service benefits for directors with life appointments. No payment is due under a whole life policy on a member’s retirement unless the policy is surrendered at that date and a surrender value paid by the Life Office. We do not consider this to be a satisfactory method of funding retirement benefits (see PSI1.3.49and 11.2.50).
2. With-Profits Policies. Any type of policy may be “with-profits”. Such a policy shares in the profits made by the Life Office. The profits are paid in the form of bonuses which are added to the basic amount guaranteed under the policy. Until the policy matures it is not known precisely what the ultimate capital value will be. Term life policies are never, in practice, “with-profits” because they are usually only operative for a single year. “With-profits” policies are more expensive than “without profits” policies which, as the name suggests, secure merely a basic sum without any bonus additions.
3. Investment Linked Policies. This is a variant on the “with-profits” type of policy. The level of benefits is linked to the performance of some investment underlying the policy such as property, equity shares or unit trusts. This is a considerable gamble: if the investment does well the level of prospective benefits will rise but if it does badly the amount will fall. Occasionally these polices continue to be wholly or partly investment-linked after the pension comes into payment, with the result that the level of the pension may fluctuate from month to month; you can accept this so long as the pensioner is content (se PSI6.1.15).