‘Such is life’ by Paula Steele in STEP Journal

It has been ten years since the UK’s Retail Distribution Review (RDR) was implemented, which changed the landscape for life insurance policies significantly. Many clients are unaware of what their policies provide and/or can do. These are significant issues for probate lawyers dealing with policies where the support from both the brokers who sold the policies and the insurance companies who issued them is often weak, as both parties have lost the expertise on these legacy contracts. 

Many of these life insurance policies will provide significant returns to clients and their estates.

Policies issued after 1 January 2013 by UK insurers are post-RDR, have no surrender values and the proceeds are always tax free. Consequently, they are much less complex to consider.

Policies issued before 1 January 2013 could have surrender values and consideration needs to be given to any renewal options or conversion options, and thought must be given to whether the policies are qualifying, non-qualifying or if there is restricted relief on qualifying policies. In addition, advisors must consider whether the trusts and trustees holding the policies remain appropriate. Points to consider on pre-RDR contracts are outlined below.

Surrender value

Many pre-RDR policies will have surrender values. These will be tax free if the policy is qualifying or subject to income tax (with a 20 per cent tax credit if issued by a UK insurer) on the gain if the policies are non-qualifying. If any changes have been made to the policies since 2013 (i.e., due to increases in premium or the transfer into or out of trust) then the policies may fall into the restricted relief regime so that gains are attributed partly to the qualifying and partly to the non-qualifying regime, and the element in the non-qualifying regime is subject to tax. The easiest way to find out if the policy is qualifying or not is to ask the issuing insurer or the broker.

Terminal bonus

Policies will also have a death-claim value, which will be the value that will be paid out on death; this is likely to be higher than the surrender value. Many of the pre-2013 policies will have investments that are wholly or partly in the insurer’s with-profit fund. Policies attached to with-profit funds normally benefit from terminal bonuses, which fluctuate from year to year. Further, when assessments are being carried out with regard to the value of policies attached to with-profit funds, it is important that the terminal bonus is taken into account as it is often not quoted by insurers and it can make a material difference to the value.

Renewal and conversion options

Many of the policies issued before 2013 will have renewal and conversion options. A renewal option allows the policyholder (often a trustee) to renew the contract for a further period or term and renewal options typically cannot extend the contract beyond the age of 70 or 75 of the life insured. A conversion option allows the policy to be converted to a whole of life contract or term to age 90. Renewal and conversion options may also allow for the sum insured to be increased by a fixed annual amount or by retail price index since the previous exercise of the option. Renewal and conversion options do not require any medical or financial underwriting but will require a smoking/non-smoking declaration. Most renewal and conversion options cannot be exercised if the life/lives insured are not UK-resident. These renewal and conversion options must be exercised before the due dates or the benefit will be lost. The options can only be exercised by policyowners and most insurers will not allow offshore trustees to exercise the options, so it may be necessary to bring the trust onshore or to the Crown Dependencies. 

Trusts

Many of these policies will be in trust and it is important that the current trustee position is recorded by the insurance company that issued the policy. While the initial notification of assignment and the initial trustee details are often passed to insurers successfully, news of subsequent changes to the trustee position rarely makes it to the insurance companies. If the insurer’s records do not align with the current trustee position, it will be difficult to get any information out of the life offices or to deal with the policies. Advisors should also consider whether the trustees are appropriate, as time will have passed since they were appointed and it may be more appropriate to align the trustees with current executors.

Author: Paula Steele, Director at John Lamb Hill Oldridge

Article published in STEP Journal in March 2024.