Introduction: Moving Beyond Fixed Benefits
In your previous studies, you likely encountered "without-profits" contracts—where the sum assured is a fixed amount decided at the start. While simple, these don't protect policyholders from inflation, nor do they allow them to share in the insurance company's success.
In this chapter, we explore With-profits, Unit-linked, and Accumulating with-profits contracts. These products are designed to give policyholders a "piece of the pie" by linking benefits to the investment performance of the insurer. Don't worry if the terminology feels a bit heavy; we will break each one down into simple, relatable parts.
1. Conventional With-Profits Contracts
A conventional with-profits contract starts with a guaranteed minimum benefit (the basic sum assured). As the insurance company earns profits from its investments, it distributes a portion of these profits to policyholders in the form of bonuses.
Key Components of Bonuses
There are two main ways these profits are added to a policy:
- Regular Reversionary Bonuses: These are usually declared annually. Once they are added to your policy, they cannot be taken away. They "revert" to the policy, meaning they are paid out at the same time as the original sum assured (on death or maturity).
- Terminal Bonuses: These are "final" bonuses paid only when the policy ends (at maturity or upon the death of the life assured). They are designed to ensure the policyholder receives a fair share of the total profits earned over the whole life of the policy.
Analogy: Imagine a savings account where the bank promises you \( \$1,000 \) at the end of 10 years. Every year, if the bank does well, they lock in an extra \( \$50 \) to your balance that you are guaranteed to get later. Then, on the very last day, they give you one final "thank you" payment based on their total 10-year performance. The yearly additions are reversionary bonuses; the "thank you" gift is the terminal bonus.
Quick Review: Reversionary bonuses are "locked in" annually; terminal bonuses are only decided at the very end.
2. Unit-Linked Contracts
In a unit-linked contract, the link between the benefit and investment performance is much more direct. The premiums you pay (after expenses) are used to buy units in an investment fund, much like a mutual fund or unit trust.
How the Benefit Works
The value of the policy at any time is the number of units owned multiplied by the current unit price. According to the CM1 syllabus, the death benefit is typically expressed as a combination of:
- An absolute amount (a fixed sum assured), and
- An amount relative to a unit fund (the value of the units).
For example, the death benefit might be the higher of a fixed amount or the unit fund value, or it might be the sum of the fixed amount and the unit fund value. This provides the policyholder with the upside of the stock market while maintaining a "safety net" for their beneficiaries.
Did you know? In unit-linked contracts, the policyholder usually chooses which fund to invest in (e.g., an equity fund, a bond fund, or a property fund). This means the policyholder bears the investment risk, not the insurance company.
3. Accumulating With-Profits (AWP)
Accumulating with-profits contracts are a "hybrid" between conventional with-profits and unit-linked contracts. The value of the policy builds up (accumulates) over time. The syllabus identifies two specific ways these are structured:
Type A: Monetary Fund (Non-Unitised)
In this version, the policy value is defined in monetary terms (cash).
- There are usually no explicit charges deducted from the fund.
- The fund increases through regular guaranteed interest plus bonus interest.
- A terminal bonus may be added at the end.
Type B: Unitised With-Profits (UWP)
This looks very much like a unit-linked contract because the fund is defined as a unit fund.
- There are explicit charges (like management fees) deducted by cancelling units.
- The value increases through regular bonus additions (which might increase the unit price or the number of units).
- A terminal bonus is usually added at the end.
Key Difference: In a pure Unit-Linked policy, the unit price can go up or down daily. In a Unitised With-Profits policy, the "smoothing" process usually ensures that the unit price doesn't fall (or at least, it grows more steadily) because the company holds back some profit in good years to pay out in bad years.
Summary Table for Quick Revision
| Contract Type | Primary Structure | How Profits are Shared |
|---|---|---|
| Conventional With-Profits | Basic Sum Assured | Reversionary and Terminal Bonuses |
| Unit-Linked | Unit Fund | Directly via Unit Price (Market Performance) |
| AWP (Monetary) | Cash Balance | Guaranteed + Bonus Interest + Terminal Bonus |
| Unitised With-Profits | Unit Fund | Bonus Additions + Terminal Bonus |
Common Pitfalls to Avoid
- Confusing "Unit-Linked" and "Unitised With-Profits": Remember that Unit-Linked has no smoothing—you get exactly what the fund is worth today. Unitised With-Profits uses bonuses and smoothing to make the "ride" less bumpy for the policyholder.
- Forgetting Terminal Bonuses: When describing with-profits contracts, always mention terminal bonuses. They are a vital tool for insurers to ensure "policyholder reasonable expectations" are met without over-committing to guaranteed annual bonuses.
- Timing of Cashflows: Note that the syllabus focus here is on the nature and timing of benefits. In later chapters, you will learn how to value these using life table functions like \( A_x \) or \( a_x \). For now, focus on what gets paid and why.
Key Takeaway: These contracts exist to balance security (guarantees) with growth (investment participation). Conventional with-profits focus on guarantees, unit-linked focus on growth, and accumulating with-profits sit in the middle.