Compare Critical Illness

The most widely used is the immediate annuity, where in return for the capital sum the company guarantees to pay a stipulated income to the annuitant for life. Normally, the annuity is paid in half-yearly or quarterly installments in arrear, but offices may agree to pay at monthly intervals or in advance, or both, in which case the annual total will be slightly lower. If the last payment is due on the last payment date preceding critical illness, it is described as an annuity “without proportion”. If a final proportionate payment is made for the period between the last due payment and the date of death, then the annuity is called “payable with proportion”. With-proportion annuities give a slightly lower return and are rarely quoted.

Annuity rates can vary continuously with the current rate of return from long-dated Government securities and other fixed interest investments, and are regularly adjusted by companies. When interest rates rise, annuity rates will rise and vice versa. At any time there is likely to be a big difference between the best and worst rates quoted for a given age and the assistance of a competent adviser is necessary to secure the best terms. Again, as with income bonds, it is worth emphasising that if interest rates are on a rising trend there is no advantage in taking out an annuity and it is much better to make the purchase when interest rates are either stable or starting on a downward path.

No medical questions are asked of prospective annuitants (the earlier the annuitant dies, after all, the better for the office), but proof of age is always required at the outset. Rates for men and women differ significantly because of women’s greater longevity. Some offices will quote improved rates for medically substandard lives, but often the cost of providing the medical information falls on the annuitant.

Many annuitants’ main fear is that they will die soon after purchasing an annuity and get little benefit from it while their capital will be lost to their heirs.

Those investing with capital gains from equities as their objective will therefore normally be better off investing in unit trusts than in equity-linked critical illness insurance bonds. The reinvestment benefit helps to produce capital growth over a period of years, which is fine for the investor interested in capital growth, but not for one who wants to draw an income from his investment.

However, bonds can be used for this purpose, too, because the bondholder is allowed to withdraw a proportion of his original investment each year without any current tax liability. Since the Finance Act 1975, the taxation of bonds has become quite complex, but the basic position is as follows. If you invest in a single-premium investment bond, you may withdraw over 20 years a sum equal to the original investment without incurring any current tax liability.

This is equivalent to 5% per annum, which is also the maximum annual income you may draw to begin with. But if you forgo it for a period, then the withdrawal rate may be higher later. For example, if you take no income for the first five years, you may then use up the full allowance in the next 15 years, or over a longer period at a lower rate. The “income” is taken by selling the appropriate number of units back to the company, and whether the amount you take is more or less than the actual income earned by your capital in that period will depend on the yield on the fund’s investments.

For the 5 percent to come solely out of income, the fund would have to be earning 8 percent before tax. So long as the capital value is also growing, however, many investors will be happy to draw off a small proportion of it as income. (Capital and income are not distinguished in the unit price, because all income earned is reinvested within the fund and is therefore reflected in the unit price). With critical illness insurance you could be sure to have the peace of mind.

While the flexibility provided by critical illness insurance policies may be very useful, it does of course have a cost. One element of the cost comes when it is combined with life insurance. For the young man such a combined critical illness insurance plan is related to the premiums he can elect to pay up to the age of 65, and this produces a larger guaranteed benefit than that on a shorter-term dated policy term. For example, the 29-year-old paying £10 a month received £3,120 critical illness cover, whereas on a shorter dated plan the same £10 premium would provide a sum assured of about £1, 800. This extra coverage amount from critical illness insurance must reduce the amount of invest­ment benefit derived from a given premium.

A less easily quantified factor is the restriction the flexibility of maturity dates imposes on an insurance company’s investment management. With dated critical illness insurance policies and illness tables, the company can predict with con­siderable accuracy the volume of claims likely in any year, and this means that it can plan its investments to produce a given amount of income to meet them. If the amount of claims is uncertain, there will be a tendency to “play safe” and allow for a margin of extra income. To achieve this will require a larger proportion of funds being invested in fixed­ interest securities, which on past evidence at least are unlikely to produce as large an investment gain over long periods as the main alternatives, shares and property.

Since, at the time of writing, open-ended critical illness policies have been in existence for less than 10 years, it is too early to say whether there is any evidence that this second factor is having such an effect. The extra cost of the flexible contract can, however, be estimated in terms of the projected benefits quoted on fixed and open-ended policies over the same period; the flexible policy’s proceeds current bonus rates are projected at between 5% and 15% below those of the fixed endowment over 10 years.