Technical Savings and Investments Information

INVESTMENT-LINKED LONG TERM INSURANCE POLICIES

HISTORICAL DEVELOPMENT

Life insurance started some 400 years ago. It was created to satisfy the need for financial security. Over the years, existing insurance products were enhanced and new insurance products were developed to satisfy the market’s evolving requirements.

Term life and ordinary whole life are the two traditional types of life insurance and have occupied the majority of the world individual life insurance market. Different features have been added to these two traditional types of life insurance to cater to customers’ requirements over the years, with universal life, variable life and variable universal life (US-name) / unit-linked (UK-name) / investment-linked (Asia-name) being the most significant derivatives over the past decades.

Universal life is a new type of whole life insurance that allows flexible premium payments and face amount. Variable life is another type of whole life that shifts investment risk to policy owners. Variable universal life combines the features of both universal life and variable life.

We will briefly discuss the historical development of investment-linked policies through the review of the two bigger insurance markets: the US and the UK. In the UK, unit-linked policies were first introduced in l957. In 1958, the government required that unit trusts could only be sold by intermediaries or by advertisements in the newspapers and for very modest commissions. This led to a problem for unit trust managers that it was almost impossible for them to produce a regular stream of sales of units. Therefore, they developed an idea to set up a regular savings plan under the form of a life insurance policy whereby the premiums would effectively be invested in a unit trust.

This type of unit-linked policies was a life insurance and not a direct holding in the unit trust. It was regulated in the same way as other forms of life insurance products, thus it was possible to sell it directly to the public by salesmen and for higher commissions.

Therefore, many unit trust companies began to write unit-linked policies or make arrangements with existing life companies to offer policies linked to their own units. A number of life insurance companies also started to develop their own unit-linked products along similar lines. At the same time, single premium unit-linked life business also began in the UK. That was considered as a better way of lump sum investment than unit trusts.

Another point to note was that originally in the UK, unit trusts were not allowed to invest in property because of its illiquidity. However, there was no such limitation on single premium life insurance. If the UK people wanted to invest a lump sum in property "units", single premium unit-linked life insurance was the only option.

The unit-linked insurance market in the UK is fast growing since then and now occupies a large portion of the individual life insurance market. The main factors which have led to the popularity of this product are:

- favourable economic trends leading to good performance of unit-linked products;
- consumers finding the product attractive;
- the sales environment of aggressive marketing;
- limited regulation on sales methods;
- tax relief on premiums; and
- advance in information technology (without which it would be impossible to administer the unit-linked business).

Another major reason for the growth in the UK for unit-linked life insurance versus unit trusts was that the latter could not offer managed funds (or more recently described as balanced funds). Unit trusts were usually single entity or specialist sector investments eg growth, technology, geographic funds, etc. On the other hand, the internal funds of unit-linked life assurance companies could offer a managed fund investing in varying proportions of fixed interest securities, equities, properties and cash deposits without the need at the outset to fix the exact proportions.

In 1993, the unit-linked insurance products constituted about 66% of individual new life business in the UK. The UK major banks have all set up their own life insurance subsidiaries and they have also concentrated on selling unit-linked products. In the US, both universal life and variable life were first introduced in the mid-1970s.

Both products gained modest success when they were first introduced. When variable life was introduced in the US, after being marketed successfully in the UK, Canada, and the Netherlands, it was considered as a product that could help offset the adverse effects of inflation on life insurance policy death benefits. Variable universal life was introduced to the US market in the early 1980s.

While universal life took off in the 1980s to take the second position in the US market after whole life, it should be noted that variable life and variable universal life still remained in the last position occupying only 8% of the life insurance market as at 1991. The limited development of variable life and variable universal life was largely due to the complicated regulatory structure. In the US, variable life and variable universal life products are considered to be securities. As such, in addition to the required regulations on securities they are also subject to the regulation of individual state Insurance Commissioners, the federal securities law and regulated by the Securities and Exchange Commission of the US. Because of this classification, insurance sales agents of investment-linked products must also be registered as broker-dealers in the US.

However, variable life and variable universal life in the US have significantly increased their market shares since 1991, occupying in excess of 20% of the life insurance market in 1996. Variable universal life is a dominant form of investment-linked life insurance products in the US. The reason of this significant growth is the good performance of equity investments and the popularity of mutual funds that prompted customer interest in these investment-oriented life products.