QUESTION: How can I leverage my life insurance in Jamaica while I am alive?

– Van

F INANCIAL ADVISER: Life insurance is accepted as a very important means of protection for the dependants of the insured, but it also provides many benefits for the insured, who must be careful not to abuse them.

Permanent, or whole life, insurance policies provide a wide range of these benefits, although reducing term policies and renewable term policies with an investment component offer significant benefits as well. Traditional term life policies do not offer living benefits.

Some policies have cash values against which the policyholder may borrow, and policies with an investment component also create opportunities for policyholders to borrow against the value of the units. Policyholders are not able to get loans to the full value of the value of the policy. This is especially true of investment policies that derive any of their value from equities, considering that such values fluctuate with the movement of prices on the stock market.

Policyholders may secure loans for several purposes, including education for self or another person, home improvement, acquiring motor vehicles, medical expenses and house purchase; and retirees may use the value of their life insurance policies to meet some of their living expenses during retirement. Rather than borrowing against the cash or investment values of their policies, they may choose to convert the value to cash.

There are at least two ways to go about doing this. Retirees who are holders of traditional life insurance policies may surrender their policies for their cash value, thus terminating the policy and leaving no death benefit for their dependants. In the case of investment-linked policies, they may opt to surrender some of the units at the unit price, similar to what happens when investors surrender units in a unit trust.

To the retiree, this is a good source of retirement income, and this approach allows the policyholder to access funds in a controlled way, as funds do not have to be taken from the policy in one lump sum, but as and when needed. In fact, some policyholders include this as a deliberate strategy for creating retirement income.

People who have universal life insurance policies, which are basically renewable term policies with an investment component, should be careful about surrendering units for cash as this could put the policy at risk. Let me explain. The premium they pay is divided into three parts covering the costs the insurance company incurs for issuing and maintaining the policy, the portion invested, and the mortality charge, which takes care of the death benefit. The premium is level, meaning it is fixed for the life of the policy, but the mortality charge increases as the policyholder gets older. If it increases to the point where the money required to pay for the full cost of maintaining the policy exceeds the stated premium, the insurance company withdraws money from the investment account by surrendering units to cover the shortfall.

There is the real risk that the policyholder who surrenders units could cause the investment portion to have insufficient funds to meet any call on it by the company to provide funds to cover the full cost of maintaining the policy, thus causing it to lapse. Additionally, this is an important source of tax-free income which should be preserved.

There are some policies that are issued for a limited time; 15 years, for example. Upon their maturity, the funds are paid to the policyholder, who is free to use them for the purposes they choose.

These policies are not without risk. How much risk the policyholder is exposed to depends on the type of fund into which the premiums are invested. Some funds are invested in portfolios that are conservative and thus concentrate on the money market and the bond market. Others focus on capital appreciation and thus focus on equities, on real estate, or a combination of both, although other asset classes may be included. This is also true of long-term, equity-linked policies.

Although the funds are managed by professional investment managers and there is scope for diversification, as the portfolios tend to be sizeable because the money that is invested comes from many policyholders, the policyholder cannot escape risk. Additionally, it is worth considering that market prices could be low at the time that the policyholder decides to convert the investment element of the policy, and it is the policyholder who bears the risk.

In some cases, policyholders are able to make regular additional investment premiums, as well as ad hoc deposits, which help them to accumulate more funds and benefit from the investment expertise of the insurance companies, and from the benefits associated with diversification.

Policyholders have other options. For example, they are sometimes offered the option of selecting the feature which offers inflation-indexed returns, and some policies include an option for policyholders to determine the portion of the premium which is to be invested in specific investment funds. These decisions play a role in determining the risk to which the funds are likely to be exposed and the corresponding level of returns.

To realise the benefits of life insurance, policyholders must pay their premiums in full and on time to prevent their policies from lapsing, and check periodically that all is well with their policies.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel. Email: finviser.jm@gmail.com