Protection policies, as we shall see, are fairly straightforward.
But in investment-oriented policies a number of factors enter into any comparison of value. The most important concern the various methods of distributing a surplus among the policyholders. In conventional companies, the method of distribution is the bonus system.
The with profit policyholder, having agreed to pay a given premium for the guaranteed sum assured, has bonuses allocated to his policy from time to time, and by the maturity date these can add up to a very substantial sum, far exceeding the sum assured itself.
There are two basic bonus systems, the simple bonus and the compound bonus.
Both are expressed as £2% and when you see that a rate of bonus is £24%, this means that £24 is added to every £21100 provided under the policy.
Bonuses may be "declared" annually or triennially, and once they have been declared they "attach" to the policy and cannot be taken away. Such bonuses are referred to as "reversionary" bonuses because they "revert" to the policyholder only when a claim is made, either at maturity or on death.
The simple bonus system is, as one would expect, the less complicated method.
If a company pays an annual bonus of £24% simple, this means that 4% of the original sum assured is added to it every year. Thus if you have a policy with a sum assured of £23,000, and the bonus rate is £24%, then after the first year the sum assured will be £23,120, after the second year £23,240, after the third year £23,360, and so on.
Under the compound bonus system, the bonus is a percentage of the sum assured plus the bonuses already declared. On a £23,000 policy a £24% compound bonus declared annually would therefore produce a sum assured of £23,120 after the first year, £23,245 after the second, £23,375 after the third, and so on.
Unfortunately, few bonus systems are as uncomplicated as that.
Many companies announce "interim" bonuses every year but compound them only every three........ see: click here for Terminal Bonus
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