Convertible term – an old solution for new times?

It could be the single best and most flexible method available to overcome the problem of enabling the customer to continue their cover beyond the term of their policy, without further underwriting.

Background

Term insurance protects clients for a set period and pays out if they die or are diagnosed with a terminal illness, within the term. However, most people survive and find themselves with no cover, at a time when their circumstances have changed and are at an age when they are less likely to get cover at standard rates. Applying for a whole-of-life (WOL) policy at that point, means the premium will be based on their current age and health, which may have changed considerably! This is where convertible term can be invaluable.

Convertible term (CT)

The ‘conversion option’ has been around for many years, but is often overlooked, because it costs a little bit extra, when customers are often looking for the cheapest cover. It may also be that advisers have forgotten about it.

The option is added at the outset of the CT application, on a single or joint life first event (JLFE) basis (i.e. death or terminal illness), with level or increasing life cover only and allows the customer to choose to convert all, or part, of their sum assured to a WOL policy with the same provider at any time (or multiple times) before the end of the policy term, without any medical questions or underwriting.

If the customer has a joint life first event term policy, when they convert they can choose to have their WOL cover on one or both lives assured, and whether they want their WOL policy to pay out on a first or second event basis, subject to a maximum WOL age at point of conversion and if written in trust (see ‘Protection policies should be written in trust’ below). For example, a customer protecting a mortgage on a JLFE basis, might convert on a second event (JLSE) basis in order to fund a future IHT liability. Similarly, customers concerned about the Budget proposals around IHT on pensions and APR/BR assets, could use a single life CT policy as an option.

Health

The biggest advantage is that it removes health conditions as a factor (or barrier!) in continuing the customer’s life cover. This is particularly valuable should a customer’s health decline after taking out the term policy e.g. a heart condition could be a barrier to getting affordable life cover once the term policy expires, but if they have and use the conversion option, they’ll be able to maintain cover irrespective of their health. Effectively they are protecting their health rating when they took out their term policy – which is generally when you are young and healthy – which turns their ‘temporary’ term policy, into a ‘permanent’ WOL policy, by guaranteeing their future insurability.

Value-for-money

Though getting life cover at the lowest possible premium is often the driving force for most customers, you should spend time explaining the flexibility and insurability this option provides your customers in the future. As this option is an enhanced customer benefit, the premiums will be slightly higher, but it’s a relatively inexpensive way to ensure customers can maintain life cover after their term policy expires. It can also be used as an alternative to higher WOL premiums, especially during the current climate, and may be the difference between them affording/having cover now and not. Here is an indication of comparative monthly premiums:

On full conversion to WOL at age 65 on a JLSE basis, would (on current rates) cost £294.10pm (Zurich quote 04/03/2025). Whilst significantly more, the customer may be in a better financial position to afford it and may be considerably less than the premium based on their actual health.

Customer conversations should emphasize the peace of mind and reassurance this provides them and their family, together with the flexibility and guaranteed insurability it provides in the future. Inevitably though, it will turn to cost and one way of making the new premium more palatable, could be to demonstrate the saving they are making between a WOL and CT policy, or the value the sum assured under the policy is adding over and above the premiums being paid – the Zurich whole of life calculator can demonstrate this.

Control and flexibility

Whilst the use of the option within the term, provides control and flexibility – as long as they/you remember they have it – the fact you can phase the conversion at different ages and for different sum assureds (up to the original sum assured under the term policy), can provide added flexibility as customers circumstances change and make the premium increase more acceptable. For example, if the 40-year old above, decided to convert £50k every 5 years from age 50 on a JLSE basis, the overall cost would phase as follows:

The total phased cost of £244.72pm, is 16% lower than the full conversion cost at age 65 (£294.10pm), which might be more digestible. Don’t forget, every time a customer converts to a WOL policy, you will earn adviser income.

This phased approach may work for buy-to-let landlords that need to cover interest-only mortgages in the early years and IHT liabilities in the later years, but whose plans (and liabilities) may change e.g. if they decide to sell or gift properties.

Protection policies should be written in trust to avoid probate, but where it’s a CT policy, it will be the trustees as legal owners, who exercise the option. Any (WOL) policies issued as a result of exercising the option will be subject to the same trust provisions. Therefore, careful consideration should be given, particularly for IHT planning, regarding whether to place the CT policy in trust. This is important because it means you cannot convert from a JLFE CT policy in trust, to a JLSE WOL policy in trust.

If a customer’s circumstances change and they no longer need or can afford the option, it can be removed to reduce premiums (but cannot be re-added).

Opportunities

There are numerous customer scenarios where a CT policy could be used, such as:

• family cover: to replace life cover in retirement and meet funeral costs;
• life cover in retirement: to fund for a shortfall in spouses’ pension or LTC costs;
• buy-to-let landlord interest-only mortgage cover: to potential IHT liability;
• paying off equity release or lifetime/RIO mortgages.

The biggest opportunity, is using a CT policy as an alternative to higher WOL premiums for IHT planning, either where cost is an issue to customers, or where they may not need the full cover indefinitely (maybe because they are looking to gift away assets to reduce their IHT liability). So, maybe always requesting a CT quote alongside WOL, gives you and the customer a fallback option – they get the cover and flexibility they need at a more affordable cost and you get the business.

Summary

I believe that a CT policy is a solution for the current climate, offering customers the best of both worlds – as it future-proofs a low-cost temporary term plan, and offers a cost-effective alternative to higher WOL premiums – together with guaranteed insurability in the future.

As an industry, not only must we support customers through the current difficult times, but as an adviser, you must also continue to look forward for customers to avoid foreseeable harm, by helping them and their families plan for the future. Fully exploring and discussing the conversion option can help.

Andy Woollon is a Technical Protection Specialist & Presenter at Zurich UK Life