ModelIC · Life insurance
Chapter 3

Life insurance product bases

The benefits of a life insurance product depend not only on the type of contract, but also on how it shares investment returns, profits and risks between the insurer and the policyholder. The main approaches considered here are with-profits, unit-linked and index-linked business.

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With-profits

A with-profits policy is one under which the policyholder has an entitlement to part or all of any future surplus arising under the contract (or to more widely share in part or all of any surplus arising within the with-profits fund).

In some jurisdictions, with-profits business may also be referred to as 'participating business'.

Alternative methods for distributing surplus have built up over time in different countries. The three main methods are:

  • The additions to benefits method.

  • The revalorisation method.

  • The contribution method.

Under the 'additions to benefits' method, profits are distributed in direct relation to the current benefits associated with each contract. This approach is primarily used in the UK and Asia. These policies may be 'conventional' with-profits or 'accumulating' with-profits. The key difference between these two approaches is how bonuses are added to policies.

Conventional with-profits

Endowments are the most common products to be associated with conventional with-profits (though it is possible to have conventional with-profits whole life assurances and annuities).

Endowment policies provide a guaranteed amount (the sum assured) payable upon maturity of the policy or on death of the policyholder if earlier.

Premiums usually start as a level monthly or annual amount, but may be increased. If premiums cease, the policy will lapse (or be made paid-up or surrendered), depending on how many premiums have been paid.

In addition to the guaranteed sum assured, the policy value will increase as a result of profits earned by the company. The profits which may be used for this purpose will be specified in the insurance company's rules. For example, profits shared with policyholders may include all profits earned by the insurer, or just the profits earned on their with-profits business. Some percentage of profits may also be transferred to shareholders, where applicable.

The value of a policy is measured by reference to its asset share. When determining the asset share for a group of conventional with-profits policies, it is important to know which sources of surplus those policies share in and what proportion of each source is received by them.

For proprietary companies, it is not immediately clear who shares in profit made on conventional without-profits and unit-linked business (collectively known as non-participating business). More needs to be known about the structure of the company to determine this. For example, all business might be written in one fund and shared between with-profits policyholders and shareholders. Alternatively, unit-linked business might be written in a separate fund with all profit from this fund being attributable to shareholders (whilst with-profits policyholders may still receive profit from any conventional without-profits business written).

In the UK, where profits are shared between conventional with-profits policyholders and shareholders, it is common for shareholders to receive 10% of the total distributed surplus with with-profits policyholders receiving the remainder.

Policyholders' share of surplus is awarded in the form of regular (reversionary) and final (terminal) bonuses. Regular bonuses are added to the sum assured (and previously declared bonuses), usually annually. Regular reversionary bonuses can be simple, compound, or super-compound. The latter is by far the most common. Profits can also be added as one-off special reversionary bonuses, but this is relatively uncommon. Once added, bonuses become part of the guaranteed amount payable at the same time as the sum assured.

Some companies may offer the option of surrendering attaching bonuses separately from the basic sum assured. This option enables policyholders to receive some money whilst keeping their policy in force and thus may make the policy more attractive. From the insurer's perspective, this option might reduce the chance of a lapse on the whole policy, which might result in a loss at early durations.

Terminal bonuses are an additional amount payable on death or maturity. These bonuses are typically calculated as a percentage of the sum assured and total attaching regular bonuses (or in some cases just as a percentage of the latter) and thus will vary depending on how long the policy has been in force. Where special reversionary bonuses have been awarded, these are also likely to be included alongside regular reversionary bonuses when applying the terminal bonus percentage. The terminal bonus is designed to make the payout of the policy as close to the policy's asset share as the company chooses and will reflect the company's smoothing policy.

Terminal bonuses are also often payable on surrender, however a different scale may be used to do this to reflect the increased risk of anti-selection on surrender.

The insurer would not disclose their charging structure on these policies and this charging structure would be implicit rather than explicit. Asset shares (and thus bonuses) will need to take account of all expenses involved in writing and administering the business and also the cost of providing life cover.

The policyholder’s perspective

A policyholder may take out a conventional with-profits policy for savings purposes, including saving to help repay a loan (whilst simultaneously providing life cover). The smoothing of the asset returns underlying policies will also be attractive to policyholders, and a larger sum assured is expected to accumulate compared to cash invested in a bank account after allowing for the cost of life cover.

Risks faced by the policyholder include the following:

  • The main risk to policyholders is that the policy does not provide the amount originally projected. If the policy was taken out to repay a loan, this may mean that the policyholder needs to find other ways to cover any shortfall or extend the term of the loan.

    A shortfall relative to the amount originally projected could arise for numerous reasons, but is most likely to be caused by worse than expected investment performance by the insurer. Higher than expected expenses incurred by the insurer could also be a cause of a shortfall. Investment performance being different from that assumed in projections is less of a concern for policies that are not target driven, in which case policyholders may instead simply save what they can afford to, rather than what it costs to achieve a particular sum at the end of the policy term.

  • If the policyholder cannot afford to continue paying the premiums on their policy, it may be necessary for them to surrender their policy or convert it to paid-up. This may not represent good value relative to the premiums paid (particularly in early years). A key drawback of conventional with-profits policies is their inflexibility in this regard. There is an active (though contracting) market for second-hand with profits endowments in the UK, known as 'traded endowment policies' (TEPs). In such cases, policyholders may consider auction values of their policies in addition to surrender values.

  • There is the risk that the policyholder did not fully understand the nature of the policy they purchased and its investment and other risks (e.g. sharing in the losses of the insurance company that are incurred on other blocks of business).

The insurer’s perspective

In countries such as the UK, a very large market for conventional with-profits policies has developed over many years. This makes the product attractive to insurers. In the UK, an expectation built up over time that regular bonuses declared would increase gradually year to year and that terminal bonuses (whilst potentially varying from year to year) would also tend to increase. The pattern of increasing bonuses observed over the 1970s and 1980s was broken in 1991 after stock markets fell in 1990. This led to falls in new business volumes for conventional with-profits products.

The decline in new business does not remove the need to manage the material volumes of policies already in force.

This history illustrates the effect of guarantees and customer expectations on an insurer’s ability to respond to adverse experience. Falling bonus rates led to adverse publicity for conventional with-profits policies. In some cases, insurers' solvencies were threatened because the sums assured and guaranteed regular bonuses could not be met by the insurers' available assets due to a fall in the value of (or the returns provided by) those assets. A number of with-profits funds were forced to seek capital support, close to new business, or reduce their equity backing ratio or surrender and maturity payments.

Adverse publicity has also arisen from the lack of transparency in the product. There has been increasing pressure for companies to disclose more about the assets supporting a with-profits fund and the rationale behind surplus distribution decisions and smoothing. These pressures resulted in a regulatory requirement for insurers to produce a document that details information that an insurer must provide to policyholders about the way it operates its with-profits fund in the UK. This is known as a 'Principles and Practices of Financial Management' (PPFM) document.

Policyholders’ reasonable expectations and treating customers fairly are also relevant when considering how closely surrender and maturity payments should reflect asset shares.

An additional appeal is that companies can often share losses with conventional with-profits policyholders (though this is a minor appeal, since insurers will generally not expect to make losses).

Risks associated with conventional with-profits policies include the following:

  • Capital is required to finance new business strain when policies are written and there is the risk that this strain could become more severe if statutory reserving requirements become more stringent.

  • Unless there is a review clause, an insurer cannot increase a policy's premium over and above those increases specified in the policy documentation. An insurer therefore cannot increase premiums to alleviate the cost of any adverse experience (e.g. poor mortality, withdrawal, or expense experience or tax increases). Adverse experience may still be reflected in bonus rates (subject to minimum bonus rates, which may be zero) but guaranteed payments cannot be reduced.

Accumulating with-profits

Accumulating with-profits policies are with-profits policies under which bonuses are added annually in relation to the premiums paid to date, plus previously declared bonuses. Terminal bonuses may also be added when policies become a claim (e.g. on maturity, death, or surrender).

By contrast, when a policyholder pays premiums into a conventional with-profits contract there is no immediately obvious relationship between the stated benefit (a distant sum assured plus attaching bonuses) and any present value of the policy.

An accumulating with-profits policy, on the other hand, operates more like a bank deposit account. The policyholder's with-profits account starts at zero and is increased (broadly) by the amount of the premiums paid and by bonuses (which are applied as a percentage of the value of the account). The values seen by the policyholder therefore are in present value terms and the policy has a readily identifiable current benefit. However, the policyholder will not necessarily receive the full value of the account if the policy is surrendered.

The most common form of accumulating with-profits contracts are 'unitised with-profits' contracts. Non-unitised accumulating with profits contracts can look and operate much like a conventional with-profits contract with recurring single premiums. Unitised with-profits contracts, by contrast, show an explicit relationship between each single premium paid and the addition to the benefit to which it gives rise (which is essentially an allocation rate).

The guarantees offered on conventional with-profits policies will generally be greater than many (but not all) guarantees provided by accumulating with-profits policies. This is because bonuses are declared on the 'current benefit', rather than on a sum assured. This effect is partially offset by the fact that companies typically hold back less surplus for terminal bonuses under accumulating with-profits policies than under conventional with-profits policies. The contract may specify a guaranteed minimum rate of accumulation (though this is now rare for new contracts).

Unitised accumulating with-profits policies look and operate much like unit-linked contracts. The key difference is the way in which the company determines the price of the units (and thus the benefit payable upon the occurrence of the insured event).

There are two basic ways in which the unit part of the contract could operate:

  • The price of a unit remains constant and the insurer allocates additional units to each contract. This would usually be done annually at the bonus declaration. Bonus declarations would normally be made up of a guaranteed addition (which could be zero) and a bonus addition. The number of bonus units awarded is at the discretion of the company.

  • Rather than allocating additional units, the company changes the price of a unit. This would usually be done on a daily basis. These increases would be comprised of a guaranteed part (which could be zero) and a bonus part.

The key difference between these two approaches is one of presentation: The first option looks like a with-profits contract whilst the second option looks like a unit-linked contract. The key distinction between unitised accumulating with profits policies and unit-linked contracts is the discretion that the insurer has over the bonuses granted (rather than unit prices being determined directly from a pool of underlying assets). Instead, the insurer will take a longer-term view of investment performance and smooth the bonuses it allocates. The pool of assets will still impact the bonuses awarded, but this link will be indirect rather than direct.

Under both of the above methods, the bonuses awarded are akin to the regular bonuses given to a conventional with-profits contract. When the insured event occurs, the insurer may add a terminal bonus onto the bid price of the units. The existence of the terminal bonus means that the benefit paid to the policyholder does not solely depend on the bid price of their units. Policies may also offer life cover, payable by explicit risk benefit charges (e.g. unit cancellations) in the same way that unit-linked contracts do. In this case, the value payable on death could far exceed the bid value of units.

A further important difference between unitised accumulating with-profits and unit-linked policies relates to the benefit payable on surrender:

  • Under unit-linked policies, the company has no discretion as to the amount payable on surrender. Instead, the surrender value is just the bid value of the policyholder's units less any surrender penalty specified in the contract.

  • For unitised accumulating with-profits policies, the surrender value will generally be specified in a similar way to unit-linked contracts, but the company may also retain the right to apply a market value reduction (MVR). The size of the MVR may be determined at the discretion of the insurer.

  • An MVR may also apply in the case of non-unitised accumulating with-profits policies, depending on the policy conditions (since the difference between unitised and non-unitised accumulating with profits policies is primarily just one of presentation).

On death, the benefit payable is likely to be a return of the fund for pension policies, or 101% of the fund value for investment bonds, but for regular premium life policies there may be an under-pinning sum assured payable on death. In some jurisdictions, legislation requires contracts to have a death benefit that is not insignificantly greater than the fund value in order to be classified as insurance business. For example, offering 101% of the fund value may, in some cases, be sufficient to classify a product as insurance business. Premiums may be payable as a single lump sum, recurring lump sums, or as regular (monthly or annual) amounts.

The charging structures vary widely across the market and can be any combination of the following:

  • A policy charge (or policy fee, taken from either the premium or the fund).

  • A percentage allocation during an initial period.

  • A different percentage allocation after the initial period.

  • A bid/offer spread.

  • A charge for risk benefits.

  • An annual management charge.

Charges may also be taken implicitly through the choice of bonus rate, with no explicit charging structure.

The policyholder’s perspective

A policyholder will effect an accumulating with-profits policy to save for the future in the expectation that a larger lump sum will be paid relative to money saved in a bank account.

The main risk to the policyholder is that money does not accumulate to the sum projected and could fall short of what would have been earned on money invested in a bank account. As for conventional with-profits policies, this risk will depend on whether the saving is premium driven or target driven. There is also the risk of insurer insolvency, or that its ownership changes, leading to adverse consequences for the policyholder's benefits.

Like conventional with-profits policies, there is also the risk that the policyholder cannot afford to keep paying regular premiums and must surrender the policy or convert it to paid-up status. This may not represent good value for the premiums paid. In particular, the cash surrender value in the early years of the policy may be less than the value of the premiums paid. However, there is often more flexibility built into accumulating with-profits policies than into conventional with-profits. For example, it is easier for insurers to allow premium variation.

Overall, there is the risk that the policyholder does not fully understand the nature of the policy effected and its associated risks. However, since accumulating with-profits policies are often more transparent, this risk should be smaller than for conventional with-profits policies.

The insurer’s perspective

In the UK, the market for accumulating with-profits business developed and grew strongly throughout the 1990s as an alternative to conventional with-profits, especially for personal pensions and single premium bonds. Sales of this product have, however, reduced significantly in the UK in recent years (initially prompted by falls in the stock market).

Accumulating with-profits policies may be profitable to an insurer, and therefore attractive for them to write. Some insurers that are open to new with-profits business (particularly mutuals) are therefore investing in developing innovative new with-profits products to attract new business. The intention is to combine some of the more attractive features of with-profits business (such as smoothed returns) with the transparency and flexibility that consumers now require in products. For example, a relatively new style of with-profits product shares surplus by rebating charges rather than by adding bonuses.

The risks posed to an insurer by accumulating with-profits business can be similar, in principle, to those for conventional with-profits (e.g. policy guarantees, investment performance, expenses, tax, adverse publicity, and depletion of capital or free reserves). However, if policyholders share in only investment profits then the nature of the insurer's risks are quite different from conventional with-profits business (e.g. if charges proved inadequate then shareholders, rather than policyholders, would be expected to bear this).

In jurisdictions where an MVR is used, it is common to exclude this from maturity (or death) payments. This introduces investment risk to the insurer arising from:

  • an explicit fund management charge (if there is one).

  • any investment guarantees under the contract.

Alternatively, shareholder transfers may be linked to the value of policyholder bonuses (rather than an explicit fund management charge). In this case, shareholders and policyholders share the expense, mortality, withdrawal, and investment risks (since these risks would have to pass through policyholder bonuses to impact shareholder transfers). In this case, the risks are pretty much the same as on conventional with-profits contracts.

Where surrender value terms are specified as the current face value of benefits plus any terminal bonus (and less a MVR), surrenders may be a source of risk to the insurer.

In theory, the MVR should mean the company can avoid losses on surrender, provided the earned asset share of a surrendered policy is not negative. However, policyholders' reasonable expectations and commercial pressures may lead to companies either not applying a MVR or applying an inadequate one on surrender. MVRs are often not fully understood and deemed unfair by policyholders. Policyholders can see an account value which they may believe is theirs and may not appreciate that this value is not necessarily available to them if they surrender. Policyholders may also have an expectation that an MVR will not be applied if this has been the insurer's past practice (at times when market conditions warranted this).

Sales materials may also have given policyholders contradictory or misleading information, which can lead to allegations of mis-selling. If this leads to policyholder losses, there may be requirements to compensate policyholders, thereby leading to further losses to the insurer.

Nevertheless, any losses could be mitigated by taking them into account when setting future bonus rates (provided that this is consistent with treating customers fairly).

The revalorisation method

Under the revalorisation method, surplus distributed to policyholders is expressed as a percentage of their contracts’ supervisory reserve. Both the benefits and premium associated with each contract are increased by the same percentage. Though premiums are increased, this still represents a gain to the policyholder since only future premiums (and not premiums previously paid) are increased, so the cost of the premium increase is less than the value of the increased benefits. This approach is primarily used in continental Europe. The profits distributed under this method are normally only investment profits (also known as savings profits).

Investment profit is the excess yield earned on the assets held beyond the yield assumed in pricing of the contracts. Often, less than 100% of the investment profit is distributed to policyholders. Insurance profit (e.g. profits arising from favourable experience in all areas other than investments) is typically retained by the insurer and distributed to shareholders to compensate them for the pure insurance risk they have taken on.

The policyholder’s perspective

Policyholders for policies which use the revalorisation method will be exposed to similar risks to those associated with accumulating with-profits policies. This method has the benefit to policyholders of a specified method for bonus distribution, which improves transparency and protects policyholders against ungenerous insurers. However, it could be argued that not sharing insurance profit with policyholders goes against the principle of mutuality (i.e. that an individual receives what they contributed).

The insurer’s perspective

The insurer will need a system in place to split their sources of profit arising over each year into insurance profit and investment profit to determine bonuses. This will require the insurer to consider how savings/insurance profits should be defined (e.g. whether it includes both investment income and capital gains arising in each year, or whether unrealised capital gains should be excluded). The insurer will also need to decide what proportion of any savings profits arising should be distributed to policyholders. This proportion will normally be stated in policy terms and conditions.

In some jurisdictions, insurers may be required to distribute a minimum percentage of savings profits to policyholders. The insurer will also need systems in place to increase policy reserves and premiums by the declared bonus percentage each year. The main advantage of the revalorisation method is that it is simple to apply (with little judgement required) as the method specifies exactly how profits should be split between shareholder and policyholder. A disadvantage of this approach is that, due to the lack of discretion and limited ability to defer profit, it tends to discourage investment in riskier assets such as equities.

The contribution method

This method distributes surplus using a formula approach.

The intention is to distribute surplus to policies in proportion to each policy's contribution to that surplus. This method is primarily used in North America (where it was originally developed), but is also used in some parts of Asia. Under this method, profits are distributed to contracts in the form of ‘dividends’. Discretionary benefits under these policies are normally paid as annual dividends, but terminal dividends may also be paid. The annual dividends may be determined by use of a formula or by reference to a scale based on a multi-factor approach reflecting a full range of experience factors with experience grouped amongst similar policies.

A common approach in the latter case is to use a three-factor formula based on experience on interest, mortality, and expenses. The scale used may also be adjusted to allow for policy fees or any other experience elements and lapse experience may also be included through use of an additional factor. In line with the concept of smoothing, the average experience of all policies in a homogeneous group (rather than per-policy experience) will be used in the formula approach. Although future dividends are not guaranteed, they cannot be negative.

Once credited, dividends form part of a policy’s guaranteed benefit. These dividends may also be:

  • Taken in cash;

  • Held on deposit (which is the same as taking them in cash, from the policyholder’s perspective).

  • Used to reduce future premiums.

Annual dividends will vary year-on-year and do have the potential to fall to zero. Since the investment return factor is generally the most significant component of the dividend scale, dividends give an indication of the smoothed investment performance over each year. At the insurer’s discretion, terminal and special maturity dividends may also be awarded, though the latter is rare. Where surplus is not entirely distributed to policyholders, it may instead be distributed to shareholders or held for future adverse contingencies (which will then benefit future generations of policyholder).

The policyholder’s perspective

The holder of a policy which uses the contribution method will be exposed to similar risks as those associated with accumulating with-profits policies. It can be argued that the principles behind the contribution method are extremely fair, since policyholders receive dividends in proportion to their contribution to surplus. Unlike the revalorisation method, the contribution method abides by the principle of mutuality.

The insurer’s perspective

The risks faced by the insurer are similar to those for the additions to benefits method (in terms of policy guarantees, investment performance, expenses, tax, adverse publicity, and depletion of capital or free reserves). In some jurisdictions, there may be a requirement to distribute a certain proportion of the surplus to policyholders. In general, there tends to be less actuarial judgement in applying the contribution method than the additions to benefits method. As usual, there is also the risk that policyholders do not fully understand how the policy works and, in particular, they may not expect dividends to decrease.

Unit-linked

A unit-linked policy (also known as a property-linked policy) offers a benefit which moves in line with the performance of some investment fund specified in the policy terms and conditions.

The investment fund may be managed by the insurer, or may be an external fund managed by a different company. Offering a link to an external fund may improve the marketability of the product by offering policyholders a wider choice of funds, perhaps run by a well-respected company. However, the provider of an external fund will charge for managing it, so charges to policyholders may be higher and/or profitability may be reduced. The premium paid for these policies may be a single lump-sum, or regular level monthly/annual amounts. Premium levels may also be flexible. Units are purchased on behalf of a policyholder with the premiums they pay.

The policy term may be any number of years, typically from 10 upwards, except for single-premium bonds which are normally written on a whole-life basis (with warnings given at the point of sale that the bond should be held for at least 5 years, typically longer). Typically, no guarantees of capital or premium refund are offered at maturity (though it is not impossible to incorporate such guarantees into a unit-linked product as a separate feature). The death benefit would typically be the surrender value of the policy at the date of death or, for single premium bonds, a percentage of the surrender value.

The percentage of the surrender value payable on a single premium bond can vary by jurisdiction (e.g. it is commonly 101% in some jurisdictions where this is sufficient to categorise the policy as insurance). Some contracts may also offer a guaranteed sum assured payable on death that would be payable if it exceeded the surrender value. The surrender value of the policy would typically be the bid value of the underlying units, subject to a surrender penalty. However, this surrender penalty may be waived in the case of the death benefit for marketability reasons.

In some cases, bonus units (known as ‘loyalty units’) may be payable to reward policyholders for keeping their policy in force up to a given anniversary. The charging structure for unit-linked policies is often transparent to the customer.

Charges for these policies would typically be a combination of the following:

  • An allocation rate (which may vary by policy duration in force).

  • A fund management charge (which is calculated as a percentage of the fund value and is usually deducted on a daily basis).

  • The bid/offer spread of the units.

  • A policy fee.

  • Charges for the cost of risk benefits, where applicable.

If the policyholder has the facility to change their funds, there may be a switching charge for this (perhaps with a given number of free switches being allowed each year). Each of the above charges may be guaranteed or reviewable. Where charges are reviewable, the insurer will usually have to give advance notice of this (typically three months notice).

The policyholder’s perspective

A policyholder will purchase a unit-linked policy to save for the future in the expectation that the product will yield a higher return than alternatives (e.g. depositing the money in a bank account). The main risk to the policyholder is that the money does not accumulate to the sum projected and could fall short of what could have been earned in alternatives such as a bank account. This could be the case at maturity or at earlier surrender. This risk depends on whether the product is premium driven or target driven. Overall, there is the risk that the policyholder does not fully understand the product or its investment risk.

The insurer’s perspective

Insurers offer unit-linked products because they can generate profits through the margins applied to expense loadings. A key risk to the insurer is that actual expenses prove to be higher than loadings collected through the various charges applied. In particular, the amount contributed by the annual fund management charge will be less than projected if fund performance does not meet the company’s expectations. Poor investment performance may also lead to increased withdrawals and lower new business volumes (depending, to an extent, on the performance of competitors’ funds). An investment risk will also arise in relation to any guaranteed sum assured. There will also be a compliance risk similar to those for other investment products.

Index-linked

An index-linked insurance policy offers a benefit that is designed to move in line with the performance of an investment or economic index (specified in the policy terms and conditions).

Various guarantees could be added to such policies to make them more marketable. Where investment guarantees are given, the assets underlying the fund will include appropriate derivatives and fixed-income investments. Where legislation allows it, the death benefit on these policies is often very low. For example, in the UK the death benefit would often be 101% of the surrender value at the date of death, though some companies offer less than this. If surrender values are subject to a surrender penalty, this penalty may be waived for the purpose of the death benefit.

The charging structure for these policies will depend on the nature of the contract, but will be similar to the charges levied on unit-linked contracts. However, for index-linked annuity contracts there is unlikely to be an explicit charging structure or a surrender value.

The policyholder’s perspective

A policyholder will purchase an index-linked policy to save for the future in the expectation that the product will yield a higher return than alternatives (e.g. depositing the money in a bank account). Policyholders may also purchase index-linked policies to provide an income in retirement (e.g. inflation-linked annuities, which protect the policyholder’s income from inflation erosion). Many index-linked policies offer some of the upside provided by direct equity investment whilst providing an underpin if there are adverse market movements. The main risk to the policyholder is that they did not fully understand the nature of the policy effected and its investment risk.

The insurer’s perspective

An insurer offers this type of product because it can generate profits through margins in expense loadings.

The main risk to the insurer is that their actual expenses are higher than allowed for in their expense loadings. Another key risk to the insurer is basis risk: the insurer may not be able to invest exactly to precisely match the benefit guarantees given. There may be a compliance risk for certain types of index-linked products if promotional material, or the sales process, lead to allegations of mis-selling. This may lead to compensation being paid. Though the concept of an index-linked policy is simple, some types of index-linked policy can be quite complex.

Other risks include credit, counterparty, and liquidity risks where the underlying provider of an investment defaults.