Key update: Treatment of investment bonds: Revised Charging for Residential Accommodation Guide LAC (2003)22

“The surrender value of any policy of life assurance” is a capital asset, which is disregarded under the local authority means-test (Schedule 4, Paragraph 13 National Assistance (Assessment of Resources) Regulations 1992). There is no clear legal definition of a policy of life assurance. That in itself is unhelpful. It has understandably led to confusion, particularly in the context of investment bonds, which carry an element of life cover.

The policy of life assurance disregard was, it is submitted, introduced to prevent people having to cash in life policies designed to protect their families. That early surrender would not only expose the family in the event of the death of the insured, but would also realise a much-reduced value over the proceeds due upon maturity. The endowment policy is the classic example of a life policy with a surrender value. If it was cashed in early then the mortgage that it would invariably support would never be paid off. The family might become worse off ultimately. The state would also need to foot the bill in terms of benefits to pay the continuing mortgage interest. For much of the last century, insurance policy premiums also enabled the policyholder to obtain tax relief. They were favoured by successive governments. Perhaps the memory still lingers that these forms of investment should still be favoured.

The Charging for Residential Accommodation Guide (2003)22 (published in October 2003), known as CRAG, is the most recent revision of revenue assessor’s “Bible”. It claims to clarify the position in respect of investment bonds. Local authorities have sometimes sought to take investment bonds into account as “assessable capital” assets for the purpose of the means-test despite their apparently falling within the definition of a “policy of life assurance”. It is clear from the CRAG guidance that this is not acceptable and has always been an unlawful practice. Unlawful capital assessments taking account of such assets should be brought to the attention of the relevant local authority with a view to obtaining a refund of care-home fees incorrectly paid as a result.

Attempts appear to have been made in the past to amend the CRAG to exclude insurance/investment bonds, as not being within “the spirit” of the policy of life assurance disregard. That appeared to indicate that an amendment of the underlying regulations on this point was likely. But that does not appear to be likely now given the more generous guidance issued. In fact, the former guidance may well have been ultra-vires for not properly reflecting those underlying regulations.

Most investment bonds carry some life cover although they are primarily investment vehicles. The life cover usually amounts to around one per cent over and above the “bid value” of the investment units within the policy. That means that the value that the sale of investment units in the bond realise on death is added to, so that 101 per cent of that value is actually payable. The one per cent is not, however, a universal. This point is expanded upon below.

One reason, though not the only reason, why investments are sold in the form of policies of life assurance/investment bonds is to help tie in the investor. In the past, a life company sought to cancel policies, claiming ab initio invalidity, when the investor found a method of selecting funds against the interests of the insurance company concerned. The investor/trader found a way to switch funds within a policy after close of markets but at that day’s opening prices. Hindsight purchases proved a wonderful way to make money. In fact, over £1,000,000. Cancelling the policy as not being a “real” policy due to its having inadequate life cover and offering a refund of premiums with interest, proved a wonderful way of annoying the investor. It also proved a wonderful mechanism for the clarification of insurance law and for the lawyers to make some money. See the Court of Appeal decision in Fuji Finance Inc v Aetna Life Insurance Ltd [1995] Ch 122. The result of that case is that investment bonds require negligible life cover to attain the status of policies of life assurance.

Life policies are broadly either “qualifying” or “non-qualifying” policies:

Qualifying policies used to obtain tax relief on premiums and the investment benefits are tax free after 7½ years or 10 years depending upon policy structure. Premiums must be regular in nature and there must be a minimum amount of life cover of 75 per cent of the premiums payable over ten years or to age 75, depending on whether the policy is a fixed-term endowment or a whole-of-life policy. Such policies are clearly within the ambit of the capital disregard;
Investment bonds are usually non-qualifying policies of life assurance. They are single premium contracts and the life cover element is not usually related to the premiums paid. But this life cover element still means that somebody has to be a life assured under the terms of the Life Assurance Act 1774, which, in itself, implies the existence of a policy of life assurance. Also, at least a 100 per cent return of the valuation of the underlying investments in the investment bond at death must be payable on death. The case of Fuji Finance Inc v Aetna Life referred to above indicated that not even the usual one per cent enhancement within investment bond contracts is necessary for an investment bond to amount to a valid policy-of-life assurance. The reason for this is that a policy of life assurance may be said to exist to create benefits that are life or death related. That is nothing to do with the amount payable. It is submitted that the wording of the means-testing capital disregard indicates that investment bonds that are non-qualifying policies of life assurance (whether they have an enhancement of one per cent or not) are within its ambit. The main issue is to do with the benefits being life or death related and not the actual value of those benefits.

Following from the above discussion, a significant restriction must be applied to the general rule. This excludes certain forms of investment bonds from the protection of the policy of life assurance disregard:

Having said that investment bonds are usually non-qualifying policies of life assurance, some investment bonds, particularly offshore bonds, are in fact offshore redemption bonds or “ORBs”. They are used when it is not desirable to trigger a chargeable event for [MH1]tax purposes on the death of an assured bond-holder. They are usually written on several lives. Some inheritance-tax-planning schemes use ORBs because they can be written for 99 years. They do not have any life assurance benefit. This point concerning ORBs is of great importance for both legal and financial advisers.
It is submitted that the wording of the capital disregard indicates that such policies are not likely to fall within its ambit. There is no reason why they should. They are quite simply not policies of life assurance.

The CRAG guidance may leave the reader lacking any background knowledge a little confused. It is worded as follows:

Paragraph 6.002A of CRAG states: “The treatment of investment bonds in the financial assessment for residential accommodation is complex because, in part, of the differing products that are on offer. For this reason, councils should seek the advice of their legal departments when they arise. However, it is possible to offer some general advice and councils are referred to the Social Security Commissioners decision R (IS) 7/98.”

This area of insurance-linked investment vehicles is not one that either most legal advisers or local authority revenue assessors will be familiar with. In the case referred to R(IS) 7/98, the benefits claimant invested in and owned an investment bond worth £10,000. This was purchased in the form of a set of single premium life assurance policies, which collectively constituted the investment bond. The claimant had the right to cash in one or more or all of the policies. There was a small guaranteed death benefit, which was the only discernable insurance element. The Commissioner of Income Support agreed with the claimant. Although the guaranteed death benefit was small, even fractional, the investment bond was held to be a disregarded capital asset. The claimant could obtain income support despite owning the investment bond. The income support regulations are mirrored by the national assistance regulations and, thus, the same principles usually apply to their application. It should be clear from the facts that the case involved an “ordinary” investment bond in the form non-qualifying policy of life assurance.

Paragraph 6.002B of CRAG states: “Councils are advised that if any investment bond is written as one or more life insurance policies that contain cashing-in rights by way of options for total or partial surrender, then the value of those rights has to be disregarded as a capital asset in the financial assessment for residential accommodation… In contrast, the surrender value of an investment bond without life assurance is taken into account.”

This part of the guidance follows quite naturally from the explanation of the types of investment bond available and from the conclusions of the Commissioners in R (IS) 7/98. It may be argued that the guidance adds a certain gloss, which is both unnecessary and unhelpful. This is because the main issue is whether or not the benefits payable are life or death related. The explanation mentions “cashing-in rights”. This is not relevant to the availability of capital disregard.

Turning to regular “actual” payments from investments bonds, of any sort the CRAG adds:

Paragraph 6.002C of CRAG states: “Income from investment bonds, with or without life assurance, is taken into account in the financial assessment for residential accommodation. Actual payments of capital by periodic instalments from investment bonds, with or without life insurance, are treated as income and taken into account provided that such payments are outstanding on the first day that the resident becomes liable to pay for his accommodation and the aggregate of the outstanding instalment, and any other capital sum not disregarded, exceed £16,000.”

The author suspects that the “£16,000” referred to should actually be the £19,500 upper capital threshold for eligibility to local authority assistance with care-home fees. The use of the word “actual” must logically mean that payments by way of withdrawal, which hit a client’s bank account, are the only ones that are relevant to the means-test. While still part of the investment bond, the value of that particular “segment” or policy is not counted as an assessable asset because it is still within the capital disregard. Some local authorities previously sought to treat the “possibility” of draw-downs of capital as an asset that was “available” to a resident and assessable as such. However, such an ability to obtain draw-downs amounts to the ability to obtain cancellation or otherwise encashment of part of the overall investment bond, which is disregarded. A local authority thus has no power to take account of or force such potential withdrawals. Logically, they cannot assess a terminated stream of withdrawals either. See 6.002B, which appears to confirm this.

Well timed, by which the author means well planned and early, conversion of non-disregarded assets such as cash and shares into a disregarded form such as a non-qualifying life policy/investment bond is a legitimate part of the “white art” of protecting the financial interests and choices of older people. All such planning must be effected by a suitably qualified and authorised person. It must also bear in mind the needs of the investor. But also and importantly, regulation 25 of the National Assistance (Assessment of Resources) Regulations 1992 must also be taken into account. Asset conversion into investment bonds is not a panacea securing the last minute avoidance of a liability for care-home fees.

Regulation 25 states: “A resident may be treated as possessing actual capital of which he has deprived himself for the purpose of decreasing the amount that he may be liable to pay for his accommodation.”

This would mean that the person disposing of assets, including by way of conversion from a non-disregarded to disregarded form, may still, in some circumstances, be billed for care fees as though they still owned the original asset. That can create a very awkward situation.

Paragraph 6.061 of CRAG states that a deprivation of capital may occur if “capital has been used to purchase an investment bond with life insurance. Councils will wish to give consideration, in respect of each case, to whether deprivation of assets has occurred, ie, did the individual place his capital in such an investment bond so that it would be disregarded for the purposes of the Assessment of Resources Regulations.”

Many clients of financial advisers will already have disregarded investment bonds taken out purely for reasons of investment that have nothing to do with planning to mitigate the incidence of care-home fees. That fact will be helpful in averting the impact of regulation 25. That is especially if additional consideration is being given to asset-protection planning, which might involve switching non-disregarded cash and other investments into suitably disregarded investment bonds. It will be apparent from the records that investment bonds were always part of the individual’s planning arrangements and more investment will be consistent with that. Indeed, good financial-planning reasons must be given for investment-bond purchases under the Financial Services Authority rules. In such cases, it would be very hard indeed for a local authority to prove any claim it might attempt to bring in respect of the purchase of new investment bonds being effectively a “deprivation of capital” with the imputation of a “notional capital” value for the money invested, despite the investment bonds themselves being disregarded. The all important element of intention to effect a deliberate deprivation of capital with the aim of securing or increasing entitlement would be hard to prove. Even if a local authority had the case assessed by a financial planner it would undoubtedly only prove that there were different investment alternatives. Evidence of intention could not normally be proven by such an analysis.

Financial planners will also need to be very careful in giving what would normally be sound advice. It may be the case that from a costs and investment perspective, investment bonds cease to be the best vehicle for a particular client. But what should the financial planner do if that is the case but to disinvest would be to expose otherwise disregarded assets? That is a difficult problem. In such a case, rounded advice should, it is submitted, refer to the advantage of the disregard. This advice cannot act as evidence of deprivation of benefit in respect of the client’s existing investment bonds. Retention of an investment bond as a result of that advice is not a deprivation of capital. The advice may induce or simply justify a continuation of the status quo but that is not a transaction and thus there is no deprivation of capital in those circumstances. Conversely future investment bond purchases by a client advised in such a way would appear to be against the pure investment aspect of the advice given. This may help support a claim of deprivation of capital in some circumstances. But rounded advice might reasonably list the pros and cons of investment bonds. Equally reasonably, the client may decide one of the pros outweighs the cons so far as they are concerned. That is even if the pure investment advice is balanced in favour of another product. In practice, the key element of intention may therefore still be very hard to prove. The financial planner would be wise to retain relevant records of the decision-making process.

It should be noted that traded or second-hand endowment policies purchased as an investment are also still life insurance policies, although not having anything to do with their new owner or their family. They may also benefit from the policy of life assurance disregard. There seems to be no legal reason why they should not. The surrender value of an annuity is also disregarded. Few annuities have capital values in practice. It is perhaps worthwhile noting that the surrender value of a life insurance policy is all that is disregarded. This appears to assume that there is no other value in the policy that a willing purchaser might pay. This was certainly the case historically but there is now a growing market in traded or second-hand endowments and perhaps other forms of policy might become marketable in the future. This may open the way for further disputes. Even if a surrender value, payable by the insurance company, is disregarded, would the value a willing trader in policies might pay be exempt as well? That would be a value on sale of the life insurance policy and not a surrender value. It will generally be higher than the surrender value. On this analysis, a financial assessment would reveal a disregarded surrender value and also a balance above that amount up to the market value, which might be assessable capital. The author would suggest that such a balance should be disregarded. That is because a sale to realise the surplus over the surrender value would require the disposal of a disregarded asset as a part of the overall transaction. The two elements of value one being disregarded and one not being disregarded cannot be severed. Such a sale would be inconsistent with the policy of life assurance disregard. It would force conversion from a disregarded to a non-disregarded form. That would be illogical.

It may sometimes be appropriate to write life policies, including insurance/investment bonds, into trust. This can add the extra layer of the trust capital disregards into the asset protection planning equation. The types of trust used may vary. So long as the trust is not a “bare trust” the combination of the life insurance disregard and the relevant trust disregard should be a potent asset-protection combination. Although the author understands the sentiments expressed by Philip Laidlow in Capital Taxes Planning (volume 19 number 12 at page 139) that: “A trust might even weaken the position [vis asset protection planning] by inviting scrutiny where none is warranted”, it is submitted that the nature of the investment bond is likely to attract attention anyway especially given the inconclusive nature of the CRAG guidance. Such matters are invariably referred to the local authority legal department for examination. The author does not agree that writing an investment bond into trust, particularly at the time of purchase, should “weaken the position”. However, the author is happy to concur with Philip Laidlow that: “Sensibly used, and not losing sight of other considerations not least investment suitability there is reasonable scope for planning through bonds,” (ibid).

In summary, cautious use of investment bonds as a result of properly recorded, qualified and authorised financial-planning advice may well be a practical method of investing and protecting the financial interests of many older people. But it should not be relied upon as an easy way to protect assets at the last moment before entry into residential or nursing care. It is not.

This article was written by the editor with extremely helpful input and assistance from ECA contributors, Mike Hurst and Michael Hague.