What is Life Insurance and How Does It Work? | Meaning/Benefits & Types
Life insurance is mainly used nowadays as a contract to save money by benefiting from the advantages of the taxation of life insurance combined with those linked to the transmission of heritage. The contracts are opened with the aim of preparing for retirement, building up capital over time, or anticipating a real estate project.
However, a distinction should be made between death insurance and life insurance. In a death insurance contract, the insurer undertakes to pay a fixed capital or annuity to the beneficiaries designated by the insured in the event that the latter dies before a certain date. Death insurance is generally taken out to allow the family to repay a loan or to pay for the children’s studies if the insured dies suddenly.
- In the event of the life of the subscriber, he remains the beneficiary and holder of the funds and can freely recover the capital and interest.
- In the event of the death of the subscriber, the contract will be settled and the capital and interest will be transferred to the beneficiary(ies) of their choice (children, spouses, partner, brothers, sisters, etc.)
There are two compartments in a life insurance policy:
- Funds in euros that offer a capital guarantee
- Units of account (UC) that do not offer a guarantee on the capital and which are invested in units of SICAVs, SCIs, SCPIs, FCPs, or trackers, themselves mainly invested in real estate, stocks or bonds.
Funds in Euros
The fund in euros of a life insurance policy is a secure medium that includes a capital guarantee offered by the insurer. The subscriber cannot, therefore, lose money on this type of fund.
Each year the interest is paid on the contract on December 31 N. The interest acquired by the subscriber is definitively acquired (ratchet effect). The return on the euro fund is made up of a technical rate (minimum guaranteed rate) and participation in the profits.
Units of account
A unit of account (UC) designates investment support on a life insurance contract that does not offer a capital guarantee. The subscriber can invest in different asset classes through units of account such as stocks, bonds, and real estate. A UC can have a negative return in the event of a fall in the financial markets, which generates a capital loss for the subscriber (loss of part of the capital invested).
Stocks and bonds are grouped together in undertakings for collective investment in transferable securities (UCITS). There are many forms of UCITS (monetary funds, bonds, shares, alternative funds, formula, and diversified funds).
Behind the term UCITS there are two distinct legal statuses:
- SICAVs (Investment Companies with Variable Capital)
- FCPs (mutual funds)
Finally, we can cite trackers (listed index UCITS) whose performance replicates a financial index (the CAC 40 for example).
For real estate, there are many supports such as:
- SCI (Real Estate Civil Society)
- SCPI (Civil Real Estate Investment Company)
- OPCI (Undertaking for Collective Real Estate Investment)
The expected rate of return on the units of account is higher than on the fund in euros in return for a capital risk.
Subscription to a life insurance policy
Life insurance contracts have no legal duration. In practice, we advise you to freely set a fixed term which will be extended by tacit agreement from year to year unless you make a denunciation. You also have the possibility of choosing a life duration according to the contracts.
Invest within the contract
It is possible to invest in a life insurance contract in 3 forms:
- The initial payment: It corresponds to the payment that you make when subscribing to the contract. It can be issued by check, bank transfer or direct debit (depending on the life insurance companies).
- Free additional payments: you place money in your life insurance policy whenever you want
- Scheduled additional payments: You define an amount and a frequency which can be monthly, quarterly, half-yearly or annually to invest in your best life insurance contract. Payments are automatically deducted by the insurer from your account. You can interrupt these payments at any time or change the frequency and the amount without tax consequences for the contract.
Attention: there is no obligation in the additional payments. The subscriber can, if he wishes, pay only one single premium (initial payment).
Life insurance policy fees
There are several categories of fees:
- Entry fees and fees deducted from each payment: these fees can vary from 0% to 5% depending on the contract.
- Management fees: these correspond to the remuneration of the insurer. They are calculated on the totality of the accumulated savings. It takes on average between 0.5% and 1.5% for unit-linked contracts. A distinction is made between the management fees on the euro fund of the life insurance company and the management fees on unit-linked supports.
- Arbitration fees: the fees are deducted from the number of sums transferred from one fund to another. In some contracts, these costs can reach 1% of the amounts arbitrated.
Life insurance policy management
There are several management methods offered by life insurance companies:
- Free management:
You distribute your savings yourself between the different supports available in the life insurance contract according to your investor profile, your profitability objectives, and your level of risk. You manage your life insurance contract with complete freedom and remain in control of your asset allocation.
- Managed management:
You give a mandate to your broker or a management company to manage your contract for you.
- Management under the mandate:
You do not choose the media that will make up your life insurance contract yourself. You delegate the management of the life insurance contract to a management company approved by the life insurance company. After having defined your risk profile, the portfolio managers will select, based on market opportunities, the investment vehicles best suited to your management orientation.
Recover the money on his contract
As we have already said in this guide, the sums placed in a life insurance contract are never blocked and at any time, you can withdraw money. This withdrawal can materialize in several forms:
- Partial redemption (free)
At any time you can make partial withdrawals or redemptions. If the beneficiary has accepted his designation since December 18, 2007, partial redemptions (and advances) can only be made with his agreement. Upon receipt of the redemption request, the insurer has two months to pay out the funds. After this period, the sums bear interest. During the partial redemption, you must stipulate the tax option either the flat-rate discharge or income tax.
In concrete terms, you send a partial redemption form to E-Patrimoine or you make this redemption online.
To find out the best option, refer to the life insurance tax page
- Scheduled partial redemptions
The life insurance investment offers the subscriber the possibility of programming partial redemptions to, for example, build up regular income for retirement. There is usually a minimum amount on the contract. The frequency and the amount follow the same rules as for free partial surrender.
An advance is a loan that the life insurance company gives you, in return for interest. Faced with a one-time need for money, it may be better to ask for an advance rather than make a partial redemption. An advance is not taxable and does not reduce the value of the contract. Its real cost is insignificant because the subscriber leaves his money on the contract which continues to produce interest.