IPTM7615 | Periodic calculations: excess events

When excess events arise

If the periodic calculation shows an excess then a chargeable event called an ‘excess event’ is treated as arising on the last day of the insurance year unless

• it is the ‘final insurance year’ - see IPTM3505 - in which case no excess event can arise, or

• there has been a part assignment, or a part surrender followed by an assignment or part assignment not for money or money’s worth during the insurance year, in which case a transaction-related calculation needs to be performed to see if a part surrender or assignment event arises - see IPTM7625.

‘5% tax-deferred rule’ or ‘5%-rule’

The fraction ‘one-twentieth’ which appears in the formula for calculating net allowable payments – see IPTM3560 – is of course equivalent to 5%, which is why periodic calculations are often commonly known as calculations under the ‘5%-rule’. This would be better referred to as the ‘5% tax-deferred rule’ to make clear that the net allowable payments are not tax free allowances. They only act to defer any gain until the sweep-up gain calculation at the end of the final insurance year.

Unused net allowable payments are carried forward to following years. So for a single premium policy, the facility to make a part surrender of up to 5% of the premium without an immediate gain arising continues until

• either the 5% allowance has been used up for each of the 20 years, or

• after more than 20 years, the total value of part surrenders and part assignments exceeds the premium.

Where there are multiple premiums, the insurer must keep track of allowances attributable to each premium so that it knows both when the 5% allowance is exceeded and also when the 20 year allowance is exhausted on each premium.

Amount of gain on an excess event

Where there is an excess event, the amount of the chargeable event gain is simply the amount of the excess shown by the periodic calculation. It is not related to any overall increase in the value of the policy. A gain on a part surrender or part assignment can arise even when value of the policy has fallen below the premiums paid, for instance if a large part surrender is made in the early years of the policy.

No excess event in the final insurance year

There is no need to perform a periodic calculation for the final insurance year if neither of the circumstances in which a transaction-related calculation is needed apply, even if there have been part surrenders in the year, since an excess event cannot arise in the final year.

It is possible that an excess event arising on part surrenders is superseded because of the occurrence of a later event, such as full surrender or death. This would be the case if the part surrenders took place in the final insurance year. IPTM7210 gives an example and explains what an insurer should do if certificates have been issued reporting the superseded excess event. Under no circumstances should the gain on the superseded event be deducted in the calculation of the gain on the final event.