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HMRC internal manual

Insurance Policyholder Taxation Manual

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HM Revenue & Customs
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Substitutions: circumstances in which they arise

Where the change to a policy goes to the root of the original contract such that thereis a fundamental reconstruction of it, the original policy is treated as surrendered andsubstituted by a new policy on the date of the change. Such a change may be by agreementbetween the policyholder and the insurer or by the exercise of an option in the originalpolicy.

A change in the contingency on which the policy pays out a capital sum would always giverise to a fundamental reconstruction but this is not the only example.

Changes of contingency

Examples of changes of contingency that give rise to a substitution are

  • adding a life assured to a single life policy or removing a life from a joint policy
  • changing the contingency on a joint policy so that death benefits are paid on the death of the last survivor rather than on the first death, or vice versa
  • adding to a policy that previously lacked it, disability or critical illness cover that would bring the policy to an end if paid, or removing such cover completely from a policy
  • converting a whole life policy to an endowment policy or vice versa
  • converting a term assurance policy to a whole life or endowment policy.

Other fundamental changes

  • reducing the premium to a nominal amount, so-called ‘peppercorn premiums’
  • making a number of changes simultaneously which separately may not be fundamental but together make a substantial difference to the contract
  • the addition or removal of an option, which if exercised would end the policy and bring into existence a substitute policy.

Change of life assured when no consideration paid - special rule

A change of life assured on a qualifying policy always gives rise to a substitution andthe new policy following the substitution must be tested to see if it qualifies, as withany other substitution, see IPTM8120 onwards.

However, where the new policy qualifies and

  • there is no consideration payable in connection with the change, and
  • the proceeds payable on the surrender of the old policy are retained by the insurer and applied as premium of the new policy

the old and new policies must then be treated as a single policy for the purposes ofthe qualifying policy and chargeable event rules. This is an exception to the normalrules, under which the policy following substitution is treated as a new policy, in linewith the contractual treatment.

There are more details at IPTM7340 on the circumstances inwhich this special rule applies and the consequences.

Further reference and feedback IPTM1013