17) USING ENDOWMENT POLICIES FOR MORTG REPAYMENT

Question 1

What are the elements of an endowment policy?

Answer 1

An endowment policy whether with-profit or unit-linked comprises two elements

• • Life assurance - guaranteed payment of sum assured (SA) if borrower dies during policy term (if SA=mortg, then mortg paid off, if all premiums are paid)
• *Investment element - targets provision of maturity value sufft to repay loan in full at end of mortg term (and possibly a surplus over that if funds perform well)

Question 2

Describe the basic str of a with-profits endowment policy

So,

Guaranteed sum assured GSA
\+
Reversionary bonuses
\+
Terminal bonus 

=

Maturity or death value

Answer 2

• –Premiums are invested in with-profits fund (typically blue-chip shares, gilts, bonds and cash - due to guarantees on maturity, cautious approach to investt)
• –Fund assessed annually and some money set aside t (to cover current and future liabilities eg GSA, death benefits, declared bonuses, to cover admin expenses related to fund and assoc policies, and to provide a reserve)
• –balance of fund provides bonuses (bonuses cannot be removed once added, but bonuses may be reduced if surrendered early, bonuses amt and declaration are discretionary)

Question 3

What is smoothing? with regard to endowment policy?

Answer 3

Smoothing is the creating of a reserve in years of good fund growth rather than paying all the growth out in bonuses, so that in poorer years it may still be possible to pay a bonus.

Question 4

Reversionary bonuses

Answer 4

Reversionary (annual) bonuses are usually added to an endowment policy each year as a percentage of the plan’s GSA. Once added, it is guaranteed to be paid on maturity (providing all premiums are paid and policy remains in force)

Question 5

What are the ways in which reversionary bonuses are calculated?

Answer 5

1 - Simple basis
2 - Compound basis
3 - Combined bonus basis

Question 6

When are terminal bonuses added?

Answer 6

Either at maturity or sometimes on earlier death.. They represent a large portion of final policy value - designed to reward longstanding policyholders - added at discretion of the company - if performance poor then may be not added. Fund performance affects maturity value.

Question 7

What are ‘paid-up’ endowment policies?

Answer 7

Policies that are discontinued but not surrendered - funds continue to grow - but no further premiums, reversionary bonuses not added any further, so GSA and death benefit could be lower.

Question 8

What is full with-profits endowments?

Answer 8

GSA is equal to mortg amount, so mortg is guaranteed to be paid off, with bonuses added providing a cash surplus over and above the mortg.. Expensive than low-cost versions

Question 9

Describe low-cost with-profits endowment

Answer 9

More affordable than full with-profits endowment, main differences with full endowment are
–GSA typically 50-60% of mortg amt, so does not guarantee repayment of mortg at end aof term
–premium calcu assuming GSA plus percentage of anticipated reversionary bonuses (typi 80%). If assumption wrong, or terminal bonus is not sufft
then not enough to repay loan, final sum not guaranteed.
–Upon death GSA plus accumu reversionary bonuses and a potential terminal bonus is paid. Gap is plugged by decreasing life assu , wh assures mortg paid on death before term.

Question 10

Describe unit-linked endowment policies

Answer 10

As alt to low-cost endowment.
Carry greater risk, but possibility of higher returns than with-profits.
Capital accumulated at end of a set term. Policy value linked to performance of chosen investt funds, but no bottom-line guarantee of GSA. No reversionary bonuses. But pays out full mortg amt upon death. Also no smoothing.
Premiums used to buy units in unit-linked funds, and some units encashed every month to cover life assu, admin and other admin costs.
Premiums are based on assumptions about annual fund growth (typi 6%), running cost, death bene cost and cost of other benefits provided. If funds grow as expected, maturity value cd be reached earlier, and mortg cd be repaid early.

Question 11

What flexilibilty does unit-linked endowment policies offer?

Answer 11

• Fund choice - low, med or high risk
• may be possible to incr or decr premiums
• can extend term (subject to insurer’s rules)

Question 12

What charges can be incurred on a unit-linked plan?

Answer 12

**initial charge - amt taken from value of units when purchased (typi 5 %)
**policy fee/monthly mgt fee - deducted from premium before investt
**annual fund mgt charge - from fund typi 0.5 - 1.5 per cent
**early surrender charge - if surrendered wi.in 10 yrs
charges deducted by cancelling units - done to cover death bene cost and other cost

Question 13

What is unitised with-profits endowment?

Answer 13

Combines security of with-profits policy with gr potential of unit linked policy. Each premium buys units in with-profits fund at a set price, with a value of £1, which will be the min guarantee to be paid at maturity. Two types of units
‘variable’ units - value of each unit is set when purchased. AS bonuses are declared value of each unit is incr and cannot be reduced
‘Fixed’ units - value of each unit is fixed and does not incr. Bonus added by crediting more units to policy at current price

Question 14

What is traffic light sys for review of endowment policy letters?

Answer 14

RED - High risk that policy will not pay target amt at end of mortg term - strong recomm to take action
AMBER - Signifi risk that target mortg amt will not be met. Recomm that policy holder take action if concerned, and to check future projection letters carefully.
GREEN - Policy on track to meet target amt but no guarantee of future. advise to check future projection letters carefully.