End of unit not done!!!Topic 21 Topic 21: Using endowment policies for mortgage repayment (Unit 6)

Question 1

What are the different types of life assurance?

Answer 1

Non-profit
With-profit
Unit linked
Unitised with-profits
Low-cost
Flexible
Universal

Note,
Non-profit, With-profit, Unit linked, Unitised with-profits, Low-cost are all investment structures. This applies to endowments . Flexible and universal apply to whole of life policies. Flexible just means unit linked ( since the policy holder has flexibility in how much investment/cover they have) and universal apples to whole of life and is just a flexible whole of life which allows the policy holder to buy add ons by selling their units

Question 2

What is flexible whole of life assurance?

Answer 2

When whole of life assurance is unit linked

Premiums pay for the equivalent amount of units. Units are then used to provide cover ( encashed at a high rate) or build up an investment ( encashed at a low rate )

It is ‘flexible’ because the policy holder can change the ratio of how much life cover to investments their policy offers

High level of cover required = large number of units are cashed each month

Low level of cover required =small number of units cashed each month so more units remain invested

Question 3

What is universal whole of life assurance?

Answer 3

Basically unit linked whole of life assurance ( ie flexible whole of life assurance) that offers a range of extra benefits and options on the policy

The additional cost of the benefits can be met by cashing in more units

Question 4

Tell me some of the add ons that can be added to universal whole of life assurance

(Many are general insurance related…)

Answer 4

1)Waiver of premiums (allows policy holders to suspend paying premiums but retain their policy cover if they are unable to work due sickness/disability
2)Indexation of benefits
3)Total/permanent disability cover
4)Accidental death benefits
5)Critical illness cover
6)Income Protection insurance
7)Hospital benefits

Question 5

Answer 5

Question 6

Answer 6

Question 7

What is the main differences and similarities between endowments and whole of life policies ?

Answer 7

Differences:

Whole life policys have no maturity date (hence they are open ended) and the sum assured is payable on death, whereas endowment policy have a maturity date where a sum assured is payable on death ( of course as long as its within the maturity date) and an investment value is paid out on maturity ( if the person survives until maturity)

Rate of premium is low for whole life policys. endowment policys are high

Premiums are payable throughout the life for a whole life policy while only for a specified period in endowment policy.

Other than that they are the same including how they have the same investment structures (non profit, unit linked etc )

Question 8

Why are endowment policies a popular method in funding interest-only mortgages?

Answer 8

Endowment policies have a savings element that can be used to build up a fund to repay the mortgage but they also have a life cover element that provides a death benefit if the borrower dies during the mortgage term

Question 9

If an endowment is non-profit what does this mean?

Answer 9

Non profit endowment: fixed sum assured payable on maturity or death. Premium payments are fixed

The policy holder does not get a share in any profits the company makes

Question 10

If an endowment is with- profit what does this mean?

Answer 10

Has a Fixed sum assured and fixed premiums. Policy holder has a share in the life companies profits

(premiums are higher than a non-profit policy for same sum assured as they have the added benefit of allowing the policy holder to receive ‘bonuses’ . These bonuses are from the life companies profits as a result of good investment performance )

Question 11

A with-profit endowment entitles policy holders to a share in the life companies profits.

How does the life company distribute these profits

What is the downside of taking out a with profits policy when compared to a non profit?

Answer 11

The life company distributes these profits through either ‘reversionary bonuses’ or ‘terminal bonuses’

The downside of a with profits policy is that the premiums are higher when compared to a non profit with the same sum assured. And u are not guaranteed bonuses since the life companies profits may be bad

Question 12

Explain what reversionary bonuses and terminal bonuses are?

Answer 12

There are the two types of ‘bonuses’ that life companies can distribute to its customer who hold a with-profit policy

Reversionary Bonuses = declared each year and once allocated to the policy cannot be removed by the company.

Terminal bonuses= Terminal bonuses are only payable on death or maturity and the life company can remove them or lower them if profits are poor.

Question 13

If an endowment policy is ‘low-cost what does this mean?

Answer 13

A low cost endowment is a with-profits policy ( access to bonuses ) as well as a decreasing term assurance element

It is for those who want a cheaper alternative to a with-profits policy

Question 14

If an endowment is ‘unit linked’ what does this mean?

Answer 14

Unit-linked endowment = premiums pay for units. Units invested into chosen fund. Pool of units build up and on maturity policy holder receives an amount equal to the number and value of the units they have. They also provide death benefit which is paid for by cashing in units each month

Unit linked policies are higher risk than other policies ( ie it do not provide guaranteed return like a with profits policy ) but are higher reward too

Question 15

All endowment polices can be used to repay mortgages. Explain how a unit linked endowment can be.

Question 16

If an endowment is unitised with profits what does this mean?

Answer 16

Combines the security of a with profits policy with the higher potential of reward offered by a unit linked policy

Exact same as a unit linked policy but the unit prices also increase with the addition of bonuses from the life company. This means unlike unit linked policies, unit prices cannot fall and therefore the value of the policy is guaranteed if held until death or maturity .

HOWEVER, if the policy is surrendered ( ie cashed in before maturity or death ) a deduction is made from the value of the units. This reduction depends on the market conditions at the time of surrender and can vary. This is known as the market value reduction.

Question 17

What is market value reduction?

Answer 17

It refers to what happens when a ‘unitised with-profits’ endowment or whole of life policy is surrendered ( ie cashed in before maturity or death ) .

Where the company will reduce the value of units transferred to protect the interests of other investors.

It is a deduction made from the value of the units when surrendered. The amount of this deduction depends on the market conditions at the time of surrender but can be high( ie market value reduction (MVR))

Question 18

Is a low cost endowment policy guaranteed to repay the mortgage at the end of the term?

Answer 18

No it’s not. The sum assured is less than than the mortgage it is funding meaning if bonuses are not good the sum assured may not increase enough to pay off the mortgage at maturity

Obvs on death it will repay the mortgage even if the sum assured is less than the mortgage because of the the decreasing term assurance element

Question 19

What add-on benefit will ensure a life assurance policy will continue to provide cover when premiums are suspended due to the policyholder’s illness preventing them from working?

Answer 19

Waiver of premiums benefit

Question 20

Charu and Rajeev have written wills leaving everything to the survivor, and on their death the estate will pass to their children. They wish to provide a lump sum for the children to be able to settle any inheritance tax (IHT) liability on their inheritance. What life assurance arrangement would achieve their objective?

A joint-life first-death whole-of-life plan for the potential IHT liability, in trust.

A joint-life second-death whole-of-life plan for the potential IHT liability, in trust.

A joint-life second-death gift inter vivos policy for the potential IHT liability, in trust

Two single whole-of-life plans, in trust, each for 50% of the potential IHT liability.

Answer 20

B

C is not a real policy that u can take out

Question 21

A single parent wants to provide an income for his two children in the event of his death, payable until the youngest child is 21. What type of life assurance policy would suit his requirements and cost the least?

Answer 21

Family Income Benefit ( a type of decreasing term assurance )

Question 22

Why do fund managers of with-profit endowment policy’s create a reserve of funds from excess profits that could otherwise be distributed as higher bonus to the policy holders?

For example, a fund may make a return of 11% in a year, but only passes on 6% through bonuses to policy holders with the other 5% going into a reserve fund.

Answer 22

The reserve allows the company to maintain bonuses in years when the fund performance is poor

This is called smoothing because it means the
policyholder will see smoother performance from their plan. If the fund achieves no growth, or even a loss, in the following year, the company may still be able to pass on a bonus by using these reserves.

NOTE: The problem in recent years has been that fund growth has been poor and reserves have been run down. Many companies have added small bonuses, or
no bonuses at all resulting in the endowment not being sufficient as a repayment vehicle resulting in a huge drop in popularity

Question 23

What is smoothing?

Answer 23

Applies to any fund that includes a with profit element. It is the process of Creating 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 24

What is a joint life first death policy

Answer 24

With a joint life first death policy, two people are
joint owners and lives assured. The policy pays out on maturity or when the first of the lives assured dies during the term

Question 25

Can a with profits policyholder discontinue their policy, but not actually surrender it?

Answer 25

Yes they can

This will mean the policy is ‘paid up’

Its called ‘paid because no further premiums are paid and the policy has a reduced GSA (guaranteed sum assured) and death benefit.
Reversionary bonuses added to date are unaffected and remain attached to
the policy. The value of the policy will continue to grow, although at a much
lower rate, because no further premiums will be paid

Question 26

Compare a full with profits endowment to a Low cost with profits endowment

Answer 26

Full with‑profits endowment = The guaranteed sum assured is equal to the mortgage amount, which
means the mortgage is guaranteed to be paid off by the GSA. Any bonuses added provide a cash surplus over and above the mortgage. Much more expensive than low cost

The low‑cost with‑profits endowment policy is a much more affordable alternative to the full with‑profits policy. Combines a with profits element and a decreasing term assurance element. The sum assured is initially less than the mortgage amount and is topped up with bonuses meaning on maturity or death it is not guaranteed to repay the loan especially if the life company experiences low profits

Question 27

Explain why a low cost with profits endowment policy does not guarantee repayment of the mortgage upon maturity

Answer 27

This is also way the low cost with profits provides a ‘bottom line’. Ie it will always pay out something on maturity. In contrary unitised endowment policys do not has the GSA is based solely off the investment fund which in theory could lose everything

Question 28

For understanding of how a low cost with profits endowment policy works

Answer 28

Question 29

Give the advantages and disadvantages of a low cost with profits endowment policy

Answer 29

Question 30

How are the premiums of unitised endowments calculated?

Answer 30

At the start of the plan, the company sets out assumptions about annual fund growth (typically 6 per cent), the cost of running the plan, the cost of
providing the death benefit and any other benefits selected. The premium for the target maturity amount (the mortgage) is then calculated based on those
assumptions.

If the investment funds grow at the assumed rate and all other assumptions prove correct, the target maturity value will be achieved.

If fund growth is lower than estimated, or the costs of running the plan or providing the death benefit prove higher than anticipated, the maturity value is likely to
be lower than the target so higher premiums will need to be paid

Question 31

Tell me briefly how unitised or unit linked endowment policies work?

Answer 31

Premiums buy units in one or more of a range of unit‑linked funds.

The unit linked fund chosen is up to the buyer but could be lower risk like savings accounts or it could be higher risk like equities. There is a range of options for this

The unit‑linked endowment is designed to accumulate capital by the end of a set term, but differs from the with‑profits endowment in the way that the
fund is built up. The policy value is linked directly to the performance of the policyholder’s chosen investment funds

On a monthly basis, enough units are encashed by the company to cover the cost of the mortality risk (life cover), administration and other benefits selected; the
remaining units remain invested to build up the fund value. The value of units is directly related to the performance of the fund, so there is no smoothing
effect because growth (or loss) is directly reflected in unit prices.

The value of the plan is simply the number of units held in the plan, multiplied by the current fund price. There are no bonuses

Question 32

When a policy holder of a unit linked endowment policy pays a premium what happens to that money?

Answer 32

The premium buys the equivalent value of units in the chosen investment fund

Those units are then encashed to pay for the
Life cover, Admin ,Benefits etc or the units remain in the fund building up the investment.

This varies depending on the policy’s terms. For example, if someone wants high death benefits more units will be encashed but if someone wants a higher investment less units will be encashed

Question 33

Units have two prices. What are they?

Answer 33

the offer price – the price at which the policyholder buys units;

the bid price – the price at which units are bought back by the fund: the maturity or surrender value

The bid price is lower than the offer price because the initial charge is added onto the offer price and there are other relatively small charges
involved in buying the units.

The bid–offer spread is not a charge, but reflects
the difference in price between the bid and offer prices. A typical bid–offer
spread would be between 5 and 6 per cent

Question 34

What are blue chip equities

Answer 34

Blue chip equities are shares of well established financially sound companies with a proven track record of consistent earnings and revenue growth

Ie apple have blue chip stocks

Question 35

What are the charges of a unit linked plan?

Answer 35

The charges on a unit‑linked plan are clearly laid out in the policy document. Typically, they include:

„ an initial charge – an amount taken from the value of the units when they are purchased (typically 5 per cent);

„ a monthly management or policy fee – deducted from the premium before investment;

„ an annual fund management charge – this is taken from the fund and typical charges range from 0.5–1.5 per cent of the fund value;

„ an early surrender charge – charged on surrender in the first ten years;

„ charges deducted by cancelling units – to cover the cost of the death benefit and other costs

You obvs also have the cost of the premiums to buy the units

Question 36

Mortgage‑related unit‑linked endowments are subject to policy reviews, where the insurer checks the plan’s progress in relation to the maturity target

Is it 1 review or several

Answer 36

Will be multiple reviews by the life company

Do not confuse this with how interest only mortgages need to be reviewed once by the lender during the term

Question 37

What are unitised with profits endowment policies?

Answer 37

Unitised with‑profits endowment policies combine the security of a with‑profits policy ( a GSA ) with the greater growth potential of a unit‑linked policy

Question 38

Give the advantages and disadvantages of unit linked endowment policies

Answer 38

Question 39

There are two types of units in a unitised with‑profits fund

What are they?

Answer 39

‘Variable’ units – the value of each unit is set when it is purchased, based on the performance of the with‑profits fund at the time. As bonuses are
declared, the value of each unit will increase proportionately and cannot be reduced in future.

‘Fixed’ units – the value of each unit is fixed when it is purchased and does not increase. Bonuses are added by crediting more units to the policy at
the current price

Most unitised with‑profits policies allow the investor to switch into and out of other unit‑linked funds. If the policyholder switches out of the unitised with‑profits fund or cashes in the plan early, the policy might incur a market value adjuster (MVA)

Question 40

The way a life assurance policy is taxed depends on whether it is a qualifying policy or none qualifying policy.

What does this mean?
What requirements must be met for a life assurance policy to be ‘qualifying’
How does the tax treatment differ for both?

Answer 40

For a life assurance to be qualifying it must meet the following requirements:

Premiums are paid annually, half yearly, quarterly or monthly.

If the term length of the assurance is more than 10 years premiums must be paid for a minimum 10 years. If the term is less than 10 years premiums must be paid for a minimum 3 quarters

The sum payable upon death must be at-least 75% of the total premiums payable

Premiums in one year must not exceed double the premiums in any other year, or 1/8th of the total premiums payable ( e.g, if total premiums payable are 8000 the person cannot pay anymore than 1000 in one year. If they do, it becomes non qualifying.

If the policy is qualifying there is no further liabilities for tax on any proceeds ( remember 20% is deemed to have already been taken for assurance policies) If the policy is non qualifying, higher and additional rate tax payers may incur 20% or 25% respectively on their proceeds

So basically if a policy is qualifying it benefits higher and additional rate tax payers greatly

Endowments can also be qualifying/ non qualifying

Question 41

LEARN THIS CARD

One traditional advantage of endowment policies is their ‘qualifying’ life policy status. However, in 2012 measures were introduced to limit the premiums
payable on qualifying endowments issued on or after 21 March 2012

What was introduced?

Answer 41

Under the updated rules, premiums to qualifying policies are limited to £3,600 per year.

The limit applies to all policies held by the same individual, not per policy. In the case of joint owners, each is limited to £3,600 per year.

Policies taken out from 6 April 2013 are totally non‑qualifying if the premium exceeds £3,600 at any
point during the term, regardless of the reason.

Policies issued between 21 March 2012 and 5 April 2013 are known as ‘restricted relief’ policies. The £3,600 limit applies to premiums paid from 6 April 2013. If premiums exceed the £3,600 limit, the part of any gain attributable to the excess premiums will be treated as a non‑qualifying policy and may be
subject to income tax.

If the premiums are subsequently increased to more
than £3,600, the whole policy will become non‑qualifying

Question 42

How many of the various types of endowment policies are guaranteed to repay the mortgage upon maturity?

Answer 42

Only a full with‑profits endowment is guaranteed to pay the agreed maturity sum assured at the end of the term and therefore pay off the mortgage.

All other forms of endowment carry the risk of the final value not meeting the target

Question 43

What can be done if it is discovered during a review the endowment policy will not be able to repay the mortgage on maturity?

Answer 43

Many options. Commonly you could:

Switch the amount of the projected shortfall from interest‑only to capital repayment. This will guarantee that the projected shortfall figure will be repaid if all future monthly payments are made on time.

Repay some, or all, of the mortgage early, either by means of a lump sum or by making additional payments each month.

Convert the whole mortgage to a capital repayment basis. This will guarantee that the loan will be repaid by the end of the mortgage term, but the monthly payment will increase considerably, particularly if the
remaining term is 20 years or less.

Build up savings and use these to reduce the mortgage debt.

Extend the term of the endowment policy and the mortgage. This will require permission from the endowment provider and the lender and it is
only possible on a unit‑linked policy. Extending the term of the mortgage and the policy will also result in additional interest and premiums being
paid.

Increase the endowment premiums to boost the maturity value if possible. The additional premiums will still not guarantee that the policy will fully
repay the loan at the end of the term, and it may not be seen as a sensible approach given the plan’s performance to date

Question 44

What does superfluous mean?

Answer 44

Refers to something that is excessive, unnecessary or more than what is required

Used in a sentence. If the policyholder decides to switch the whole mortgage to a repayment basis,
the endowment may become superfluous