Endowment policy

Endowment policy

Overview
An endowment policy is a life insurance contract designed to pay a lump sum after a specified term (on its 'maturity') or on death. Typical maturities are ten, fifteen or twenty years up to a certain age limit. Some policies also pay out in the case of critical illness.

Policies are typically traditional with-profits
With-profits policy
A with-profits policy or participating policy is an insurance contract that participates in the profits of a life insurance company. The company is often a mutual life insurance company, or had been one when it began its with-profits product line...

 or unit-linked
Unitised insurance fund
Unitised insurance funds or unit-linked insurance funds are a form of collective investment offered through life assurance policies.An insurance company's contract may offer a choice of unit-linked funds to invest in. Insurers that offer these contracts are mainly found in the UK and British Isles...

 (including those with unitised with-profits funds).

Endowments can be cashed in early (or surrendered) and the holder then receives the surrender value which is determined by the insurance company depending on how long the policy has been running and how much has been paid in to it.

There is an amount guaranteed to be paid out called the sum assured and this can be increased on the basis of investment performance through the addition of periodic (for example annual) bonuses.
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Encyclopedia
An endowment policy is a life insurance contract designed to pay a lump sum after a specified term (on its 'maturity') or on death. Typical maturities are ten, fifteen or twenty years up to a certain age limit. Some policies also pay out in the case of critical illness.

Policies are typically traditional with-profits
With-profits policy
A with-profits policy or participating policy is an insurance contract that participates in the profits of a life insurance company. The company is often a mutual life insurance company, or had been one when it began its with-profits product line...

 or unit-linked
Unitised insurance fund
Unitised insurance funds or unit-linked insurance funds are a form of collective investment offered through life assurance policies.An insurance company's contract may offer a choice of unit-linked funds to invest in. Insurers that offer these contracts are mainly found in the UK and British Isles...

 (including those with unitised with-profits funds).

Endowments can be cashed in early (or surrendered) and the holder then receives the surrender value which is determined by the insurance company depending on how long the policy has been running and how much has been paid in to it.

Traditional With Profits Endowments


There is an amount guaranteed to be paid out called the sum assured and this can be increased on the basis of investment performance through the addition of periodic (for example annual) bonuses. Regular bonuses (sometimes referred to as reversionary bonuses) are guaranteed at maturity and a further non-guaranteed bonus may be paid at the end known as a terminal bonus. During adverse investment conditions, the encashment value or surrender value may be reduced by a 'Market Value Reduction' or MVR (It is sometime referred to as a market value adjustment but this is a term in decline through pressure from the Financial Services Authority to use clearer terms). The idea of such a measure is to protect the investors who remain in the fund from others withdrawing funds with notional values that are, or risk being, in excess of the value of underlying assets at a time when stock markets are low. If an MVA applies an early surrender would be reduced according to the policies adopted by the funds managers at the time.

Unit-linked endowment


Unit-linked endowments are investments where the premium is invested in units of a unitised insurance fund. Units are encashed to cover the cost of the life assurance. Policyholders can often choose which funds their premiums are invested in and in what proportion. Unit prices are published on a regular basis and the encashment value of the policy is the current value of the units. This is the simplest definition.

Full endowments


A full endowment is a with-profits endowment where the basic sum assured is equal to the death benefit at start of policy and, assuming growth, the final payout would be much higher than the sum assured.

Low cost endowment (LCE)


A low cost endowment is a combination of: an endowment where an estimated future growth rate will meet a target amount and a decreasing life insurance element to ensure that the target amount will be paid out as a minimum if death occurs (or a critical illness is diagnosed if included).

The main purpose of a low cost endowment has been for endowment mortgage
Endowment mortgage
An endowment mortgage is a mortgage loan arranged on an interest-only basis where the capital is intended to be repaid by one or more endowment policies. The phrase endowment mortgage is used mainly in the United Kingdom by lenders and consumers to refer to this arrangement and is not a legal...

s to pay off interest only mortgage at maturity or earlier death in favour of full endowment with the required premium would be much higher.

Traded endowments



Traded endowment policies (TEPs) or second hand endowment policies (SHEPs) are traditional with-profits endowments that have been sold to a new owner part way through their term. The TEP market enables buyers (investors) to buy unwanted endowment policies for more than the surrender value offered by the insurance company. Investors will pay more than the surrender value because the policy has greater value if it is kept in force than if it is terminated early.

When a policy is sold, all beneficial rights on the policy are transferred to the new owner. The new owner takes on responsibility for future premium payments and collects the maturity value when the policy matures or the death benefit when the original life assured dies. Policyholders who sell their policies, no longer benefit from the life cover and should consider whether to take out alternative cover.

The TEP market deals exclusively with Traditional With Profits policies. The easiest way of determining whether an endowment policy is in this category is to check to see whether your policy document mentions units, indicating it is a Unitised With Profits or Unit Linked policy, if bonuses are in sterling and there is no mention of units then it is probably a traditional With Profits. The other types of policies - “Unit Linked” and “Unitised With Profits” have a performance factor which is dependent directly on current investment market conditions. These are not tradable as the guarantees on the policy are much lower and there is no gap between the surrender value and the market value...

Modified endowments (U.S.)


Modified endowments were created in the Technical Corrections Act of 1988 (H.R 4333, S. 2238) in response to single-premium life (endowments) being used as tax shelters. They are contracts with fewer than 7-level annual premiums, and are subject to more stringent tax regulations (tax code 7702, 7702A). They are also subject to IRA-like annuity rules (such as penalties for pre-death proceeds before age 59½). If a life insurance policy is changed and then fits the seven-pay rules, it may then be redefined as a modified endowment.