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A With-Profit Endowment (WPE) is simply a life assurance policy which has a guaranteed sum assured or face amount which is payable at a specified maturity date or on the death of the life assured if earlier. They developed in the late 18th century originally from life assurance policies purchased by merchants. Mortality calculations were hardly a science in those early days and often the premiums paid more than covered the risks creating surplus funds for the life companies. These surpluses were later distributed by the life companies to the surviving policyholders, in the form of bonuses, which were added to the original sum assured and the WPE was born. The early WPE, therefore, had two components; the Guaranteed Sum Assured which is fixed at outset and the Annual or Reversionary Bonus which is declared each year. At the end of each financial year the life company determined its assets and its liabilities and from the profits made declared a bonus which was added to the policy. Although the bonuses accrue annually they are only paid out, with the sum assured, at maturity or earlier death. The Annual Bonus once paid is guaranteed but future rates of bonus can and will vary to reflect market conditions, going up in the good time and down in the bad. In the late 1960s, to compete with the increasing popularity of the new unit-linked life plans, a third component was added, the Terminal Bonus. This is normally only paid at maturity or early death, although some companies pay them on early surrender, and reflects the extra value earned over the life of the policy which has been held in reserve until the surplus return can be accurately calculated at maturity or death. The size of the terminal bonus is dependant on the investment conditions prevailing at the time of maturity or death. Although the Terminal Bonus can be a large part of the final pay out it is not guaranteed. So the policyholder agrees to pay a premium, monthly or annually, for a set term and the life company agrees to pay a guaranteed sum assured plus annual bonuses to the policyholder at the end of the term or to their estate if they die prematurely. The WPE is an ideal plan for someone who needs to produce a lump sum at a known future date, such as to repay a mortgage or loan, to boost retirement income or to meet school fees and, as such, they tend to be long term from 10 through to 25 years or more. The Annual Bonuses help to create a smoothing effect, as markets fluctuate, over the life of the contract and the Terminal Bonus, when paid is an added extra. In fact a more up to date name which seems to be gaining acceptance is 'Smoothed Growth' plans. Even in very difficult market conditions, the WPE still stacks up, very favourably, against other asset classes. An article in the FT Money Management magazine in April 2003 had this to say, 'Compared to the balanced managed and UK all companies sectors, the average With-Profits policy shone over 10, 15, 20 and 25 years. The worst performing With-Profit policy beat the best Balanced Managed fund, proving that With-Profits can outperform equity funds with far less volatility. The table below shows the annual yields on a 25yr With-Profit maturing on 1/02/03.
Sales of new WPE represented around 25% of total new life and pensions business in 2002 and, at £1 Billion of regular premiums and £18.2 billion of single premiums, were only around 10% lower than in 2001 and at similar levels to those seen in 1997 and 1998. In spite of falling world markets and negative press the public are still happy to invest in WPE. The assets of life companies are invested across a wide range of investments in order to produce the profits from which bonuses are paid. As well over 50% have traditionally been held in equities bonuses have reduced considerably in the past few years with a few companies not paying any bonus at all. Continuing to pay high bonus rates when underlying investments are not achieving the returns would put too big a strain on the reserves of a life company. The lower Annual and Terminal Bonus rates being paid have affected the returns on maturing policies but not to any great degree and this is clearly illustrated by the table above. A WPE running to its full term does not seem to be a problem and, in spite of the present depressed markets, still offers a good return. But what happens if you no longer want or need your WPE and wish to encash before the maturity date? With a long term contract like a WPE the reasons for wanting to surrender are many and varied; divorce, loan repaid, house sold or simply a need for cash. When you took out the plan you effectively entered a contract to pay a regular premium for a set term and the life company contracted to pay you a Guaranteed Sum at maturity plus the Annual Bonuses and, market conditions permitting, a Terminal Bonus. The life company will allow you to break the contract but will penalize you for doing so. The company will determine the actual cash value, apply a surrender penalty, and then pay out a surrender value. The earlier in the term the policy is encashed the greater the penalty that is applied. A further complication in surrendering a WPE over the last year or two is that the majority of life companies are applying Market Value Adjustments (MVA) or Reductions (MVR). This is just a further penalty and, although most WPE policies have them written into the terms of the contract, it is the first time since the WWII that they have been applied. These MVA/MVR are a reflection of the difficult and prolonged downturn in market conditions that the world is experiencing. The companies are saying 'Yes you can surrender but in order to protect our own reserves and not penalize policy holders who remain invested with us we will apply an additional penalty'. The good news is that over a dozen major life companies have reduced their MVR over the last few months. A sign that times are getting better? Traded Endowment Plans (TEP) The UK second hand insurance market has been around for over 150 years but it really started to take off about 30 years ago. These early market makers quickly realized that they could pay 10 to 20% more than the surrender value, thereby satisfying the seller, and then resell the plan for a profit but still well below its guaranteed cash value, thereby satisfying the investor. The new owner will have the benefit of the capital guarantees contained in the sum assured and attaching annual bonuses which once declared, and as long as premiums continue to be paid, are also guaranteed. The original policy holder gives up all rights to any maturity proceeds, although it is still their life that is insured. If the original policyholder dies then the new owner gets an early payout of the guaranteed sum assured plus attaching annual bonuses and sometime a terminal bonus. The UK secondary life market, as well as being more mature, is also better regulated and in 2002 the UK Financial Services Authority issued Policy Directive 106 which compelled life assurance companies to inform policy holders wishing to surrender that they may get a better price by contacting a market maker. This also has to be stated on any written surrender value quotations sent out to policy holders. This fact plus the continued downturn in markets and resultant reduction in bonus rate has produced a significant increase in WPE hitting the market and at discount prices. It is a buyers market. The TEP market has grown considerably over the years, rising from £60 million traded in 1992 to £550 million in 2002. The Association of British Insurers states that over £14.5 billion of WPE policies were surrendered in 2001 and the Association of Policy Market Makers (APMM), the principal TEP industry association, estimate that between £1 to 2 billion would have been suitable for the TEP market. The APMM also estimate that over £125 million is lost annually by policy holders surrendering rather than trading their policies. These surrendered policies are also lost to would be investors. But with the implementation of FSA Policy Directive 106 and concerted advertising campaigns by the APMM and individual market makers a greater number of both sellers and buyers are becoming aware of the TEP market. A list of reputable market makers is available from the APMM. There are about 15 market makers in the UK of which 8 are members of the APMM.
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