Unit-linked endowment policies were specifically designed
for use with mortgage repayment and are being offered by
life offices more and more. They differ quite substantially
from with-profit endowments in the way they work but also
carry a reasonable degree of risk:
As with other endowments, you still make interest payments
on the full value of the loan. However, you are not locked
in to this type of endowment by annual and terminal bonuses.
Instead, the borrower is able to cash in the policy and
repay the mortgage as soon as the investment element has
accumulated enough to repay the whole mortgage amount.
Your premiums are used to buy units in a managed fund
at the prevailing market price. An assumed rate of growth
for the value of the units is used to predict a necessary
level for your monthly repayments. The number of units you
hold increases over time as more and more premiums are paid.
The value of these units can fluctuate in line with the
investment performance of the fund.
Not all the premium goes towards investing and units.
Some of the units are cashed in to buy life cover. As with
other endowments, the life insurance element is there to
ensure that the full loan can be repaid if you die. With
this type of endowment, however, the level of cover required
fluctuates depending on the value of the units. The amount
of cover required is the guaranteed death sum assured (amount
needed to repay the loan) minus the current surrender value
of the policy. As the policy value rises, the amount of
life cover (and therefore the amount of your premium needed
to purchase it) decreases.
There is no guaranteed annual growth rate caused by the
additional of annual reversionary bonuses. In a year of
poor investment performance, the value of your endowment
may drop considerably. Equally, in a successful year, the
value of your unit holding may rise dramatically. This means
that a unit-linked policy has both the potential for greater,
faster growth than a with-profits endowment and a greater
risk of failure to meet investment objectives.
Providers differ in the percentage of your premium that
is used to buy units. Whatever percentage is used, it will
take a few years for your premiums to start buying any significant
volumes of units - charges and commission payments eat up
much of the premium in the first few years. Once you have
built up a significant volume of units, you will start to
receive an annual unit allocation statement showing your
holding of units and their current bid price, or how much
you can sell them for. This means that it is possible to
gauge exactly how much the policy is worth at any point
in time.
The investment performance of the fund is reviewed at
set intervals and the level of your payments can be altered
accordingly. Unlike other types of endowment, a unit-linked
policy can allow you to pay off the loan early. Since there
are no bonuses to be added during the course of the term
or at the maturity date, the encashment value of your units
at any point in time is the value of your policy. If this
reaches the value of your loan, you can cash it in and repay
the loan.
