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:
As with other interest only mortgages, you still make
interest payments on the full value of the loan until the
end of the term.
However, the bulk of your premium is used to buy units
in a managed fund at the prevailing market price. 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.
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-profit endowment and a greater
risk of failure to meet investment objectives.
Life offices 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.
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 assurance 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.
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.
