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What
is a TEP?
A Traded
Endowment Policy (TEP) is a mid-term with-profit endowment no longer
required by the original policyholder who has sold it on the open market at
a price greater than the surrender value.
Whilst some
endowment policies were simply regular premium savings plans, the vast
majority of endowment policies were taken-out by the original policyholders
as a means of repaying a mortgage. However, a large number of policies are
either surrendered early to the issuing life company or they are sold
through the Traded Endowment market.
It is
estimated that only around 30% of endowments are held to maturity by the
original policyholders and about 30% are cancelled or surrendered in the
very early years. The remaining 40% are either surrendered or sold in the
mid to late term of the policy. Not all policies can be sold. There is, for
example, currently no market for unit-linked or unitised policies.
The Traded
Endowment market exists because the surrender values quoted by many life
offices do not fully reflect the true value of the policy as a continuing
contract and many investors are willing to buy policies for more than the
surrender value because they recognise such policies represent a low to
medium risk investment opportunity. Examples are pension funds and investors
looking for a guaranteed return at a future date in time.
The
mechanics of the process.
Endowment
policies are normally taken out for a specified term, usually between 10 and
25 years, but occasionally longer. They are taken out for an agreed amount,
the ‘basic sum assured’, which is the guaranteed figure the life office will
pay out at maturity or on the earlier death of the life assured. The
policyholder pays a regular premium to the life office, which is invested to
provide the plan benefits. Life office with-profit funds are invested in a
wide range of asset classes such as fixed interest securities, property and
equities (both UK and overseas) and the investment managers are able to make
long-term investments. However, the returns are not guaranteed.
In addition
to the basic sum assured, with-profit policies receive a share of the
profits earned from the investments in the with-profit fund. There are two
ways that life offices distribute these profits.
-
An ‘annual or
reversionary’ bonus normally added to the basic sum assured each year,
which once added cannot be reduced or taken away.
-
A ‘terminal’ bonus that
is added at the end of the policy term, or on the earlier death of the
life assured.
With-profit
policies benefit from a technique known as ‘smoothing’ which basically means
that in years of good investment performance not all of the investment
growth achieved in the with-profit fund is paid out as bonuses. Some is held
back in reserve so that bonuses do not necessarily have to be reduced in
years of poor investment performance. However smoothing can only go so far
and in prolonged bear market phases such as 2000-2003 many insurance
companies with-profit funds reserves have been depleted to the extent that
most have reduced bonuses. As investment conditions improve and the reserves
replenish, increases in bonus rates should return.
Bonus rates
depend on the investment performance of the life offices, the strength of
the life offices, which has a bearing on asset allocation of the with-profit
fund, and the way they choose to allocate profits.
When an
investor buys a traded endowment policy he is buying an existing investment
which comes which a number of benefits:-
-
The vast majority of
the charges inherent in the policy are incurred in the first few years and
these have effectively been paid by the original owner.
-
The policy will also
have several years reversionary bonuses already attached to it (once added
these cannot be reduced or taken away).
-
The policy will also
participate from future reversionary bonuses (increasing the guaranteed
value) and normally a final terminal bonus.
-
The policy can be used
as security against a loan.
Trading
and ownership responsibilities
There are a
number of companies who specialise in traded endowment policies and have
developed sophisticated valuation systems enabling investors to purchase
TEPs at rates that provide the potential to achieve attractive returns from
low risk and sometimes no-risk investments. Trading is very simple and can
be completed in a very short period of time.
When an
investor buys a policy it is legally assigned to the new owner who takes on
the responsibility for future premiums.
The life
assurance element of the policy remains on the original life assured. When
the policy reaches maturity (or if the original life assured dies) all the
benefits are paid to the new owner. |
