U6: T21 - USING ENDOWMENT POLICIES FOR MORTGAGE REPAYMENTS

Question 1

An endowment policy involves what 2 characteristics?

Answer 1

1) Life insurance
2) Investment Element

Question 2

What are the 2 types of with-profits endowment policies?

Answer 2

1) Full with profits
2) low-cost with profits

Question 3

What does the reserve on an endowment policy allow the endowment policy to do?

Answer 3

Pay bonuses when fund performance would not usually allow them to

Question 4

Define GSA

Answer 4

Guaranteed sum assured, the amount that will be paid on maturity (or death if this occurs earlier), assuming premiums are paid as required.

Question 5

Define Smoothing

Answer 5

Creating a reserve in years of good fund growth rather than paying all the growth out in bonuses, so that in poorer years it may still be possible to pay a bonus.

Question 6

Which of the two endowment policies have terms most clearly laid out?

A) With-profit
B) Unit-linked

Answer 6

Unit-linked

Question 6

Which of the two endowment policies have terms most clearly laid out?

A) With-profit
B) Unit-linked

Answer 6

Unit-linked

Question 7

What was the endowment originally intended to support interest-only mortgages?

Answer 7

Full with‐profits endowment is the original product designed to support interest‐only mortgages.

Question 8

Which of the following guarantees mortgage repayment at the end of the term?

A) Full with-profits
B) Low-cost with-profits

Answer 8

A) Full with-profits

Question 9

Which of the following has decreasing term assurance into the endowment?

A) Full with-profits
B) Low-cost with-profits

Answer 9

B) Low-cost with-profits

Question 10

A low-cost with profits gives the possibility of there being a surplus above a mortgage at the end of the endowment term. True or false

Answer 10

True

Question 11

Bonuses are guaranteed for low-cost with profits endowments. True or false

Answer 11

False. Bonuses are not guaranteed

Question 12

With low-cost with profit endowments it is often difficult to identify product charges. True or false

Answer 12

True. Often difficult to identify product charges

Question 13

Terms can be extended on low-cost with profit endomwments. True or false

Answer 13

False.

Inflexible policies: term cannot be extended and increasing premiums may not be possible

Question 14

What provides the potential for higher returns than with‐profit policies?

Answer 14

Unit-linked policies

Question 15

An endowment policy with no GSA is:

A) With-profits
B) Unit-linked

Answer 15

B) Unit-linked

The policy value is linked directly to the performance of the policyholder’s chosen investment funds, which can result in higher returns if the funds perform well, but there is no ‘bottom line’ guarantee such as the GSA provided by a with‐profits policy.

Question 16

For unit-linked policies, the only guarantee is that the policy will pay a guaranteed death benefit equal to the mortgage amount if the insured dies during the term. True or false

Answer 16

True

Question 17

For unit-linked policies apply smoothing. True or false?

Answer 17

False.

The value of units (accrued via Premiums) is directly related to the performance of the fund, so there is no smoothing effect because growth (or loss) is directly reflected in unit prices.

Question 18

Endowment policies with no bonuses are which kind of policy?

Answer 18

Unit-linked policies

Question 19

Unit-linked endowment include life cover. True or false

Answer 19

True. Premiums buy units in the fund which pays for life cover, admin and benefits

Question 20

The surrender value of a unit-linked policy is paid by:

A) The buyer
B) The seller
C) The fund

Answer 20

C) The fund

Question 21

The surrender value of a unit-linked policy is the:

A) The bid
B) The offer

Answer 21

The bid

Question 22

If you can adjust the premiums paid on an endowment policy, it must be:

A) A full with-profits policy
B) A low-cost with-profits policy
C) A unit-linked policy

Answer 22

C) A unit-linked policy

Question 23

If an investor has a say over how their policy is invested it must be:

A) A full with-profits policy
B) A low-cost with-profits policy
C) A unit-linked policy

Answer 23

C) A unit-linked policy

Question 24

Charges of unit-linked policies are clearly stated. True or false

Answer 24

True

Question 25

Tax is payable at maturity of a unit-linked policy. True or false

Answer 25

False - no tax is payable

Question 26

Unit-linked endowment policies typically have high charges. True or false

Answer 26

True

Question 27

If endowment premiums are paid into both variable and fixed units. The policy must be?

Answer 27

Unitised with profits endowment

Question 28

If a Unitised with profits endowment is encashed will it be subject to a market value adjuster (MVA)?

Answer 28

Yes as with other with-profit endowments

Question 29

What is meant by a ‘qualifying’ life policy and the advantages it offers over non‐qualifying policies?

Answer 29

The term ‘qualifying policy’ relates to its tax treatment. There is no tax payable on the proceeds of such a policy on death or maturity.

Question 30

What is the criteria a life policy must meet in order to be a qualifying policy?

Answer 30

Premiums must be payable annually, half‐yearly, quarterly or monthly for at least ten years.

If premiums cease within ten years, or three‐quarters of the original term if this is less than ten years, the policy becomes non‐qualifying.

Sum payable on death must be at least equal to 75 per cent of the total premiums payable.

Premiums in any one year must not exceed twice the premiums in any other year, or one‐eighth of the total premiums payable.

Question 31

Once added to the GSA, reversionary bonuses:

a) cannot be removed but may be reduced if the policy is surrendered early.
b) cannot be removed but may be reduced if the policyholder dies before the policy reaches maturity.
c) may be removed if the policy is made paid up.
d) cannot be removed or reduced in any circumstances.

Answer 31

A) Reversionary bonuses cannot be removed but may be reduced if the policy is surrendered early.

Question 32

What is meant by ‘smoothing’?

Answer 32

‘Smoothing’ refers to the building up of a reserve when fund performance is good, with the aim of ensuring that when fund performance is poor it is still possible to pay some level of bonus, ie it reduces the potential variation in the level of bonus paid across a number of years.

Question 33

A low‐cost with‐profits endowment guarantees to repay the mortgage on the death of the borrower. True or false?

Answer 33

True. A low‐cost endowment guarantees to repay the mortgage on the death of the borrower through the automatic inclusion of sufficient life cover.

Question 34

The low‐cost with‐profits endowment has reduced premiums for the first five years. True or false?

Answer 34

False. It is the low‐start low‐cost with‐profits endowment that has reduced premiums for the first five years.

Question 35

In what ways does a unit‐linked endowment differ from a with‐profits endowment?

Answer 35

he unit‐linked endowment does not have a GSA at maturity.

The maturity value is the bid value of the units, which may or may not be enough to repay the mortgage.

With‐profits plans have a GSA, although in the case of the low‐cost version it will not be as much as the mortgage.

The unit‐linked endowment is flexible, in that the premiums and sum assured can be changed (within limits). The with‐profit endowment sum assured and premium are fixed at the start and cannot be changed.
The unit‐linked endowment allows the investor to select from a range of funds, while the with‐profit endowment offers only the with‐profits fund.

In the event of early encashment, the unit‐linked plan will pay the bid value of units. There will sometimes be a surrender penalty in the early years, as stated in the policy terms. The with‐profits plan’s early surrender value is worked out by actuaries and is unlikely to represent the plan’s value at the time or include the bonuses added to date. The company might also impose a market value adjustment.

The charges on a unit‐linked endowment are ‘transparent’ – that is, clearly stated in the policy terms. Other than a policy administration fee, the charges on a with‐profit fund are taken from the fund and are worked out by the actuaries.

Question 36

Unit‐linked endowments can usually be extended to a longer term if there is a shortfall in the amount needed for repayment. True or false?

Answer 36

True: most unit‐linked policies can be extended to compensate for a shortfall, subject to qualifying rules.

Question 37

Which of the following types of unit‐linked fund is most commonly used for investment for mortgage repayment purposes?

a) Fixed interest.
b) UK equities.
c) Managed.
d) Property.

Answer 37

c) Managed (also known as balanced) funds are most commonly used in relation to investments intended for mortgage repayment.

Question 38

If a borrower’s endowment policy seems likely to result in a shortfall, the mortgage can be converted to the repayment method with the agreement of the lender. True or false?

Answer 38

True: converting a mortgage to repayment is the safest method of ensuring a full repayment, although it may be expensive.

Question 39

Gavin is a CeMAP-qualified mortgage adviser with no other financial services qualifications. In relation to endowments, he can:

A) provide a customer with information about the product.
B) make recommendations to a customer about the product.
C) provide an execution-only service to allow the customer to arrange an endowment.

Answer 39

A) provide a customer with information about the product.

Only qualified financial advisers can provide recommendations on investment products.

Question 40

Jack and June would like to arrange an endowment-backed interest-only mortgage to buy their house. It should be set up using:

A) two ‘single life’ policies.
B) a ‘joint life first death’ policy.
C) a ‘joint life second death’ policy.

Answer 40

B) a ‘joint life first death’ policy.

If a mortgage is arranged in joint names, any endowment should be set up on a ‘joint life first death’ basis, which will pay out when the first joint owner dies and allow the survivor to pay off the mortgage. A ‘joint life second death’ policy would provide the death benefit when the second person died, which is too late.

Question 41

With a with-profits endowment, the fund manager will:

A) take a relatively cautious approach to investment.
B) invest only in guaranteed investment areas.
C) take a significant element of risk to achieve growth.

Answer 41

A) take a relatively cautious approach to investment.

The manager will take a relatively cautious approach to investment, but will make some investment in areas such as stocks and shares that do not provide guarantees. They are unlikely to take significant risks, due to the guarantees and liabilities provided by this type of fund.

Question 42

Julian has a low-cost with-profits endowment to support his interest-only mortgage. His reversionary bonus is likely to be added to the policy:

A) each day.
B) each month.
C) each year.

Answer 42

c) each year

Reversionary bonuses can be calculated in a number of ways and are usually added to the policy each year.

Question 43

Assuming all were set up to cover the same mortgage, which type of endowment would guarantee to repay an interest-only mortgage on maturity?

A) Low-cost with-profits endowment.
B) Full with-profits endowment.
C) Unitised with-profits endowment.

Answer 43

B) Full with-profits endowment.

A full with profits endowment has a guaranteed sum assured equal to the mortgage, so if premiums are maintained the maturity amount will be at least equal to the mortgage. Both low-cost with-profits and unitised with-profits endowments have a guaranteed sum assured lower than the mortgage and rely on bonuses, which are not guaranteed, to meet the maturity target.

Question 44

A potential advantage of a unit-linked endowment over a low-cost with-profits endowment is that:

A) there is a choice of investment funds.
B) the guaranteed maturity value is usually higher.
C) bonuses may be higher if the fund performs well.

Answer 44

A) there is a choice of investment funds.

Unit-linked endowments offer a range of funds, while with-profits offer just one fund. While the guaranteed sum assured on a with-profits plan will be paid on maturity, there is no such guarantee on a unit-linked plan. Unit-linked plans do not offer bonuses.

Question 45

The death benefit on a unit-linked endowment is:

A) guaranteed and comprises the plan’s value on death plus variable term assurance.
B) guaranteed and provided by a form of level term assurance.
C) not guaranteed and comprises the bid value of units at the time of death.

Answer 45

A) guaranteed and comprises the plan’s value on death plus variable term assurance.

The death benefit is guaranteed and comprises the plan’s value on death plus variable term assurance to plug the gap between the guaranteed death benefit and the unit value.

Question 46

For a typical 25-year unit-linked endowment, policy reviews would occur after:

A) 5, 10 and 20 years and then annually.
B) 10, 15 and 20 years and then annually.
C) 10 years and then annually.

Answer 46

B) 10, 15 and 20 years and then annually.

Question 47

Which of the following statements about qualifying unit-linked endowments are true? Select all that apply.

A) Investors buy units at the bid price.
B) There is no tax to pay on maturity.
C) Maturity benefits are partially guaranteed.
D) The death benefit is paid for by a separate charge on the plan.
E) It may be possible to stop, restart or alter premiums.
F) Good fund growth may mean the mortgage could be paid off early

Answer 47

B) There is no tax to pay on maturity.
E) It may be possible to stop, restart or alter premiums.
F) Good fund growth may mean the mortgage could be paid off early

Units are bought at the offer price. There is no maturity benefit guaranteed. The death benefit is paid for by cashing in units from the plan. See sections 17.3–17.3.2.

Question 48

A unitised with-profits plan offering ‘fixed units’ fixes the value of units on purchase, and:

A) does not add bonuses.
B) adds bonuses by buying more units.
C) adds bonuses by increasing unit values.

Answer 48

B) adds bonuses by buying more units.

With fixed units, bonuses are added by buying more units at the current price.

Question 49

Which of the following courses of action would be the least prudent if a unit-linked endowment policyholder received a red letter from the insurer?

A) Increase the endowment premiums.
B) Switch the projected shortfall to a capital repayment basis.
C) Convert the mortgage to a capital repayment basis.

Answer 49

A) Increase the endowment premiums.

There are a number of approaches, but increasing the endowment premium would not guarantee a sum sufficient to repay the mortgage, and given the existing performance the policyholder would not have much confidence in this approach. Converting some or all of the mortgage to a capital repayment basis would provide a higher level of security.

Question 50

‘Smoothing’ refers to the building up of a reserve when fund performance is poor. True or false?

Answer 50

False

‘Smoothing’ refers to the building up of a reserve when fund performance is good, with the aim of ensuring that when fund performance is poor it is still possible to pay some level of bonus, ie it reduces the potential variation in the level of bonus paid across a number of years.

Question 51

In which of the following ways does a unit‑linked endowment differ from a with‑profits endowment?

A) The unit-linked endowment has a GSA at maturity.
B) The unit-linked endowment does not have a GSA at maturity.
C) The unit-linked endowment is regulated by its own sourcebook.

Answer 51

B) The unit-linked endowment does not have a GSA at maturity.

The unit‑linked endowment does not have a GSA at maturity. The maturity value is the bid value of the units, which may or may not be enough to repay the mortgage. With‑profits plans have a GSA, although in the case of the low‑cost version it will not be as much as the mortgage.