Traded endowment policies (Teps) remain popular, but developments such as the increasing number of Te...
The current Teps market is almost exclusively in traditional with profits endowment policies, where there is a large gap between the surrender value offered by the life company and the price the market will pay. As this type of policy has been replaced with unitised policies there is a long-term liquidity problem, as more and more policies are surrendered or mature. In addition, the increasing popularity of Tep mutual funds is affecting the market's short-term liquidity.
Despite the growing awareness among policy holders that there is an alternative to surrendering their policies, there are still more buyers than sellers.
Traditional pre-1990s endowment policies are difficult to value. There are two components to the policy - the investment side that increases as premiums are paid and a decreasing term assurance, usually paid out on the death of the policyholder. Together these cover at least the cost of the mortgage. Eventually the decreasing term assurance vanishes and the policy becomes a pure investment - if a policyholder decides to sell mid-term, it is this component that is of real interest to the policy market.
For traditional policies, the life company 'smooths' returns. It deliberately understates the annual or 'reversionary' bonus it determines at the start of each year to ensure a consistent annual bonus even after a market disaster. As long as there is no serious long-term underperformance, the terminal bonus should then make up for all the low yearly returns.
The standard industry method of determining the value of a Tep is to sum all the reversionary bonuses to date and make the assumption that they will continue to be paid at the same rate. Added to this is the average terminal bonus of similar Teps currently maturing. The final result, given similar market conditions, should be close to correct. The true valuation is only determinable after the Tep matures.
Closed-ended Tep funds are similarly determinable as the Teps mature at the end of the fund's lifetime. However, the appearance of open-ended mutual funds has confused this situation as there is no final reckoning. This is because as the Teps mature, they are replaced.
The advantage to the investor of an OEIC Tep fund is that there are no fixed maturity dates for investors - a flexibility only possible through owning a large number of policies constantly being replaced. On the negative side, the need to have so many policies potentially puts pressure on fund managers to pay more for Teps to ensure quantity, especially during periods of illiquidity. This makes the whole market more expensive.
There is currently something like a 17% gap between the surrender value of a policy - the amount the life company will pay - and the value of selling the policy on to someone else. The presumption is that the secondary investor will continue to pay premiums and hold on to the policy until maturity, thereby reaping its full benefits.
Morris Burgoyne, managing director of Policy Register International and chairman of the Association of Policy Traders, said: "Insurance companies are judged by the
amount of assets under management and persistency rate. It is much better for a life company to keep hold of current business than to have to send a salesperson out to replace the business you just let walk through the door."
So, to deter policyholders from surrendering, the company actuaries keep surrender values low.
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