An endowment policy is a life insurance contract designed to pay a lump sum after a specific

term (on its 'maturity') or on death. Typical maturities are ten, fifteen or twenty years up to a
certain age limit. Some policies also pay out in the case of critical illness.
Policies are typically traditional with-profits or unit-linked (including those with unitised withprofits funds).
Endowments can be cashed in early (or surrendered) and the holder then receives the surrender
value which is determined by the insurance company depending on how long the policy has been
running and how much has been paid into it.

Traditional With Profits Endowments

There is an amount guaranteed to be paid out called the sum assured and this can be increased
on the basis of investment performance through the addition of periodic (for example annual)
bonuses. Regular bonuses (sometimes referred to as reversionary bonuses) are guaranteed at
maturity and a further non-guarantee bonus may be paid at the end known as a terminal bonus.
During adverse investment conditions, the encashment value or surrender value may be reduced
by a 'Market Value Reduction' or MVR (It is sometime referred to as a market value adjustment
but this is a term in decline through pressure from the Financial Conduct Authority to use clearer
terms). The idea of such a measure is to protect the investors who remain in the fund from others
withdrawing funds with notional values that are, or risk being, in excess of the value of
underlying assets at a time when stock markets are low. If an MVA applies an early surrender
would be reduced according to the policies adopted by the funds managers at the time.

Unit-linked endowment
Unit-linked endowments are investments where the premium is invested in units of a unitised
insurance fund. Units are encashed to cover the cost of the life assurance. Policyholders can
often choose which funds their premiums are invested in and in what proportion. Unit prices are
published on a regular basis and the encashment value of the policy is the current value of the
units.

Full endowments
A full endowment is a with-profits endowment where the basic sum assured is equal to the death
benefit at start of policy and, assuming growth, the final payout would be much higher than the
sum assured.

Low cost endowment (LCE)

A low cost endowment is a medley of: an endowment where an estimated future growth rate will
meet a target amount and a decreasing life insurance element to ensure that the target amount
will be paid out as a minimum if death occurs (or a critical illness is diagnosed if included).

The main thing of a low cost endowment has been for endowment mortgages to pay off interest
only mortgage at maturity or earlier death in favour of full endowment with the required
premium would be much higher.

Traded endowments
Main article: Endowment selling
Traded Endowment Policies (TEPs) or Second Hand Endowment Policies (SHEPs) are
conventional (sometimes referred to as traditional) with-profits endowments that have been sold
to a new owner part way through their term. The TEP market enables buyers (investors) to buy
unwanted endowment policies for more than the surrender value offered by the insurance
company. Investors will pay more than the surrender value because the policy has greater value if
it is kept in force than if it is terminated early.
When a policy is sold, all beneficial rights on the policy are transferred to the new owner. The
new owner takes on responsibility for future premium payments and collects the maturity value
when the policy matures or the death benefit when the original life assured dies. Policyholders
who sell their policies no longer benefit from the life cover and should consider whether to take
out alternative cover.
The TEP market deals almost exclusively with conventional With Profits policies. The easiest
way of determining whether an endowment policy is in this category is to check to see whether
your policy document mentions units, indicating it is a Unitised With Profits or Unit Linked
policy. If bonuses are in sterling and there is no mention of units then it is probably a
conventional With Profits endowment policy. The other types of policies - Unit Linked and
Unitised With Profits have a performance factor which is dependent directly on current
investment market conditions. These are not usually tradable as the guarantees on the policy are
often much lower, and the discount between the surrender value and Asset Share (the true
underlying value) is narrower.

Modified endowments (U.S.)

Modified endowments were created in the Technical Corrections Act of 1988 (H.R 4333, S.
2238) in response to single-premium life (endowments) being used as tax shelters. The Act of
1988 established the 7-Pay Test, which is a stipulated premium that would create a guaranteed
paid up policy within 7 years from policy inception. If premiums paid to the contract go beyond
(i.e. are higher than) the premium amount stipulated then the contract has failed the 7-Pay Test
and is reclassified as a Modified Endowment Contract. The following new tax rules apply to
Modified Endowment Contracts:
Distributions will switch from a First In First Out (FIFO) basis to a Last In First Out (LIFO)
basis. This means that withdrawals will require the policy owner to withdraw taxable gain before
withdrawing untaxable basis.

Policy loans will be realized as ordinary income to the policy owner and could be subject to
income taxes in the year the loan is made.
Distributions (either withdrawals or loans) that go beyond the policy basis will be subject to a
10% penalty tax for policy owners under the age of 59.5 (this can be avoided by the use of a
72(v) distribution)
Transferring funds from a Modified Endowment Contract to a new life insurance policy via the
1035 exchange privilege will render the newly issued contract as Modified Endowment Contract
as well.