Endowment policies and mortgage endowments

An endowment policy is a savings plan that combines life cover with investing in savings¹. You pay a regular premium, and the policy pays out a lump sum after a fixed period, or earlier if you die within that time¹. Millions of these policies were sold from the 1970s onwards, mostly to people with interest-only mortgages, and many are still running today.

The reason so many people still hold one is that the payout is not guaranteed to match what was promised. When interest rates fall, for example to 5% or 6%, there is an increased risk that the policy will not earn as much as was predicted when it was set up². That gap, between what the policy will pay and what is needed, is the shortfall that worries policyholders. This page explains how these policies work, what is guaranteed and what is not, and what the options are: keep the policy, cash it in, sell it, or complain about how it was sold.

What an endowment policy is: savings plus life cover

A savings endowment policy is a savings plan that combines life cover, sometimes called life assurance, with investing in savings¹. It is a long-term investment: you pay into the plan regularly, and at the end of the policy it pays out a lump sum¹. If you die before the policy ends, it pays out then instead¹. The length of the policy can vary, but it is usually at least 10 years⁶.

Life cover is always included in savings endowment policies³. This is what separates an endowment from an ordinary savings account or investment fund: part of what you get for your premium is insurance, and part is investment. The insurer takes the cost of the life cover from the returns on your investment³, so the insurance element is not billed separately. That cost varies according to how old you were when the plan started, and charges tend to be higher if you were older³.

The investment side pays out a lump sum at the end of the policy term, and the value of that lump sum can go up or down⁴. Unlike a savings account, there is no fixed interest rate building the pot: the premiums are invested, and the final amount depends on how those investments perform and on the bonuses the insurer adds along the way. An endowment mortgage is basically a combination of life insurance and a savings policy⁶, which is why the two products are so often discussed together.

For a broader explanation of how invested products behave, see how investing works, and for the general category these funds sit in, investment funds explained.

Mortgage endowments: repaying an interest-only mortgage

An interest-only mortgage works differently from a repayment mortgage. You pay back the interest on a monthly basis and repay the capital, the original loan, at the end of the mortgage term⁶. With interest-only mortgages, borrowers just repay the interest, with the full loan payable at the end of the term⁷. The monthly cost is lower than a repayment mortgage for the same loan, but the full debt does not shrink: it all arrives at once on the last day.

That is where the endowment came in. Many borrowers took out an endowment policy with the hope that it would repay the capital owed on the mortgage at the end of the mortgage term². The Financial Ombudsman Service describes the same arrangement from the other direction: with an interest-only mortgage, you can use money from different sources to meet the final payment, such as an endowment policy or savings⁸. The endowment was meant to grow into a pot at least as large as the loan.

The route an endowment mortgage was designed to take, and where a shortfall appears.

The rules that govern interest-only lending today reflect how this is meant to work. A mortgage lender may only enter into an interest-only mortgage, or switch a repayment mortgage onto an interest-only basis, if it has evidence that the customer will have in place a clearly understood and credible repayment strategy with the potential to repay the capital borrowed and any interest reasonably expected to be accrued⁹. Where a firm identifies interest-only as appropriate, it must ensure the customer is aware that they will have to demonstrate a clearly understood and credible repayment strategy to the mortgage lender¹⁰. Acceptable strategies include regular deposits into a savings or investment product, periodic repayment of capital from irregular sources of income, and the sale of assets such as another property or other land¹¹. An endowment policy is one example of the first of these.

When assessing affordability, a lender may assess it on the basis of payment of interest only over the term, plus repayment of such capital as may be due, and must consider the cost of the repayment strategy as committed expenditure⁹. The exception is a retirement interest-only mortgage, where the lender may assess affordability on the basis of payment of interest only over the term and need not treat the repayment strategy's cost as committed expenditure¹².

The critical point for anyone still running one of these arrangements is the last box in the diagram: if the policy pays out less than the loan, the shortfall is still owed to the lender. The mortgage does not shrink to match the policy. For what to do about that gap, see the section on cashing in and reducing payments below, and for the wider mortgage context, mortgages.

How with-profits funds work

Most endowment policies invest through a with-profits fund. This is a pooled investment run by an insurer, and the way it pays out is what gives endowments their character. Rather than passing investment returns straight through, the fund adds returns to your policy as bonuses over the years, and the insurer manages the fund so that payouts are spread more evenly than the underlying investments would produce on their own.

One feature of with-profits funds matters a great deal to anyone thinking of moving their money: your money might be invested in funds that pay an extra payment after a certain date, typically called a terminal bonus, which could be lost on transfer¹³. In other words, part of the value shown in a projection may depend on you staying in the fund until the policy's own date. Moving out early can mean leaving that part behind.

With-profits funds also appear in pension products, and the rules treat them specially: benefits under a personal pension scheme are excluded from being eligible pension benefits if they are provided from sums invested in a with-profits fund¹⁴. That is a technical point, but it shows that with-profits money is treated differently from other pension money when a complaint or transfer is assessed.

The dedicated guide to with-profits funds and market value reductions covers how these funds are managed and what happens when you leave one early. For how pooled investments work generally, see investment funds explained.

Bonuses: annual, interim and final

The payouts from a with-profits policy are built from bonuses added over its life. The regular additions, often called annual or reversionary bonuses, are added each year and, once added, form part of what the policy is expected to pay. The final addition, the terminal bonus, is different: it is an extra payment made at or after a certain date, and it could be lost on transfer¹³. A policy's projected value therefore has two layers, one more secure than the other.

Bonus rates are not fixed. They depend on how the underlying fund has performed, and insurers change them as conditions change. The clearest illustration of why is the interest rate environment the policy was priced in: when interest rates fall, for example to 5% or 6%, there is an increased risk that the policy will not earn as much as was predicted². Many older endowments were projected on the assumption that investment returns would stay high, and when returns came in lower, the bonuses added each year were cut, which is why statements started showing lower projected maturity values.

For a policyholder, the practical consequences are these:

• The bonuses already added are the more secure part of the policy's value.
• The terminal bonus is the least secure part, and it can be lost if the policy is transferred or stopped before its date¹³.
• Bonus rates can change from year to year, so a projection is a snapshot, not a promise.
• The annual statement from the insurer shows the current rates and the latest projection.

If a projection has fallen below the amount needed, the shortfall does not have to be met from the policy alone. Options for catching up are covered below, and the wider question of what to do about a mortgage endowment shortfall is the subject of a later section.

Charges and the costs of running the fund

Every endowment policy carries costs, and they come out of the returns rather than being billed separately. The first is the cost of the life cover, which the insurer takes from the returns on your investment³. This cost varies according to how old you were when the plan started, and charges tend to be higher if you were older³. This is why two people paying the same premium into similar policies can end up with different payouts: the older policyholder's money is working harder to pay for the same insurance.

The second set of costs is the cost of running the fund itself. In pooled investments generally, the main types are the ongoing charge figure, an annual percentage of your investments paid to the fund manager; performance fees; trading fees and stamp duty reserve tax; exit fees; and platform fees¹⁵. In a with-profits fund these costs are reflected in the returns the fund produces, which in turn feed the bonus rates. You will not usually see them itemised on an endowment statement; you see their effect in the bonuses.

The third cost is one that only arises if you act on a shortfall by borrowing against your home. If you decide to deal with a shortfall by taking out an equity release arrangement, you will have to pay arrangement fees, which can reach £1,500 to £3,000 in total, depending on the equity release plan being arranged¹⁶. That is a cost of the remedy, not of the policy, but it belongs in any comparison of options.

For how fund charges are disclosed in modern investments, see fund charges and the ongoing charges figure.

What is and is not guaranteed at maturity and on death

What an endowment promises is precise and narrower than many policyholders expect. The policy will pay out after a fixed period or when you die¹. It pays out a lump sum at the end of the policy term, and it also pays out if you die within that time⁴. Those are the two events that trigger a payment, and the life cover element is always included³.

What is not fixed is the size of the lump sum at maturity. The value can go up or down⁴, because the premiums are invested rather than accumulated at a guaranteed rate. The risk that it falls short is real and has been the experience of many policyholders: when interest rates fall, for example to 5% or 6%, there is an increased risk that the policy will not earn as much as was predicted². The terminal bonus, the extra payment a with-profits fund may make after a certain date, could be lost on transfer¹³, so even the projected figure on a statement has a part that is conditional.

On death, the position is different in one important respect: the payment is triggered by the event itself rather than by the fund reaching a target. The policy pays out if you die within the term⁴. How joint policies behave on a death, and what happens to the survivor, is covered in a later section.

For anyone comparing this with products that do guarantee their payments, an annuity is the contrast: annuity payments are guaranteed for your lifetime. An endowment promises a payment at a date or on death, not a guaranteed amount at maturity.

Market value reductions: when you can get back less

A market value reduction, or MVR, is a deduction an insurer can apply when you take money out of a with-profits fund early. Its purpose is to stop someone leaving a fund with more than their share of its value when the fund's own investments have fallen. The result for the policyholder is the same in appearance: you get back less than the figure shown on your statement.

The tax rules recognise a related mechanism. A time apportioned reduction may reduce a gain made on your policy if it was issued by a UK insurer on or after 6 April 2013, or issued before this date and varied or assigned on or after this date¹⁷. This is a reduction applied when a chargeable gain on a life insurance policy is worked out, and it is one reason the tax figure on a cashed-in policy can differ from the cash figure.

The practical points for a policyholder are:

• An MVR can apply when you cash in or transfer a with-profits policy before its maturity date.
• The insurer's terms set out when an MVR applies and how it is calculated.
• The tax treatment of any gain has its own rules, including the time apportioned reduction for policies issued on or after 6 April 2013, or varied or assigned after that date¹⁷.
• Holding the policy to its own maturity date is typically when an MVR does not bite, which is one reason projections assume the term runs its course.

The guide to with-profits funds and market value reductions goes into the mechanics, and for how gains on life insurance policies are taxed, see how investments are taxed.

Cashing in, reducing or stopping payments

If you have been paying into your policy for at least five years but do not want to keep it to maturity, you may get more money for it by selling it than by transferring or surrendering it¹⁸. That guidance, published by Shelter Cymru, is the single most useful comparison for anyone weighing up an exit: surrender, which means handing the policy back to the insurer, is not the only route, and a buyer may pay more.

Selling is only an option if you have endowment insurance⁴, so the first step is to check what the policy actually is. Beyond that, the options group into three:

1. Keep paying and hold to maturity. The policy pays out after the fixed period¹, and the terminal bonus, the extra payment a with-profits fund may make after a certain date, could be lost on transfer¹³.
2. Stop or reduce payments. The effect depends on the policy's terms, and the insurer must tell you what the reduced payout would be. Ask before acting, because the change is not always reversible.
3. Cash in or sell. Surrendering early often returns less than the premiums paid, as the discussion of surrender values below shows, and selling may bring in more¹⁸.

If the reason for considering an exit is a projected shortfall, there are ways to close the gap without giving up the policy. Catching up can mean increasing payments into the policy, switching part of the mortgage to repayment, or using other savings. Where equity release is used as the remedy, arrangement fees can reach £1,500 to £3,000 in total, depending on the plan being arranged¹⁶.

One point that surprises many people: you may be able to complain about how the policy was sold even if you have already sold or cashed it in⁵. Exiting the policy does not close off the complaints route, which is set out in full in the final section.

For the wider question of whether invested money is working for you at all, see when investing makes sense instead of saving.

Joint endowments and what happens on death

Joint life insurance is a policy taken out by two people, typically a couple, that pays out upon the death of the first policyholder during the term, and the policy then ends, so it does not cover the surviving partner¹⁹. This matters for a joint endowment: the death benefit is paid on the first death, and the survivor is left without the life cover element of the policy.

The main disadvantage of joint life insurance is that you get only the single payment per policy, even if both policyholders die during the term¹⁹. There are two forms: first-to-die pays out on the first death, while second-to-die, sometimes called survivorship, pays out after both policyholders have passed away¹⁹. A slightly different policy, dual life insurance, sometimes called joint life second death insurance, pays out only if and when the second person dies during the term, and is usually used to cover a large inheritance tax bill¹⁹. Joint life policies pay out on the first partner's death, while dual life policies pay out on the second partner's death²⁰.

For a joint endowment held against a mortgage, the first-death payout is the feature that matters: it is designed so that if one borrower dies, the policy pays out and can be used towards the loan, leaving the survivor with a smaller or cleared debt rather than continuing cover. What the survivor does not get is a second payout later.

For the wider picture of life cover types, see types of life insurance policy and the guide to protection insurance.

Complaints and where to get help

If you believe you were misled when the policy was sold, for example about the payout being guaranteed or about the risk of a shortfall, you may be able to make a complaint against the person or company who sold you the endowment policy, and in some cases you might be able to get compensation². Complaints about endowment mis-selling were one of the largest categories the Financial Ombudsman Service has handled: in 2008/09 it opened 3,515 whole-of-life policies and savings endowments complaints²¹, and in 2010 it recorded 4,199 new cases, with mortgage endowments accounting for a 24% share of investment and pension complaints in 2009/2010²².

The route a complaint takes, and who handles it at each stage.

The process runs in a fixed order:

1. Complain first to the company or adviser that sold you the policy. This could be the endowment company itself or an intermediary broker⁵.
2. Wait for the firm's response. All companies selling financial products have to have a proper complaints procedure and have to provide information about how to use it⁵.
3. Take it to the Financial Ombudsman Service if you are not satisfied. If you aren't satisfied with the response you get, you may be able to make a further complaint to the Financial Ombudsman Service⁵.

Two rules shape the detail. The policy summary for an insurance contract must state how to complain to the insurer and that complaints may subsequently be referred to the Financial Ombudsman Service²⁴. And the Financial Conduct Authority itself does not take complaints about the firms it regulates: complaints about firms it regulates are outside its Complaints Scheme, which covers its rules and guidance and the actions of the ombudsman service and other bodies²⁵.

Free, impartial help is available: MoneyHelper offers guidance on financial matters, and the Financial Ombudsman Service is free to use. For mis-sold investments more generally, see mis-sold investments and bad investment advice, and for the wider framework, consumer protection in UK financial services.