Endowment Policies and With-Profits Funds: A Guide for Policy Holders

Endowment policies were sold in very large numbers in the UK between approximately 1970 and 1995. Millions of UK homeowners were advised to take an interest-only mortgage and an endowment policy alongside it, on the basis that the policy would grow sufficiently to repay the mortgage at maturity and leave a surplus. For a significant proportion of those policyholders, this projection has not been met.

Whether you hold a legacy endowment approaching maturity, received a letter warning of a projected shortfall, or are simply trying to understand an old policy on a pension or investment statement, this guide explains how these products work and what options you have.

What Are Endowment Policies?

An endowment policy is a life insurance policy with an investment element. It runs for a fixed term (typically 20–25 years, though sometimes as long as 30 years). At the end of the term, the policy "matures" — paying out a sum to the policyholder. If the policyholder dies during the term, it pays the sum assured or the fund value, whichever is greater.

The premiums paid by the policyholder are invested by the insurance company in a with-profits fund — a pooled investment fund that uses an accounting technique called "smoothing" to even out short-term investment volatility.

How With-Profits Works

The with-profits fund invests in a mix of equities, bonds, property, and cash. Rather than passing the investment volatility directly to policyholders (as a unit-linked fund would), the with-profits fund smooths returns using two types of bonus:

Reversionary bonuses (also called annual bonuses): declared by the insurer once or twice a year, added to the policy's guaranteed sum, and cannot be taken away once added. The rate of reversionary bonus is set at a level the insurer believes is sustainable based on the fund's long-run expected returns. During poor investment years, the insurer draws on reserves; in good years, it builds them up.

Terminal bonus (also called a final bonus): added to the policy at the point of maturity, surrender, or death claim. The terminal bonus is not guaranteed — it can vary significantly and can be reduced or removed entirely in poor market conditions. Historically, the terminal bonus has represented a very large proportion of the total payout — sometimes 50% or more of the total maturity value.

The terminal bonus is what makes the decision of when to surrender an endowment policy so significant: surrender the policy before maturity and you typically lose the terminal bonus.

The Mortgage Endowment Shortfall Problem

Mortgage endowment policies were sold with projected maturities based on assumed investment returns. In the 1980s, projections of 12% annual growth were common — reflecting the high inflation environment of the time. As inflation and equity returns fell in the 1990s and 2000s, with-profits funds delivered substantially lower returns than projected.

From the late 1990s, the FSA (now FCA) required insurers to write to policyholders with colour-coded letters indicating projected shortfalls:

• Green: on track to meet the target mortgage sum
• Amber: some risk of shortfall
• Red: likely shortfall against the mortgage target

Tens of millions of letters were sent. Estimated aggregate shortfalls across the UK were in the range of £20–50 billion in the early 2000s estimates, though the actual outcome varied significantly by policy and insurer.

The Mis-selling Dimension

Many endowment policies were sold to mortgage borrowers without adequately explaining:

• That projections were not guaranteed
• That the policy might not repay the mortgage
• That alternative repayment methods (a repayment mortgage) were available

This constituted mis-selling for many policies. The deadline for making mis-selling complaints for most endowment policies has now passed (typically three years from receipt of the red or amber letter, or six years from the sale, whichever is later), but for policies sold more recently, complaints can still be made to the Financial Ombudsman Service if within the time limits.

Should You Keep or Surrender a Legacy Endowment?

The decision depends on several factors:

Surrender Value vs Maturity Value

Obtain your current surrender value from the insurer. This is what you would receive if you surrendered today. Compare this with the projected maturity value at the scheduled maturity date (also available from the insurer).

The gap between the surrender value and the projected maturity value represents the potential benefit of holding on — primarily the deferred terminal bonus.

Market Value Adjustment (MVA)

Many with-profits policies include a Market Value Adjustment (also called a Market Value Reduction or MVR). This is applied at the insurer's discretion when market values have fallen below the with-profits fund's smoothed unit values. It represents the insurer bringing the surrender value back in line with the actual investment value.

MVAs are typically applied in periods of poor investment performance — they were common after the dot-com crash (2000–2002) and the financial crisis (2008–2009). In good market conditions, MVAs may not apply.

Always ask whether an MVA is currently being applied before deciding to surrender.

The Traded Endowment Policy (TEP) Market

You do not have to surrender your policy to the insurance company. There is a secondary market — the traded endowment policy (TEP) market — where you can sell your policy to a third-party buyer for more than the surrender value.

TEP buyers (market makers and investors) pay a premium over the surrender value because:

• They can hold the policy to maturity and receive the terminal bonus
• They can continue paying the premiums to keep the policy in force
• The policy may have a guaranteed sum assured that is valuable to an investor

TEP market makers include specialist firms who will provide a free valuation. The Traded Endowment Policies Association provides a directory of authorised dealers. In some cases, the TEP market value exceeds the surrender value by 5–15%, making it a worthwhile alternative to direct surrender.

Conditions: TEP purchases typically require the policy to have a minimum remaining term (e.g., five or more years), be above a minimum value, and be a standard policy type (some complex variants are harder to sell).

Tax Treatment of Endowment Policies

For qualifying policies (which most regular premium endowments are), the maturity proceeds are not subject to income tax for UK taxpayers. Non-qualifying policies (certain single premium bonds) are subject to income tax on gains. Check whether your policy is qualifying or non-qualifying before making decisions, particularly if you are a non-UK resident.

Unitised With-Profits

Unitised with-profits (UWP) is a more modern and transparent version of traditional with-profits, introduced from the 1990s onwards:

• The policyholder holds a number of units (rather than a guaranteed sum with bonuses)
• The unit price is "smoothed" — increased by bonuses and potentially reduced by MVAs
• The unit price history is visible, making performance easier to track than traditional with-profits
• Bonus rates are applied to unit prices rather than to guaranteed sums

UWP is conceptually simpler and more transparent than traditional with-profits but operates on the same fundamental principle. Major providers offering UWP include Prudential (now known as M&G Prudential), Standard Life, and Aviva.

The Major With-Profits Funds

The largest with-profits funds in the UK include:

Prudential (M&G Prudential): one of the largest with-profits funds globally. The Prudential With-Profits Fund manages tens of billions in assets. Always operated as a PLC (never a mutual), so policyholders do not own a share of the fund's inherited estate.

Aviva: the result of numerous mutual life office mergers (CGNU, Norwich Union, Commercial Union). Large with-profits fund; policyholders who were former mutual members have varying rights.

Standard Life: demutualized in 2006, meaning historical mutual policyholders received windfall shares in the new PLC. Now part of Abrdn (following the Aberdeen/Standard Life merger). The with-profits fund continues.

Legal & General: a PLC, not a mutual. With-profits fund smaller than Prudential but significant.

Phoenix Group: has acquired multiple closed with-profits books, including Pearl Assurance, NPI (National Provident Institution), and others. Phoenix is a specialist in managing legacy insurance books. (Note: Royal London remains an independent mutual — it is not part of Phoenix Group.)

The "inherited estate" (the accumulation of profits held by the insurer over decades beyond the guaranteed liabilities) is a source of complexity — policyholders have varying degrees of entitlement to benefit from the inherited estate depending on the insurer and the policy type.

Practical Steps for Endowment Holders

1. Locate your policy documents: if lost, contact the insurer directly with your name, address, and approximate start date of the policy
2. Request a current surrender value and projected maturity value
3. Ask whether an MVA is currently applied
4. Get a TEP market valuation if the policy has significant remaining term
5. Check whether the policy is tied to a mortgage — if the original mortgage is paid off, the policy can be kept for its investment value or surrendered
6. Consider whether a mis-selling complaint might be viable — check the relevant time limits first
7. For any policy over £5,000: speak to an independent financial adviser before making a decision to surrender

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The information in this article reflects a general understanding of with-profits products in the UK. Individual policy terms vary significantly. Always obtain specific information from your insurer before making any decision about an existing policy. This article does not constitute financial advice.

How Global Investments can help

Global Investments helps clients assess legacy endowment policies and with-profits funds as part of a comprehensive review of their financial arrangements. We can obtain valuations, assess the TEP market option, and advise on the optimal decision given the client's tax position and financial planning objectives. For internationally mobile clients, we consider the UK tax treatment of policy proceeds and how the policy fits within the broader estate plan. Contact our team to arrange a review of any legacy policy.