Wednesday, July 9, 2008

FAQ: Traded Endowment Policies

1. What is a traded endowment policy?

A traded endowment policy is a policy that is sold by the policyholder to an investor. The investor pays a sum that is higher than the surrender value offered by the insurance company.

The investor will continue to pay the premium under the policy and will collect the death or maturity benefit on the policy.

The investor expects to get a good rate of return on the amount paid to buy over the policy, and the future permiums paid.

2. Is it advisable to invest in a fund of traded endowment policies, where the fund manager undertakes to manage these policies?

It depends on the following:

> Is the fund manager reliable and trustworthy?
> What are the charges taken away by the fund manager?
> What is the underlying gross and net yield of the fund, after deducting the charges?
> What is the underlying risk of the traded endowment policies?

3. What is the underlying risk of the traaded endowment policies?

These traded endowment policies carry the following risks:

> The future bonuses paid under the policies may be reduced.
> The insurance company may become insolvent
> The fund manager may overlook to keep the policy in force, leading to its termination

These risks have to be factored in considering the net yield on the fund.

4. What is a satisfactory rate of return, considering the risk?

If the investment is in the UK, you should compared the expected yield on the traded endowment fund with the yield from UK Government Bonds.

You should expect to get at least 2% to 3% higher than the bond yield of similar duration, to compensate for the higher risk.

If the fund has a duration of 5 years and the UK bond yield for 5 years is 5%, you should expect to get a net yield (after deducting the fund manager’s fees) of 7% or 8% from the traded endowment fund, to make it worth the risk.

5. Do you invest in traded endowment policies?

I avoid investing in this type of policy as I am not familiar with the risk, the yield and the integrity of the fund manager.

I prefer to invest in Government bonds or equities, as these products are traded on the exchange and there is liquidity. flexibility and price transparency.

Tan Kin Lian