Under this product, the premiums buy units in the fund of the investor’s choice. This might be run by the life office itself, or it might be a unit trust or open ended investment company run by the life office or another institution.
It has the following characteristics:
- The value of the policy is measured by the total value of the units allocated to it.
- Immediately a policy is effected, its surrender value will be lower than the premium paid. This will be because of the difference between the buying and selling price of the units, usually a percentage and/or because there is an early termination penalty.
- From then on, a policy’s value depends on the performance of the fund, or funds, to which it is linked.
Unit-linked performance
There is a big difference between the performance of the best and worst life offices, and the best and worst unit-linked funds within life offices.
- The more specialized the fund, the greater the chance of spectacular rises in value and also spectacular falls.
- The more broadly based a fund, the more likely it is to conform to an average return and the less likely it is to suffer a disastrous fall.
- There is some evidence to suggest that new funds tend to perform better than average in their early years because their small size tends to make dealing easier.
- There have been problems in the past with small funds investing too high a proportion in one single investment.
It is fair to say that unit-linked policies therefore have a higher risk/reward profile than with-profits endowments. Unit-linked policies maturing when stock market prices are high will normally perform better than with-profits counterparts. However, policies maturing when stock market prices are low may perform badly. Most policies include an extension option so that encashment can be deferred at maturity date until depressed stock markets recover.
