Similarly, to the above, a with-profit endowment has a fixed basic sum assured and a fixed regular premium. The premium, however, is higher than that for a non-profit policy of the same sum assured, and the additional premium entitles the policyholder to have a share in the profits of the life assurance company.

If the person invests a lump sum or saves regularly, using a life insurance policy, a with-profits fund may be opted for. The aim of this is to give you a return or dividend linked to the stock market but with less fluctuation than a direct shares investment. This involves a high level of complexity and is therefore not as popular as they were in the past.

The company divides its profits among policyholders by declaring bonuses periodically. These increase the value of the policy, and are payable at the same time and in the same circumstances as the sum assured.

With-profits policies are offered by insurers as a medium to long-term investment. The individual’s investment is added to a pot of money alongside other people’s ,and invested in the insurance companies with-profits fund, which is managed by a professional fund investment manager – who invests it in a variety of schemes such as shares, cash, bonds and property.

There are two types of bonus.

Reversionary bonuses – these are typically declared on a yearly basis and, once they have been allocated to your policy, they cannot be removed by the company, provided that the policy is held until the end of the term (or early death).

Some companies just declare a simple bonus, where each annual bonus is calculated as a percentage of the sum assured; others declare a compound bonus, with the new bonus being based on the total of the policy assured sum and the previous bonuses.

Most reversionary bonuses are placed at a level that they hope to be able to maintain for a significant period of time, in order to level out the short-term variations of stock markets. A trend of falling bonus rates over the last few decades means that bonus rates are considerably lower than they were in the 1980s and 90s.

Terminal bonuses –are bonuses that may be given in addition when a death or maturity claim becomes payable. Unlike reversionary bonuses, a terminal bonus does not become an actual part of the policy benefits until death or the point of a maturity claim, thus allowing the company to adjust or change the bonus rate – or sometimes remove the terminal bonus altogether. Terminal bonuses are intended to reflect the level of investment gains that the company has made over the term of the policy, so the rate of bonus can often vary according to the length of time that the policy has been in force. In the last few decades, many companies have reduced the amount given in terminal bonuses.

The running costs are deducted from the fund and the remainder (the profit) is then available to be paid to the investors, and a share of the annual bonuses are added to the policy.

The company attempts to avoid large changes in bonus sizes from one year to another by retaining some of the profits from good years in order to bump up the profits in the bad years, using a process called ‘smoothing’.

‘With-profits’ is the term is used to describe a policy that pays bonuses to the plan. When referring to mortgages, a full with-profits policy defines a policy set up with an initial sum assured that is equal to the mortgage debt. On death, or at the end of the term, the worst possible scenario is that the mortgage is fully repaid. If bonuses have been added then these will raise an additional sum over and above the mortgage when the policy pays out.

When your policy matures you may get what is called a “terminal bonus”, but it is advised to ask for further details about bonuses before buying the policy.

The amount of profit that is earned is dependent on the performance of the investments in the with-profit fund in most policies.

Once bonuses have been added they can’t normally be taken away. If you decide to surrender early, the insurer may apply a Market Value Reduction (MVR) or Market Value Adjustment (MVA) to the policy which may limit some or even all of the bonuses paid. During occasions such as a stock market crash, this is most likely.