This is a not something that the UK version of Microsoft Money has built into it, and so is difficult to track without some sort of workaround.
What ever you do, make sure the monthly debits are in the bills/deposits area, either through your mortgage payment or as a separate debit. Then at least your monthly cash flow will be much more accurate.
If you cash in your policy early, then things can get really tricky - maybe the easiest way to solve that would be to subtract any cost or charge that you take to cash the policy in (option 2 above). If you don't track the value of the account (option 1 above), and only the debits, then this is a bit easier as you don't have to worry about it.
Keywords: investment, premium, commission, insurance, endowment, loans