Personal Finance: Endowments may not be dead yet
But if you have a doomed endowment mortgage there are still many ways you can mitigate the effects of a policy that may not pay off the final debt on your home, says Hilaire Gomer
Saturday 06 November 1999
At one point, 80 per cent of mortgages were linked to an endowment. These days new endowment mortgages account for around a third of the total as the public has slowly become aware of the shortcomings - unreliability, inflexibility and the expense. Soon that third is likely to be halved, says John Jenkins of the Institute of Actuaries.
Ten years ago, a combination of a tax break on premiums, MIRAS tax relief, high interest rates, higher dividends and inflation softened the impact of expensive, front-end loaded policies. For thousands endowments seemed, and indeed were, a good idea. The opposite is true now. A low inflation and interest rate environment suggest hundreds of thousands of endowment policies will not grow at their once-projected rate and won't be able to pay off the loan at the end of the policy.
Many will have to pay an extra pounds 250 a year to help bridge the gap. The actuaries say 1.3 per cent reduction in yield or RIY was an acceptable maximum rate but only 25 per cent of policies are within this.
The Association of British Insurers say policy holders were made aware of the possible dangers of an endowment being unable to deliver because of the uncertainties of the stock market.
They claim that insurance companies "have broken no promises" and the cost of mortgages has come down in the Nineties. They feel this has more than compensated for any possible shortfall.
Sadly, the actuarial working party did not concern itself with those already with endowment mortgages, concentrating on what guidance there should be for future buyers.
For those, in comparison with the simplest and financially safest method of repayment - the interest and capital repayment mortgage - an interest- only endowment mortgage might be considered as good if:
It has a term of 20 to 25 years. Ten to 15 year endowments are not as good as the repayment equivalent
The costs of the policy need to be kept low
A policy is assessed on the basis of 6 per cent growth a year, rather than the 8 to 12 per cent traditionally quoted and compared with a repayment on the same basis
An endowment could be taken out only by those who take an optimistic view of the stock market during the term of the policy (where 80 per cent of an endowment's sums are invested)
Anyone taking on an endowment must realise it risky, along with other vehicles it might be attached to, such as an ISA tracker fund.
Make any decision in close liaison with an established independent financial adviser, because he may be needed ten years down the line.
But what about endowment policy holders who may discover the policy will need to be supplemented? What can they do to mitigate their problem?
First thing is not to panic. Do not surrender or sell your policy.
Contact your life office and/or your IFA. If you haven't got one, acquire one.
Ask an IFA if you get one of the dreaded letters from a life office informing policyholders their policy has a projected shortfall and they need to pay so much extra a month. Life offices don't give advice, and they will say they don't know enough about the policyholder's personal circumstances to give useful advice. Your policy may not be due a review so if you haven't got a letter and want to know what the situation is, again, contact your broker.
It is unwise to surrender an endowment because you always lose out. Selling it on the second-hand market at a premium to surrender value of 10 to 20 per cent is an option. But find out how this figure compares with a repayment mortgage at the same point using the actuarial working party's 6 per cent growth to give an idea how much you are losing.
There are a number of options your IFA may discuss. First he should assess the amount of risk you are comfortable with, and the extent of your other investments and savings. He may suggest:
1. You top up your premiums to the required amount with other monies, perhaps accumulated from having to pay less in mortgage repayments due to lower interest rates. It may be possible to persuade the broker not to charge for this.
2. You might like to set up a (preferably) low-cost investment ISA, perhaps tracking the share index, which should grow to pay the shortfall.
3. If you can afford it, you may decide to scrap the endowment as a repayment vehicle but keep it for its savings and life and insurance function and switch to a repayment mortgage.
4. You may decide to do nothing at all for the moment and pay the difference from various sources when the time comes. If your pension is released at the same time as the mortgage finishes you could ear- mark funds from the pension to pay off the shortfall.
Remember, no one knows the ultimate worth of an endowment policy. For most policyholders they have ten to 15 years to run so there is plenty of time sort work out a solution.
Bear in mind that higher interest rates and dividends may return, terminal bonuses may be better than projected and the problem may shrivel and even disappear.
one endowment case study
Peter Jackson, 41, an insurance special investigation unit manager, or to you and me a fraud officer, lives with his second wife Marion and their two children Simon and Emma in a dormitory village called Deeping St James, north of Peterborough. In 1991 he was setting up home with Marion and bought their house for pounds 70,000. It is now worth pounds 90,000.
PETER JACKSON explains: I was offered an endowment mortgage by a perfectly adequate one-man band independent adviser. I was in difficult circumstances, given that I had a mortgage already, and the impression I got was if I took a 20-year Axa endowment policy he'd see I got another mortgage. He obviously had a good commission arrangement with Axna. But I was happy with that.
Anyway, abut two years ago I got my first letter from Axa telling me that my policy was running below long-term projections and I needed to start supplementing my payments by pounds 20 a month. I didn't feel particularly alarmed by this development, because it's still got a long way to run.
We are in fact moving house and my current IFA said I could do a repayment, an ISA endowment or an endowment. He said the ISA was medium-risk, the endowment was low-risk and he said nothing at all about the repayment. He did say the actual performance of my Axna policy is absolutely fine and I should have no problems in meeting its maturity target.
On this basis, I reckon that there is no real evidence not to go for an endowment again. I think one of the problems is that the regulators insist the industry revalue all their policies on the basis of a lower projection percentage rate, regardless of what is going on in the market. They create the problem in a sense, but I realise their job is to be very cautious.
I am not the sort of person who has sufficient excess funds not to worry about having a supplementary payment on my endowment. I would be very worried indeed if the demand was a large sum each month because we live pretty carefully, given the fact of alimony. But I feel confident I haven't got a problem with my policy and I'd say to others to find out how their policy is really performing before deciding to make any big change.
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