From shortfall to chasm for endowments

James Mawson asks what policyholders should do as projected returns get worse

All over the country, people are being reminded to ask themselves what would happen to their wealth if they suffered a blow to their health. City watchdog the Financial Services Authority (FSA) began advertising in 6,000 doctors' waiting rooms last week. Its posters issue a warning about the dangers of ignoring your financial well-being, particularly when it comes to repaying your mortgage.

For up to six million people, this message is painfully close to home. Between them, they hold more than 9 million mortgage endowments, policies that were designed to provide a lump sum on maturity to cover the capital they borrowed from mortgage lenders to buy their homes.

All they are currently paying back to the lenders each month is the interest on the loans; the capital must be repaid in full at the end of the mortgage terms.

Most people know by now that many mortgage endowment policies are likely to fail to live up to the promises made by the salesmen. Of the estimated £350bn borrowed to purchase properties, the shortfall could be £100bn, or £11,000 per policy, according to research by Ned Cazalet, an independent consultant.

This is a much higher estimate than the earlier assumptions made by trade bodies, which had forecast a possible average £3,000 shortfall per policy.

This potential chasm has arisen as a result of the assumptions made when the policies were sold. High interest rates and inflation meant investment returns on policies were higher in the 1980s and 1990s, but falling inflation has reduced bond yields and since 2000 the stock markets have been disappointing.

This has encouraged endowment providers to be more cautious, moving away from equities into bonds, which are safer but tend to produce lower returns. Mr Cazalet says that, as a result, even 6 per cent growth on policies this year could be over-optimistic: 4 per cent might be more realistic. And this in turn could mean an average shortfall of £14,000 per policy. Eagle Star started writing to its 130,000 endowment holders last week informing them that returns this year would probably be 3.75 per cent, instead of its previous assumption of 6.25 per cent.

Some people with endowments may have been encouraged by the recent recovery in shares. But Mr Cazalet believes this will have "bugger all" impact.

However, John Barton, an endowments expert at Lambourne Consulting, which is helping insurers review complaints relating to the policies, believes that rising markets will help people who still have some years to go before their policies mature and so time to benefit when their insurers switch back into shares. An equity revival will also feed through directly to the 20 per cent of unit-linked mortgage endowment customers, although those holding with-profits endowments will see a more modest effect owing to actuarial smoothing.

Garry Morrison, the director of life servicing at Standard Life, the biggest seller of mortgage endowments with 1.4 million policies, says: "It is important not to trivialise the issue but to keep in context that rising markets lead to any potential shortfall being less or disappearing completely. [As a result,] in August we improved the surrender value offered to clients by the order of 10 to 15 per cent.

"Ned Cazalet's numbers have highly speculative assertions," he adds. "But we encourage policyholders to do something, to pay in more - and not just to the endowment.

"For our average policyholder, with nine years to maturity, an extra £56 a month into repaying the mortgage would eliminate any shortfall. For a typical £60,000 mortgage, interest rate cuts since September 2001 alone mean they are saving £50 a month on their outgoings."

An estimated 41 per cent of people affected by potential shortfalls have enough alternative savings to cover the gap, according to the Association of British Insurers. But for those who haven't, the FSA is encouraging endowment holders to "act now" as the situation could get worse.

While many endowment holders understandably feel wary about putting more money into their policies, there are other ways to address the problem. The FSA suggests switching the amount of the projected shortfall to a repayment mortgage (and if necessary buying life cover). Or policyholders could ask their lenders to convert the loans from interest-only to capital-and-interest repayment. Alternatively, they could repay part of the mortgage early or start an extra savings plan to make up the shortfall.

And if you feel you have got a valid mis-selling grievance, you should take action as soon as possible as there are limits on how long you have in which to make a complaint. The Consumers' Association recommends that policyholders write to the endowment provider - a draft letter is available on its website - and, if they are still unhappy, contact the Financial Ombudsman Service.

Eight endowment providers - Abbey Life, Equitable, Lincoln, Winterthur, Norwich Union, L&G, Barclays Life and Woolwich Life - have been so inundated with complaints that they have asked for a waiver in dealing with them beyond the eight-week maximum.

As a result, although the FSA is advising policyholders to act now, the problem could drag on for many years.

Contacts: FSA, www.fsa.gov.uk/endowments; Consumers' Association, www.endowmentaction.co.uk