Preparing for poor payouts: As investment prospects grow dimmer, policies need monitoring, reports Vivien Goldsmith

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The Independent Online
----------------------------------------------------------------- Endowment payouts ----------------------------------------------------------------- 10 YEAR 25 YEAR 1993 1992 1993 1992 COMPANY pounds pounds pounds pounds General Accident 6,590 7,023 65,464 65,255 Commercial Union 7,164 7,484 62,941 65,596 Tunbridge Wells 7,292 8,087 62,790 61,330 Scottish Life 6,216 6,926 62,282 65,496 Friends Prov 6,885 7,457 61,496 62,438 Clerical Medical 6,958 7,576 61,419 61,283 AXA Equity & Law 6,117* 7,263 60,256 62,374 Norwich Union 7,532 6,992 58,237 60,073 Sun Alliance 6,005 7,060 50,048 52,021 NPI 5,820 5,972 48,355 52,716 GRE 5,022 5,479 44,062 44,093 ----------------------------------------------------------------- 30 pounds a month, 29-year-old man. * provisional figure. January 1993/January 1992 unless otherwise stated. -----------------------------------------------------------------

PREMIUMS for endowment policies taken out to repay mortgages are increasing as the life companies lower their assumptions about investment prospects.

A borrower taking out a Norwich Union policy to back a pounds 60,000 loan with Leeds Permanent Building Society last year would have been asked for premiums of pounds 80.35 a month. This year premiums of pounds 91.52 will be needed to back the same loan. If the policy performs in line with expectations this should produce pounds 60,700 at the end of the 25-year term.

This is because Norwich Union is now assuming that the policy returns will grow on average by 7 per cent a year rather than 8 per cent.

The borrower who took out an endowment mortgage last year is not being asked to increase premiums yet. But borrowers may have to get used to the idea that they need to keep checking their policies to see that the performance is in line to repay the debt at the end of the term.

Those who take out unit-linked policies, which vary directly in line with the performance of the fund backing them, already have a review as part of the package. But in the past with-profit policies were considered safe and steady enough not to need monitoring.

The assumptions used about returns have always been so conservative that investors have been able to rely on a lump sum windfall as well as enough to repay the loan.

The final bonus, which has no guarantee, is ignored and only 80 per cent of the annual bonuses are taken into account. A homeowner with a pounds 30,000 mortgage with Leeds Permanent Building Society that matured after 20 years last year would have had pounds 58,430 extra cash.

This week has seen a radical round of bonus rate cuts as life insurance companies try to bring the returns on their with-profits policies into line with the actual profits earned by the life fund.

Traditional with-profits policies are designed to smooth out the peaks and troughs of investment. They gradually build up in value as annual bonuses are added, and then on maturity a final bonus is added that makes up an average of half the final payout.

When the stock market and commercial property investments failed to produce expected profits two years ago, the companies were slow to react and are having to cut back to ensure that policies maturing now are not taking an unfair share of the life funds.

In fact, the cuts this week still mean that most policies maturing in 1993 will be getting more than they have earned. So investors with a policy from a particular company should not necessarily be overjoyed when they see their life office near the top of the payout tables.

This could be a sign that the life fund has been well invested and the payments reflect this, or it could be that payouts are still excessive and are in effect taking assets that should belong to future generations of policyholders.

Philip Scott, chief actuary at Norwich Union, said the trend to cut annual and terminal bonuses needs to continue so that total payouts drop. The current yields of 13 per cent on a 10-year policy and 12.9 per cent on a 25-year policy are still too high and need to drop by around 4 percentage points, he said.

The life companies are keen to point out that with-profit endowment policies are still delivering decent returns - especially in the light of lower inflation rates.

And the margins on policies maturing soon are still high. Lenders are grappling with the problem of whether to risk alarming borrowers by warning them that policies will not be delivering as much as they thought.

Nationwide, which is pledged to sell policies from GRE, has not yet decided whether to write to borrowers. A spokesman pointed out that it was only those who bought with-profits policies three or four years ago who had any need to be concerned.

If inflation and investment returns are on a permanent lower track then the assumptions used when setting up the policies will not hold, and there will be real problems as the policies run on.

Anyone who wants to abandon an endowment mortgage and switch to the repayment method should consider either making the policy paid-up or selling on the second-hand market, as well as surrendering to the company.

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