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Spend & Save

Be prepared for disappointment on endowments

Policyholders should brace themselves for yet more poor bonuses, reports Neasa MacErlean

About seven million people are due to get news in the next few weeks about one of their major investments. These are the individuals who still have with-profits endowment policies, despite all the controversy attaching to them over the last 15 years.

In late January and early February, the major providers of these plans, the life offices, are due to announce the amounts – so-called "bonuses" – that policyholders will have transferred to their plans for this year.

However, as those long-suffering policyholders will be well aware by now, the outlook is not as good as most of them once expected. More than 70 per cent of financial advisers expect this year's annual bonus rate to be 2 per cent or less, according to a survey carried out by Skandia and given exclusively to The Independent. Last year [spring 2010], the annual rate averaged 1 per cent.

"Bonuses on good funds are averaging 2.5 to 3 per cent," says Danny Cox, head of advice at financial adviser Hargreaves Lansdown. "I would expect bonuses to be flat this year."

Alan Steel of Alan Steel Asset Management has always been suspicious of these plans.

"I cannot see how you can expect any bonuses," he says. This is true of the weaker funds which have been unable to make any payment in recent years. "Bonus rates for a lot of contracts are zero or close to zero," says insurance industry expert Ned Cazalet of Cazalet Consulting.

Aviva is seen as one of the stronger life companies. Talking of the investment performance of its with-profits funds, Richard Kelsall, Aviva's head of investment, says: "I don't think anyone will be expecting returns this year to be as good as last year. This year markets have been very difficult. They've been very volatile."

A year ago Aviva reported a 12 per cent return on its main fund, and this translated into a bonus rate on its endowment bonds of 2.75 per cent and on its pension plans of 3.25 per cent.

But since one of the fundamental aims of with-profits funds is to convert volatile market returns into a smoother pattern of annual bonuses, Aviva could maintain its bonus rates from last year.

Kelsall hints at the use of this smoothing mechanism this year when he adds: "There will be a positive message for policyholders."

As well as declaring the annual bonuses, life offices will announce the final or "terminal" bonus given on maturing policies. These were sometimes extremely substantial in the past but, in some of the weaker offices, now amount to very little.

With-profits policies became particularly controversial 20 to 25 years ago when millions of housebuyers bought endowment mortgage plans which were frequently forecast to pay out at over 10 per cent a year. Those plans are now maturing with final payouts that are often only a half of even a third of what the policyholder expected(see box).

Kelsall, however, says that some of the criticisms have been overstated.

"A lot of the negative press has been unfair," he says.

While only 3 per cent of Aviva mortgage-linked endowment plans are still on course to pay off the full mortgage loan, annual returns over the last 25 years averaged 6 per cent, according to last year's bonus rate announcement. In comparison, the best variable savings rates, according to MoneyFacts, have been offering less than 3 per cent during recent months, while the top five-year bonds have been pegged at under 5 per cent.

Many people have already decided what to do with their endowment policy – whether to keep paying in, freeze it, surrender it or sell it on the second-hand market. But there will be some who are still uncertain as to what they should do.

An important indicator is the proportion of assets held in equities.

"If they have, across the fund as a whole, a reasonable proportion of equities, of 55 or 60 per cent or more, that is probably a backward-looking indicator of reasonable strength," says Mr Cazalet. "But if a fund has 0/2/5/10 per cent in equities, it is almost certainly doing so because it can't hold any more. That is usually because its liabilities are fairly onerous."

He is reluctant to use current asset allocations or recent investment performance as indicators of the future because several funds in recent years have shifted, within a few months, from 70 per cent to 10 per cent equity allocations.

Many funds will make zero bonus declarations for certain groups of policyholders because they simply cannot afford to do anything more. In these cases, they have already – like the famously failed Equitable Life – given guarantees of returns to some groups of policyholders at over-generous rates. This means that they have no choice but to limit extending themselves further.

Policyholders trying to decide what to do should find out to what extent their fund is committed by existing guarantees. The annual statement should be the source for this, but Mr Cazalet says: "The quality of statements is, in general, absolutely abysmal rubbish."

If the statement does not explain whether, for example, guaranteed annuity rates have been offered to pension plan endowment-holders, then policyholders could ring their life company and ask them.

Mr Cox takes a fairly straightforward stance on helping people decide what to do with their plan.

"If you have four or five years to maturity, then you might as well stick with what you have got and keep on paying in," he says. "Where would your money go instead?"

But if someone has a longer period to go, he suggests that they turn to stocks and shares ISAs (Individual Savings Accounts) which "offer much more tax efficiency, don't have the complexity and charges of with-profits funds" and where "you are likely to get a better deal".

Policies can be simply surrendered to the life company which will give you a quote first on what it will pay for them. There are often penalties, called market value reductions, for getting out early, although they are occasionally lifted – on the 10th anniversary of starting some with-profits bonds, for example.

For policies that have already run 10 or 15 years, there is also the option of selling the policy on the second-hand market. Traders here operate online and can easily be found by searching for "traded endowments" or "second-hand endowments" on the internet. People who stay invested can keep on paying or suspend their payments.

If someone wants to be absolutely sure they have the best chance of getting the decision right, they might want to take advice. This does cost money, and many might feel they could not afford it.

Graham Bentley of Skandia says: "An adviser will be able to take into consideration things such as any guarantees their policy might have, along with the client's personal circumstances, including age, health and personal tax situation."

Mr Cazalet, however, is not even sure this would work. He thinks annual statements are so poorly prepared by life companies that the documentation "defeats even good financial advisers".

The current economic crisis has made the situation even worse for with-profits investors. Continuing low interest rates will make it more difficult for life companies to get a good return and be able to afford decent annual bonuses.

The main area for hope is that there is huge variation of performance in this sector. Some people are in relatively good funds and, although they will not get as much as they hoped for, they will get returns which compare well to other savings and investment options.

Complaining: Why you may have a case

More than 300,000 homeowners have complained to the Financial Ombudsman Service over the last 11 years about endowment policies they were persuaded to buy as a way of paying off their mortgage.

A third won their case, usually receiving compensation which would put them in the same position as if they had taken out a safer, more traditional, "repayment" mortgage instead.

Even though many of those mortgages are getting to the end of their term, it has become much harder to have a complaint upheld in the last three years. This is because strict deadlines were set up which prevented most people from taking action after 2008.

Nevertheless, some people do have a case now – particularly those whose endowment was on course to repay the loan until recently. Someone who gets a warning letter from their provider, telling them the policy might not be sufficient to pay off the loan should consider making a complaint that they were mis-sold the endowment. The provider's letter should make clear the timescale in which they need to complain.

Complaints are still running at about 3,000 a year to the Ombudsman. About half are ruled out of time. Of the rest, about 28 per cent are being decided in favour of the consumer.

The Ombudsman held in favour of Mr and Mrs T, for instance, whose provider warned them of the problem but had not explained the practical options open to them.