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Spend & Save

Jonathan Davis: Mortgage sums don't add up

In a ghoulish sort of way, I have been rather looking forward to the arrival of the letter about my top-up mortgage endowment policy from Scottish Life. There is some embarrassment, as someone who writes about investment as part of their professional life, in having to admit to having one of these much-derided mortgage policies at all.

In a ghoulish sort of way, I have been rather looking forward to the arrival of the letter about my top-up mortgage endowment policy from Scottish Life. There is some embarrassment, as someone who writes about investment as part of their professional life, in having to admit to having one of these much-derided mortgage policies at all.

Okay, I was young and ignorant at the time, and it was long before I first started to look more closely at what financial products actually delivered. What I do remember hazily from 15 years ago is that the idea of a mortgage endowment policy seemed reasonable at the time. The convenience of a one-stop product that combined life insurance, tax-friendly savings and an interest-only mortgage was an attractive feature for a busy married professional with children.

It was certainly what the pundits in the newspapers were recommending at the time and it did save me a few pounds a month in the early years of the term, for which I was grateful. Like everyone else, I did not focus much on the overall costs of the policy, which were not prominently displayed in those days (to put it mildly), let alone broken down.

Periodically, I have looked at records of my payments, at how the sum assured was growing, and more recently I started to calculate what rates of return might be needed to reach the eventual target sum. I have also checked the value of the policy with two or three traded endowment policy specialists.

So when the letter finally arrived, I was not expecting surprises. I had worked out correctly that my main endowment policy should not be affected by the review. My sums suggested that, even without assuming any terminal bonus, the fund needs to return around 4 per cent a year net to me for the next 10 years to meet the redemption figure, which is surely well within the bounds of the possible, even for an insurance company, and even allowing for today's low interest rate environment. (The implied return on my actual contributions over the 25-year life of the policy, I calculate, will be just under 7 per cent if no terminal bonus is paid - despite the greatest and longest bull market of all time.)

But I also have a small top-up endowment of £5,000 which, from memory, dates from the day we discovered we needed to fix the roof and the dry rot in the loft. Extending the mortgage seemed the simplest way to pay for it.

This, I calculated, might suffer some shortfall, given that the central assumption for investment returns now demanded by the regulators is 6 per cent per annum.

Well, the letter confirming this has arrived, and, I have to say, a more absurd communication I have rarely encountered, although (at nine pages) it is by some stretch the longest letter I have had from the company. What the letter informs me is that the projected shortfall on my £5,000 endowment policy, assuming a 6 per cent growth rate, is £450.

In other words, in 10 years, my contribution of £8.62 a month, which I have been paying since 1988, will fail to produce a sum greater than £4,550. To make good this potential shortfall, the company offers me the chance to pay an extra £5 a week (more than half as much again) for the next 10 years, and solemnly warns me that if I do not take the option, then I will lose the guarantee in the original policy.

Well, the nimbler amongst you may already have realised what makes this such an absurd suggestion. It does not take a genius to work out that paying £5 a month for 10 years would involve me in total extra payments of £600. In effect, the good folk at Scottish Life are inviting me (in all apparent seriousness) to pay them £600 to make good a projected shortfall after 10 years of £450. I would do a third better by putting the money in a sock under the mattress.

Now we all know life companies are not the hottest hands at the investment business, and that the projections are no more than that, but this reticence is surely taking the matter too far. As the Key Features document helpfully makes clear, the implied rate of return on the new policy I have been offered (assuming investment returns of 6 per cent a year) is minus 2 per cent a year.

This surely marks a new phase in the long and far from glorious history of the insurance business - instead of the offer you can't refuse, the offer that you cannot possibly accept. What make such a nonsensical offer possible are the costs and commissions. As the table shows, the letter helpfully explains that charges and other commission will eat up some £200 of the extra £600 I am being asked to pay.

Just to rub salt into the wound, part of this sum will be commission to the adviser who first put me into this policy - step forward a well-known High Street bank, though quite what the bank has done to earn such largesse, is nowhere explained. You might have thought they should be paying me, not the other way around. The costs also include a premium for extra life cover for the projected shortfall amount, which I have surely already paid for, and am now being asked to pay for again.

Rather than creating a new policy, the common-sense solution to the projected shortfall would have been simply to increase the monthly premium on the existing policy. But this is not allowed, since to do so would apparently breach the regulations which allow the sum assured to be returned tax-free on maturity (you can always trust the Inland Revenue to get in on the act somewhere).

So instead of common sense, we have an absurd solution to a ridiculous problem. Quite what Scottish Life think they are doing by sending out such a letter defeats me. They cannot seriously believe what they are suggesting is either helpful or in the best interests of the recipients.

Either they should say it makes no sense to take out this new policy (if they believe the assumptions) or they should explain in what circumstances it could possibly make sense. Better, if they really had the interests of their policyholders at heart - and Scottish Life is a mutual society - it should clearly offer a cheaper and more sensible alternative to the shortfall problem. The company could eliminate the problem by buying a 10-year gilt that actually yields today the 6 per cent that is assumed in the projections.

So why have they done it? Presumably the answer will be, "It was the regulators who made us do it". That is a defence, but hardly a convincing one. As a certain tabloid columnist likes to say, you simply cannot make this kind of thing up. It needs an acid pen to do justice to the full absurdity of it.

If this is the kind of tosh being sent to those affected by much more serious shortfalls than mine, or are unclear what to do, I dread to think what further suffering will be caused before this whole ridiculous affair is brought to a close.