Another year has passed, and with it comes another chance to review the state of the with-profits endowment policy that once supported my mortgage.
For some years now this exercise has been a doleful experience - one shared by millions of other people - in which the annual bonuses have shrivelled to virtually nothing and the projected terminal value continues to shrink. What used to be a proven and sensible way to invest has more recently become something of a lottery in which, for many people, the returns are now only tangentially related to the performance of the financial markets in which you thought your money was being invested.
This year, however, five years on from the end of the bull market and two years on from the start of the recovery in share prices, the news from my endowment provider is not unremittingly bad. True, the annual bonus last year was minimal, and I have had the pleasure of receiving yet another red alert warning letter in respect of the loft insulation mortgage top-up that I took out 18 years ago. (The main portion of the endowment, now 20 years into its 25-year term, is in better shape).
The good news is that the surrender value of the policy has risen quite steeply since I last enquired about it a year ago. So it should have, of course. In the past 12 months, the government bond index has risen by 10 per cent and the stock market is up by 25 per cent. The surrender value quoted by Royal London (formerly Scottish Life) has risen by 11.5 per cent over the past year, though the figure reduces to 6.7 per cent if you take account of the further 12 monthly contributions made over the period.
When I telephone to ask for more details, the company tells me that the terminal bonus on policies of similar term to my top-up policy has now risen for the first time in years, from its all-time low of 21.1 per cent to 25 per cent now.
On the main part of my endowment policy, whose term is three years longer, the terminal bonus of similar-aged policies maturing now is 40 per cent. (You might wonder at the marvels of actuarial science that such a small difference in the term can make such a big difference to the bonus rates, but this merely underlines how variable the annual movements in payouts have become, making a nonsense of the principle of smoothing on which the with-profits concept was once based).
So should I be pleased or not with this development? In a narrow sense, it could be argued that it was the right decision not to dispose of the policy a year ago. The extra year of contributions has resulted in a significant increase in the realiseable value of the policy, and the first sign that terminal bonus rates are now on the increase. If that continues, it holds out the prospect of a reasonable final value when the policies mature in five years' time.
We all know that you pay a high penalty for surrendering endowment policies before they have reached their full term, even if (as you should do) you have checked whether you can obtain a higher value by selling the policy to one of the many dealers in traded endowment policies. It would be irritating to discover in five years' time that you had disposed of your policy at exactly the lowest point in the cycle of returns. On my calculations, disposing of the policy today would cost me the equivalent of about 2 per cent per annum in returns over the remaining term of the policy. That may not be a huge sum to forgo, but it is not insignificant.
There is, sadly, no realistic prospect that the level of terminal bonuses will return to their heights of the 1990s. According to Royal London, the typical terminal bonus that was paid out on 25-year endowments in 1995 was 125 per cent of the basic guaranteed sum and accumulated annual bonuses. That figure rose to 172 per cent at the peak of the market five years ago, before being slashed to its current level of 40 per cent.
One reason is that, as a closed fund which has been forced to slash its exposure to equities by solvency considerations, most of its assets are now invested in places that simply cannot deliver anything better than single-digit returns over the rest of the policy's life.
If I persist with the policy, therefore, it is certain that the returns I will achieve will be barely half those achieved by people who took out similar policies just five years earlier that I did - hence my comment earlier in this article about the lottery-style nature of what with-profits has become.
It is true that, because inflation over the life of the policy will turn out to be lower than that experienced by investors who started their policies five years before me, my return in real terms will not be as inferior as it rates to be in nominal terms.
Because I have maintained the policy for so long, there is also the comfort that even if I do choose to surrender it today, forgoing the terminal bonus, I will have made a positive real return on the money I have invested, although it is nothing like as much as those whose policies have matured earlier.
The real issue here is the opportunity cost involved. The issue for all holders of endowments is whether they could do better by taking their money out and investing it elsewhere, at the same degree of risk. The better the markets do over the next five years, the more likely it is that the payouts from endowments will grow - but, also, the better you would do taking the money and investing it yourself, or in some alternative fund.
On the other hand, in a perverse way, the ultra-conservative investment policy that has been forced on weaker life companies in effect underwrites the real returns for those near the end of their terms. If I end up with a 5 per cent real return from my policy over its term, despite having picked a weak provider, should I be that unhappy, just because other investors have done better?
It is not so obvious. The equation is more complex than it appears. It depends a lot on your attitude to risk and expectations of where markets will go. In a recent paper commissioned by Jupiter Asset Management, the life company analyst Ned Cazalet argues that multi-manager funds will increasingly come to be seen as attractive alternatives to life company with-profits funds. The idea that one provider can produce good returns from all the valuable asset classes now looks increasingly anachronistic, and has long since been abandoned by professional investment institutions in favour of a multi-manager approach.
The point Mr Cazalet makes well, and which seems incontrovertible, is that the performance of life company with-profits policies does not depend solely on their investment skill. If it did, Equitable Life would still be in good shape, as its investment performance was comparatively good. It is also about managing the company's balance sheet and liabilities successfully. The real indictment of many life companies (by no means all) is that they made such a hash of that part of their job. The difference between the best and worst performing with-profits funds has been strikingly wide.Reuse content