Second-hand endowments are more attractive than new policies because the original buyer has done the hard work and paid for the heavy charges and life insurance costs. After about seven years the charges ease off and the policy becomes a highly desirable investment.
It will go on growing through annual bonuses paid by the life firm that issued the policy. (These are called reversionary bonuses by the life companies.) Once added, this annual bonus cannot be taken away. And there is an extra bonus at the end of the term, when the policy matures. The trend has been towards larger final bonuses (known as terminal bonuses) and smaller annual increases.
All endowments include a guarantee that they will pay out a minimum lump sum if the owner dies. "People don't appreciate that traded endowments have a built-in minimum value," says Bill Weston of Foster & Cranfield, the only firm offering TEPs at auction. "Apart from gilts there are few things which have a guarantee in them." If you buy a second-hand policy and the original owner dies before the end of the term, you would get the basic guaranteed payout (known as the sum assured) plus any annual bonuses that have already been paid and a percentage of the projected final bonus.
When a policyholder wants to give up an endowment, he or she will be quoted a "surrender value" by the life company that issued it. This is the price the life firm will pay to buy back the policy. There are several market-making firms that deal in TEPs. They pay sellers 10 to 15 per cent more than the surrender value. The dealer will then sell the policy on at a profit.
Foster & Cranfield puts policies into weekly endowment auctions, with full details of the investment, the owner's age and estimated selling price. The auctioneers take one-third of the difference between the surrender value and price at auction.
There are some health warnings attached to TEPs. One concern is that there's no cooling-off period after you sign a contract to buy a policy, so there's no chance to change your mind. You must be absolutely certain that you want the investment and that you understand it.
Helen Langton, marketing director of the market makers Neville James, says buyers do get a chance to find out what is on offer. "When anyone wants to buy a policy he or she can make a reservation. We then send out information by fax or post." This includes a breakdown of what is in the policy, how long it has to run and the monthly premiums. Customers have to make a decision and confirm that they want the policy, usually within a couple of working days.
Market makers can only tell independent financial advisers the "formula maturity value" of the policy. This is a notional amount that a buyer might get at the end of the term, based on previous performance. By law TEP firms are not allowed to supply this information in written form to private investors. The way round this is to phone up and ask to be talked through the process - TEP dealers are allowed to tell you how to work out the maturity value for yourself.
A few policies sell for less than pounds 5,000, but a typical example would be a Legal & General policy, maturing in 2008, with a locked-in value of pounds 17,439. A buyer would pay pounds 12,996 for the policy plus monthly premiums of pounds 36.82. At current market expectations, the buyer could expect to receive about pounds 50,000 when the policy matures.
The most popular policies are from the likes of Standard Life and Norwich Union - financially strong firms with decent track records. Market makers are picky about which policies they will buy.
There are not many bargains around and there has been some concern that some policies are overpriced. Ms Langton says the prices are driven by demand. "There just aren't enough policies to meet demand. There is another whole argument about how many people still don't know they can sell their policy." The Association of Policy Market Makers (APMM), the industry trade body, wants life firms to give out the addresses of TEP sellers instead of simply allowing customers to sell with-profits policies back to the life firm for less than their market value.
Sometimes market makers cannot take on policies because they have a high surrender value. Mr Weston, at Foster & Cranfield, says some Scottish Widows policies fall into this category, but it is still worth putting one into auction because the margins are smaller. The seller has a chance to make extra money and buyers get more choice.
The biggest demand is for policies with just two or three years left to run; many investors use TEPs for particular financial goals, such as school fees planning or a family wedding. A TEP with a longer term to run is still a good bet but you must be sure you can keep up the premiums.
TEPs are tax-efficient investments. Most are "qualifying" policies for tax purposes: this means the policy has at least a 10-year total term and all income tax is already deemed to have been paid on the final lump sum. So qualifying TEPs are a good investment for higher-rate taxpayers, although there may be a capital gains tax (CGT) liability when the policy pays out. You can cut this down by using your annual CGT allowance (pounds 6,800). A policy in joint names qualifies for two allowances.
If the policy is non-qualifying, higher-rate taxpayers have to pay the difference between basic and higher rate tax on the proceeds. Even so, buying a TEP is still likely to be a good investment bet.
q Contacts: Neville James (market makers), 01243 520000; Foster & Cranfield (auctioneers), 0171-608 1941; the APMM (sends out lists of TEP dealers), 0171-739 3949.
Make a collective effort
IF YOU don't have the money to buy a policy or want to invest on a monthly basis, there are several investment trusts and offshore funds that buy endowment policies. These funds have the advantage of owning a wide range of endowments, so you are not dependent on the performance of one with-profits fund. The downside is that you have to pay extra charges.
Dresdner Kleinwort Benson has three funds. Stephen Westwood, head of marketing at Dresdner RCM, says: "Our first trust, the Kleinwort Endowment Policy Trust, winds up in 2003. We bought 2,000 endowment policies for it and they all mature before 2003." Investors will get a capital sum when the trust winds up, based on the payouts from these policies. The other trusts have a similar structure with later wind-up dates.
Barclays Global Investors also has two endowment funds that have to be bought through an independent financial adviser or stockbroker.
q Dresdner Kleinwort Benson savings scheme: from pounds 25 per month or a lump sum of pounds 500. Telephone: 0800 317573.
ANNIE WALKER (above), executive officer for a retailers' association in London , recently spent pounds 10,000 on two second-hand endowment policies at auction. She first became interested in endowments as investments when an existing policy with Scottish Amicable matured, giving her a bonus with extra cash from the Prudential's takeover.
"I was delighted with it and couldn't believe the return," she says. "I'd read about second-hand endowments in the papers and was interested as they are a short-term investment. I didn't want to invest in stocks and shares, and wanted something safe."
Ms Walker studied the auction brochure carefully before asking her solicitor to go to the sale and buy the policies for her. She pays premiums totalling pounds 164 a year.
The policies mature in 2001 and 2004 and are projected to give a total payout of pounds 18,200.Reuse content