Endowments that beat the cost drag

AN INFALLIBLE guide to getting the best-performing endowment policy over the next 25 years is the personal finance equivalent of the philosopher's stone. Infinitely desirable, but it does not exist.

Until recently, investors and their advisers have had to rely on past performance as a guide to the future. The conventional table of best-performing insurance companies in the endowment policy market, compiled by Money Marketing, selects the funds that have made the most with a specimen investment of £20 a month over 25 years, a total of £6,000. The results vary, ranging from 10 per cent to 14 per cent a year growth, but in every case the investments, aided by a high rate of inflation averaging 9 per cent a year, would comfortably have paid off the mortgages they were linked to.

But as every O-level student of personal finance knows, past performance is no guide to the future. If that is true of unit trusts, which operate on a one-year time-scale, it is far more so of endowments policies that take 25 years to mature. Even the traditional "half-way house" at 10 years will include new and different financial situations, which even the fastest and most flexible investment managers cannot guarantee to anticipate.

It is increasingly likely, however, that in an era of low inflation, investments will grow much more slowly than in the past 25 years, and even the target 7.5 per cent a year compound growth insurance companies are allowed to project for illustration could be hard to achieve.

The new rules requiring the disclosure of commission charges from the start of this year has provided a second method of performance assessment. All companies are allowed to project the value of a regular monthly premium by the time the policy matures, assuming the investment grows at a standard compound rate of 7.5 per cent. But tables produced by The Exchange, a Woking-based independent data service supported by the leading insurers, show that after allowing for charges, the true yield on a 25-year policy would be reduced by 1-2 per cent each year. Put another way, the actual premiums now required from a non-smoking couple, both aged 25, to repay a £50,000 mortgage over 25 years, would vary from a low of £72.20 a month at Friends Provident to £83.29 per month at Scottish Mutual, and the total amount swallowed up in charges and expenses, also compounded at 7.5 per cent a year, would range from £11,200 to £20,600. Alternatively, a premium of £75 a month invested at 7.5 per cent compound over 25 years would pay the £50,000 mortgage with £2,000 to spare at Friends Provident, while General Accident would break even, and the remaining 13 policies would leave a shortfall ranging from a few hundred to £5,400, at Scottish Mutual.

But these examples only illustrate the effects of commission drag on a notional return of 7.5 per cent compound.

Individual companies might well still offset the effects of drag through a superior investment performance. For that there is no measure at all. The best proxy is to choose those companies with the highest ratio of free assets or surplus reserves after covering the liabilities that arise from their existing business.

This because the higher the free-asset ratio, the freer the company is to invest in shares that have been (and should remain?) the best long- term investment available.

Companies with lower free-asset ratios have to put a higher proportion into gilt-edged stocks to meet their cash-flow requirements, rather than seek long-term gain. It is not an infallible measure, but the best that can be devised.

Company returns to the DTI in December 1993 show a remarkably wide range - from 40 per cent at General Accident to 5 per cent at Eagle Star..

Best performers

Maturity pay-out on with-profit endowments over past 25 years. Male aged 30 paying £20 a month.

TOP TEN 1994

Company Payout Surrender

value %*

Tunbridge Wells 45,999 83

RNPFN 44,497 78

Gen Accident 43,759 83

Comm Union 43,586 84

Wesleyan 43,289 83

Standard Life 42,444 85

Scottish Mutual 42,018 77

AXA 41,861 85

Scottish Life 41,677 91

Royal London 41,252 82

*Surrender value 12 months early

Source: Money Marketing

Best performers

Maturity pay-out on with-profit endowments over past 10 years. Male aged 30 paying £35 a month.

TOP TEN 1994

Company Payout Surrender

value %

Swiss Life 8,543 61

Royal London 8,427 78

RNPFN 8,367 77

Tunbridge Wells 8,093 78

Equitable Life 7,992 79

Scot Mutual 7,930 77

Med Sickness 7,927 80

Comm Union 7,915 83

Friends Prov 7,829 73

Norwich Union 7,825 76

*Surrender value 12 months early

Source: Money Marketing

Total charges

For with-profit endowments to pay £50,000 mortgage over 25 years from now (non-smokers aged 25).

Company Charges

Friends Provident £11,200

General Accident £13,200

Scottish Provident £13,800

Legal & General £14,200

Sun Life £15,500

Scottish Widows £15,600

Scottish Amicable £13,800

Standard Life £16,200

Eagle Star Life £16,700

Clerical Medical £16,700

Axa Equity & Law £17,300

Norwich Union £18,200

Commercial Union £18,300

Scottish Life £19,100

Scottish Mutual £20,600

Maturity values

Values after 25 years from premium of £75 per month on £50,000 loan.

Company Values

Friends Provident £52,000

General Accident £50,000

Scottish Provident £49,700

Scottish Amicable £49,600

Legal & General £49,300

Sun Life £48,200

Standard Life £47,800

Eagle Star £47,400

Clerical Medical £47,400

Axa Equity & Law £47,000

Commercial Union £46,300

Norwich Union £46,300

Scottish Life £45,700

Royal Life £45,600

Scottish Mutual £44,600