OUTLOOK:Sales binge endows homebuyers with nasty legacy

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The Independent Online
Endowment policies have long been a notoriously dangerous way to finance a mortgage. Norwich Union may not be getting out of the business altogether, as reported, but it is surely right to urge homebuyers to look to traditional repayment mortgages instead. Since endowment policies continued to be stuffed down the throats of homebuyers long after falling investment returns began to make them deeply suspect, this is a long overdue admission.

Juicy commissions, which can absorb all the first couple of years' payments, have made endowments irresistible to building societies, banks and financial intermediaries. If you include administrative costs during the whole life of a policy, as much of 30per cent of the money invested can vanish in expenses.

The result of the sales binge is that some homeowners now have endowment policies whose value will not grow fast enough to pay off their mortgages when they mature.

The reason is simple enough. Inflation has fallen to a level that makes the expected nominal returns on the stock market investments on which endowment policies are based look much worse than they have been in the past. In practice, even the worst-hit holders of poorly performing endowments will have plenty of warning on a 25-year policy, giving time to organise top-up payments or even to cancel and switch to an ordinary repayment mortgage. Even so, many people have clearly been sold to under false pretences. The sales pitch was that these were policies that would not only pay off the mortgage but would yield a healthy lump sum on top.

The problem of falling returns is one of the less-welcome side effects of the transition to a low-inflation economy, and in that sense is a temporary phenomenon. New endowments are being sold on much more realistic projections of future returns.

Norwich Union argues that the problem for endowment mortgages sold from now on is rather different. It is that reductions in mortgage interest tax relief have substantially increased the actual interest rate paid on a mortgage. There is now a much stronger financial case for repaying a mortgage early. That means, for many people, taking out a repayment mortgage. Conveniently, with low interest rates, capital repayments in the early years are much higher than they used to be.

As for mortgage endowments, new premiums were running at an annual rate of £600m a year in the first three quarters of last year, £235m less than in 1991. The decline is certain to continue.

This does not necessarily mean the age of the endowment policy is over for good. Older policies should certainly be kept, since many are now producing annual returns in double figures.

Second, there is still a minor role for the traditional endowment as a form of savings, which fills a gap in the spectrum of riskiness somewhere between deposits and equity investments such as PEPs. In the first nine months of last year, endowments for straightforward savings were still being sold at an annual rate of more than £450m a year. Marketed honestly under the new disclosure rules that took effect on 1 January (which incidentally reveal which insurers have high expenses) there is no reason why the sales of traditional savings policies should not begin to rise again.

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