Policies on a path to insecurity: Lenders appear unworried that some endowment policy payouts may fall short. Gail Counsell finds out why

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The Independent Online
THE PROSPECT may have sent shivers down the spines of borrowers, but mortgage lenders appear unconcerned by the likelihood that some endowment policies will fail to clear the mortgage to which they relate.

Despite warnings from insurance groups like Guardian Royal Exchange that the bonuses on which people depend to make up the bulk of the money used to pay off the mortgage at the end of the term may no longer be sufficient, lenders are continuing to rely on existing projections.

Building societies such as Halifax and Woolwich, and banks like National Westminster, argue that the slack built into most policies means there is little danger that any of the mortgages currently backed by low-cost endowment or unit-linked policies will fail to cover the loan.

Traditionally, such lenders have only given mortgages on the basis that about 80 per cent of current bonuses would be used to pay off the mortgage. And they have refused to take the terminal bonuses, which are often paid when the policy matures, into account.

'I don't think we are in a problem scenario yet,' a Halifax spokesman said. 'People with existing policies have built up a lot of fat over the years.'

Lenders also insist that responsibility for ensuring that sufficient funds are available to pay off the mortgage after 20 or 25 years lies with the borrower, not with them.

'If your insurance company has advised you the policy is not growing as it should, then it's up to you to do something about it,' a spokesman for Woolwich said. 'Policies aren't assigned to societies or deposited as security with us any more. Now it's up to the houseowner.'

The houseowner may not realise he or she has a problem, however. Unit-linked endowments are usually reviewed after 10 years to ensure they are performing according to plan. But with a low- cost endowment - unless the houseowner examines his or her annual statement in detail and then works out that the policy is not keeping pace - it may not be until the bitter end that the shortfall becomes clear. Nevertheless, no large lender has yet instituted a system for checking up on the performance of existing policies to ensure that they continue to be likely to generate enough profits to cover the mortgage.

They are not even asking for a review when approached for a fresh mortgage by someone with an existing policy. As long as the insurance company involved is on their approved list (most are) and the amount the policy was originally expected to pay out is more than the new mortgage being sought, they will not check up on its performance to see if it really is likely to be sufficient in current circumstances.

The Building Societies Commission, the regulator responsible for societies, says it 'expects' societies to evaluate policies to satisfy themselves that they will generate sufficient funds. But it admits this would be 'good practice' rather than a legal or regulatory obligation.

'Our role is to protect investors. So long as the society has proper security in the shape of the house that is all they need,' a spokesman said.

Yet should the worst come to pass, mortgage lenders will be placed in the uncomfortable position of having to repossess properties to meet any shortfall if borrowers do not willingly stump up the difference.

In a low-cost endowment or unit- linked mortgage, the borrower pays only the interest on the loan from the building society or bank during the lifetime of the mortgage. A policy taken out from an insurance company, timed to mature when the mortgage expires, is used to pay off the capital. But to reduce the cost of the premiums, the insurance company only guarantees to pay off about a third of the mortgage; the borrower must rely on the profits earned by the company to meet the rest.

In the past this has not been a problem. High inflation has ensured that sufficient profits or bonuses were generated by the contract. But with prolonged low inflation - or even deflation - now a possibility, there is a growing danger that such policies will not generate enough profits.

Borrowers will accordingly have to choose between paying extra premiums to boost returns or meeting the shortfall from other sources.

'In the 1990s, the interest yield is undoubtedly going to be lower than in the 1980s,' a spokesman for the Guardian Royal Exchange said. 'It's not proper to assume current rates will continue forever, though it's more likely that for most people that would simply mean there would be no terminal bonus, rather than there would not be enough to pay the mortgage itself.'

The danger has been partly recognised by the Life Assurance and Unit Trust Regulatory Organisation, which regulates the insurance sector. In a consultative document published in December 1990, it said the basic uncertainty surrounding the returns that would be generated by a policy was such that insurance companies should in theory be banned from giving any examples of such possible profits.

'No one can say what the future returns under any investment contract will be . . . The actual results will depend on a number of factors but primarily on future investment performance. That in turn is likely to be heavily influenced by the rate of inflation.'

But Lautro went on to conclude that since for some purposes, such as mortgages or pensions, projections were needed, illustrations could be given under limited circumstances. Instead of giving the rate of return they expected, insurance companies had to quote two theoretical sets of projected returns - one based on making profits of 7 per cent a year (a figure soon to be reduced to 5 per cent), the other based on profits of 10.5 per cent a year.

The idea was to stop companies quoting excessive values, and also, by having two different limits, to illustrate to consumers the degree to which returns are uncertain.

Yet even at 7 per cent per annum, most policies would not repay the mortgage they ostensibly cover. A policy to obtain a pounds 30,000 loan, which would be acceptable to most bank and building society lenders, would only guarantee to pay around pounds 9,930. Assuming growth of 7 per cent per annum, it would typically produce only pounds 24,200 - insufficient to clear the mortgage.

At 10.5 per cent, the kind of returns typical for equities over the past 70 years, such a policy would admittedly generate pounds 40,100 - more than sufficient to clear the mortgage. But given that zero inflation is the current government target, it must be questionable whether the inflationary past is any longer an appropriate guide.

In that case, borrowers and lenders alike may need to rethink their assumptions.

(Photograph omitted)