Endowment bargains at the second-hand stores

Toby Walne explains why second-hand endowments are a good investment

Looking for an investment guaranteeing returns that will beat a bank or building society savings account and meet all sorts of financial needs you may have in the future? If so, endowments, the life insurance policies that have let down millions of mortgage borrowers might not be the first thing that springs to mind. And yet, on the second-hand market, sales of endowments are picking up, because many offer such outstanding value.

Endowment policies are investment funds made up of savings, bonds, and shares. Although lacking the spice of pure stock market performance, a good endowment policy can easily beat top savings deals with typical returns averaging 7 per cent a year. They also include life insurance cover for the policyholder.

Anyone who wants to cash in an endowment policy has two choices: to surrender it back to their life insurance company, generally for a poor return, or to sell it on the second-hand market, often at a much better price. It is this market in traded endowment policies (Teps) that is beginning to interest many investors.

While bonuses on life insurers' with-profits funds, in which endowments are invested, have fallen in recent years, some Teps already offer a risk-free locked-in value of more than 100 per cent of the purchase price. This means that even if there is a total collapse in future bonuses, investors would still make money.

In addition, Teps are on sale at a wide range of prices and with all sorts of terms to maturity, so there is the added attraction of being able to tailor a portfolio towards specific needs. They are well suited as savings vehicles for future planned expenses, such as school fees, university costs or extra retirement nest eggs. Teps are most suitable for those with the ability to pay an initial lump sum that is typically between £5,000 and £25,000.

Investors must also be able to commit themselves to keeping up the monthly payments until maturity, typically between £20 and £100, even though the maturity date may be up to 20 years away.

By continuing regular monthly premiums, a Tep owner reaps the current value of the policy, plus all future bonus payments, as well as the potentially big final terminal bonus on maturity. The buyer does not take on the cover offered by the life insurance element of an endowment. But if the original owner dies while the policy is still being paid, the Tep holder gets the death benefit.

It is also worth noting that the biggest charges come early in the life of an endowment so by the time a Tep investor is involved they are guaranteed a payout.

Brian Goldstein, chairman of the Association of Policy Market Makers, the self-regulating trade body for the industry, says the Teps business is heavily weighted towards buyers right now. Plunging bonuses and a collapse in confidence in the endowment market a few years ago are to the advantage of a Tep investor, he argues.

"With-profits policies taken out as endowments to pay off mortgages have had some pretty bad press in recent years which means that their value on the open market has tumbled,"

Goldstein says. "This can be good news for Tep investors as they are able to pick up endowments at bargain basement prices while still benefiting from improving bonuses."

Stock market turmoil a few years ago hit with-profits bonus rates hard and thousands of homeowners with endowments found themselves out of pocket. But Goldstein believes that media scare stories omitted to mention that bonuses were still being paid - just not at the level previously expected.

He adds: "With-profits tend to lag behind stock market performance so they could well start to improve again in the future, meaning this is a good time to buy."

Even if the level of bonuses being paid out falls, endowment policies do not actually drop in value - the value of the fund is locked in each year. It's just that the policy does not continue to rise in value at such a high rate. Goldstein believes that investment returns speak for themselves. Tep holders have been rewarded with maturity pay-outs that cannot be beaten by savings rates.

More than half of all endowments fail to make it to maturity with many being cashed in early by jittery mortgage borrowers who fear bonus shortfalls. Although these customers may not actually be losing money, red and amber letters warning of endowment shortfalls have caused many to panic and jump ship.

Up to £1bn worth of policies were surrendered to insurers last year yet only £500m-worth was sold on the second-hand market. This year the figure is expected to rise to £600m. Life insurance companies are now legally obliged to flag this option to customers as an alternative option to surrendering and many are keen for customer not to cash in.

Anyone selling their policy on to a market maker can expect, on average, 10 per cent more money than they would receive from cashing it in.

However, for an endowment policy to be worth purchasing, it must have at least five years to run and a surrender value of more than £1,000. And the small number of unit-linked or unitised with-profits policies in issue cannot be turned into Teps.

David Carrington, sales and marketing director at market maker PolicyPlus, is keen to point out that the fact that Teps mature on a set date makes them ideal for specific occasions where cash is needed.

"It's a hidden gem - get in now and you could be buying at the bottom of the bonus cycle," Carrington says. "By the time the policy matures who knows what the value will be? You can be certain it will be more than you put in."

Recent changes to pension regulations also mean that Teps can be owned within self-invested personal pensions - effectively enabling higher-rate taxpayers to invest 60p to get a tax-free investment of £1.

Naturally, as with all financial products, there are some great deals on the market plus some really bad ones. There are half a dozen dealers signed up to the Association of Policy Market Makers (APMM) and potential investors should contact at least a couple of these before making a purchase.

All providers should be able to provide a range of Tep offers, including a full breakdown of costs, bonuses and projections. The APMM ( www.apmm.org) operates a central clearing house for Tep sales, which is a good first port of call.

Three TEPs with almost risk-free returns

1. PolicyPlus has a 25-year Clerical Medical traded-endowment policy for sale at £6,534 with a maturity date of September 2013. The investment has a current locked-in value of £8,375, made up of a £4,954 sum assured with accrued bonuses of £3,421. The Tep investor would have to pay £19.13 a month until maturity.

This means a total investment of £8,275 will provide a guaranteed return of 101 per cent of your money even if another bonus is never paid. However, by adding expected bonuses in line with previous payouts the maturity value would be £9,976 - a gain of 28 per cent over the next seven years.

2. PolicyPlus also offers a 20-year Royal London Mutual policy for £8,264 with a maturity date of December 2016. The investment has a locked in value of £16,627, including a £13,000 sum assured with accrued bonuses of £3,627. The Tep investor would have to pay £68.32 a month until maturity. The total investment of £17,146 is thus already 97 per cent covered even if another bonus is never paid.

However, by adding expected bonuses in line with previous pay-outs the maturity value would be £35,126 - a total return of 101 per cent.

3. PolicyPlus is selling a 25-year General Accident traded-endowment policy for £10,929 with a maturity date of October 2019. The investment currently has a locked in value of £25,629, which is made up of a £19,968 sum assured with accrued bonuses of £5,661. In addition, an investor would have to pay a premium of £100.46 a month until maturity.

This means a total investment of £27,404 is already 94 per cent covered by the locked-in value built up so far. By adding expected future bonuses in line with previous payouts the maturity value would be £71,430 - a total investment return on the starting capital of 135 per cent over the next 14 years.