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Endowments appear in their true colours

Millions of borrowers will be receiving a letter from their mortgage

endowment provi^_der over the course of the next year providing projections

of the potential maturity value
on their contract.

The industry will be using a traffic light system to indicate to borrowers

how likely
it is that the target will be met.

What often seems to be forgotten in the media coverage is that few, if

any, maturing mortgage endowments have failed to hit their target.

Stan^_dard Life&#39s experience is that maturing 25-year endowments are

typically producing a mat^_urity value of more than four times the original


The traffic light indicator refers to future returns from the date of the

projection to the maturity of the contract. The projections are based on

possible future returns which, clearly, no one can know in adv^_ance. It is

also, of course, well publicised that past performance is not necessarily a

guide to future performance.

Contracts that require a fut^_ure rate of return of 6 per cent or less

will get a green light indicating that the policy will probably repay the

loan alth^_ough there is no guarantee that this will be the case.

Pol^_icy^_holders will be told that they do not need to take any action.

In spite of what media coverage would lead you to think, there will be

significant numbers of green lights given to policyholders. In fact, there

will be many contracts where the basic sum assured plus reversionary

bonuses already exc^_eeds the mortgage amount.

Contracts that require a future return of bet^_ween 6 and 8 per cent are

categori^_sed as amber. Policies in this cat^_egory are at risk of not

repaying the loan and it is important for the borrower to consider

whe^_ther action needs to be taken.

Many borrowers, in conjunction with their financial adviser, could

reasonably be expected to conclude that the required rate of return may

well be achieved over the rem^_aining term of the contract and that no

action is required at the present time. In most cases, there will be many

years left until maturity to take action should it become necessary.

The final category of contract is red, where the requi^_red rate of return

exceeds 8 per cent. In these cases, it will be important for the borrower

to take action in most cases.

While returns in excess of 8 per cent over the remaining term of the

contract could well be achieved, it would be imp^_rudent to base financial

planning decisions on this ass^_^_um-
p^_tion. The communication sent to

borrowers will include a comprehensive list of the options available to

them. In many cases, they will require guidance to help select the best

course of action for them.

Recent media coverage has focused on the reported numbers of amber and red

cases, implying that all these will fail to repay the loan. It is worth

looking at some of the historical evidence with regard to achieved rates of

return to consider whether borrowers can only reasonably expect a future

rate of return of 6 per cent.

I refer to a paper, The Risk Premium on Ordinary Share, written by

Professor David Wilkie in 1994 which looks at the return on UK equities

from 1919-93. Over this period, the average annual return on equities was

14.95 per cent. The average annual rate of inflation was 7.21 per cent so

the real annual return on equities was 7.74 per cent over this period.

Assuming future inflation averages 2.5 per cent and that real returns are

at their average historical level, a fut^_ure net rate of return of 8 per

cent seems reasonable. It would equally be possible to argue that a more

conservative view is appropriate and that the 6 per cent net rate of return

is reasonable.

The point of this analysis is simply to show that an amber review letter,

while certainly not welcome news, should not cause excessive concern.

The letter that borrowers will be receiving puts it as follows: “It is

possible that your plan may not pay out enough. To repay the target amount

when it matures, it needs fut^_ure inv^_estment growth to be towards the

top end of the current projection rates set by the independent regulator.

In view of this, you may wish to think about taking action.”


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