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Evidence and endowments

The endowment debacle just refuses to go away. The FSA is pilloried for taking what seems a very balanced view over the controversy. It is probably correct in saying that most housebuyers seem to be more likely to be better off with an endowment policy rather than a repayment mortgage.

However, the selection of 4-6-8 per cent for returns seems very conservative. The problem is really that a significant number of hard cases about bad endowment policies have been allowed to be viewed as the norm by a consumer press that churns old news, dishing it up in a new form to keep a controversy running.

The news that many endowment policies may not repay mortgages as promised or expected has provided a heaven-sent opportunity for the unqualified and unregulated providers of consumer financial advice. The scaremongering consumer press will never miss an opportunity to make capital at the expense of commission remunerated financial advisers.

What constituted incorrect advice? What constitutes mat-erial loss or disadvantage? I suggest that criticism that a “commission-hungry” salesperson made more money from selling an endowment than a repayment mortgage hardly warrants the obsessive innuendo that this alone was a good enough reason for endowment mortgages to be bad.

Historically, there is no evidence that those plans which have matured or are due for maturity within, say, seven years are looking likely to suffer a shortfall in expected maturity value. That, however, is not a reason for believing that recently commenced plans will achieve expected returns. Equally, it does not give any evidence that they will not deliver. We all know the maxim “past performance does not etc£133;”

So what circumstances really do constitute misselling?

An unwarranted guarantee that the maturity value would pay off the mortgage at end of term.

Selection of a premium which was low so as to project an over-optimistic rate of growth necessary to achieve the required maturity value. Any premium set on the basis of a rate of return which was, say, more than 3 per cent over the rate of interest at the time would be likely to be risky.

Any sale which did not point out that the only absolutely sure way of repaying a mortgage was to pay exactly whatever was demanded every month by the lender according to variations in interest rates.

Failure to advise that the plan is a long-term contract and payments must be maintained monthly and that failure to maintain payments would result in the mortgage not being repaid at maturity.

Failure to advise that the payments into the plan might have to be adjusted if the required rate of investment return was not being achieved for the plan to remain on track to repay the mortgage. Possibly, where a joint-life policy was taken, advice should have been given that a split could cause a problem with it.

The argument that an endowment policy which was payable past retirement was missold is on shaky ground where the alternative was a repayment mortgage with similar monthly payments. After all, the mortgage interest and indeed the capital repayment element still has to be paid regardless of reaching retirement. At least with the endowment policy there was a possibility the potential returns could permit early repayment with better than expected maturity value.

I have seen many 25-year endowment policies which have run for 18 years and have enough value to repay the mortgage. This argument about endowment payments past retirement could be a red herring.

An additional factor is that I have seen rare cases when the cost of life insurance plus interest and capital repayment mortgage far exceeded the cost of an endowment policy plus interest-only for an older person. In some cases, life insurance was only obtainable within an endowment policy. The early surrender values of some endowment policies meant it was better to take a view on possible early surrender after, say, five years on account of the very small amount of capital that is paid off from a repayment mortgage during the first five years, where interest is calculated annually.

There are cases where right-to-buy purchases for people late in life are made on the basis that, after the three-year qualifying discount period, the property would be sold, profit released and the surrender value of the policy taken appears to be a cheaper option.

The real crux of the problem is that, all too frequently, endowment policies were sold as a cheaper option to the repayment mortgage.

It is hard to believe that, over 25 years, investment returns will not show a margin over that rate of borrowing. There has been a margin of profit over any 25-year period over the last 80 years by investing money in stocks and property. Oh, of course, past performance is no guide, etc. Charges are, of course, to be taken into account. But reduction-in-yield figures for 25-year endowment policies have usually been low, with many providers showing less than 1.5 per cent.

The problem is it is almost inevitable that, under the usual present arrangement of these policies, they will show a deficiency in expected maturity value at any time in the term without the reversionary bonuses equal the FSA-approved growth rate. Unless the annual bonus exceeds 6 per cent,then there will have to be an amber review notice. Given that any long-term with-profits policy has this feature, there will always be a problem.

Only when the non-guaranteed terminal bonus has been added, is the final reckoning of investment return known. Unit-linked plans are “what you see is what you got”. The plan has an immediately identifiable value which may offer the peace of mind that it is on track to repay the mortgage.

However, that may change during a period of stockmarket falls whereas the with-profits plan may be more secure from this. Inevitably, with-profits plans will cause potentially more alarm and despondency than unit-linked plans, even though the unit-linked plan is deemed less appropriate for the risk-averse investor. Most insurance companies show a similar long-term return for both life and with-profits funds. It is clear that, with terminal bonuses making up so much of the final return, with-profits endowment holders are far more likely to receive a red or amber notice, yet be in no worse position than the client who is in a unit-linked managed fund.

The FSA has been panicked into action by the sheer weight of consumer press antagonism against endowment policies and that is why it has come up with such a strange and pessimistic way of assessing the likelihood of the policy providing the hoped for maturity value.

With current 25-year maturity values showing over 12 per cent CAR, the 6 to 8 per cent default rate for amber notices is a very pessimistic view by any standards.

Is there an answer? All the criticism so far of the requests for increased premiums has ignored the huge saving on interest compared with eight years ago. It is not unreasonable to expect that some of that saving should be directed towards repayment of capital. The bottom line is whether the endowment policy plus mortgage interest had been at greater total cost than the alternative of the repayment mortgage plus life cover. If it had, there may have been misselling. If the endowment policy had been the cheaper option on final accounting, there may have been a misselling but not a disadvantage. There needs to be a system to assess retrospectively this comparison at the end of term to establish if there has been a loss.

I suspect there will be very few people who have been disadvantaged. Unfortunately, no one will really know until they have got much nearer to end of the mortgage term and we have a better idea of long-term investment and with-profit returns

Fortunately, the major players in this market and the two which are likely to remain, are very well financed. A recent art icle in the Sunday Times drew attention to a grave fault in the design of Eagle Star&#39s policies which effectively render them potentially non-qualifying.

If this is so, then a massive misselling situation could arise. Eagle Star premiums may have been set at the lowest level. But that sham competitiveness was at the expense of the policyholder who was dangerously exposed to any general fall in investment returns. These holders may have problems and the situation with this company deserves scrutiny. As advisers know, a company will always guarantee that the mortgage will be paid regardless, just so long as, on review, the client pays the premium demanded. I suppose that such a guarantee is not too onerous for Eagle Star (Zurich) to provide.

Most life companies have halved their term insurance rates over the last five years so the original endowment premium will include a very healthy ongoing life insurance margin which could assist the profits and, therefore, ability of the endowment provider to provide some form of retrospective guarantee of maturity value. As endowment-holders are locked in to paying this high life insurance premium, this protects the life company from the reduction of profits caused by rebroking the term insurance.

In considering the entire issue of what constitutes entitlement to compensation, the FSA has specified two requirements – the endowment policy was wrongly sold at the time and a loss has resulted.

This will inevitably restrict the number of cases where compensation will be paid or even justified. It also means that, as loss must be established, it could be very difficult to resolve the matter of compensation in most cases until policy maturity has been reached.

In this respect, the situation is somewhat different to pension misselling, where the review of misselling did not wait for the outcome at pensionable age to quantify the actual loss. Applying the terms of the FSA briefing notes on the subject, the matter of compensation could still be in contention in 25 years time.

The level of savings and investments has sunk to an all-time low as a proportion of the GDP. The destruction of endowment policies as a means of repayment of mortgages, unless replaced with an alternative other than repayment mortgages, will presumably result in a lower level of investment, which is prob ably not good for UK Plc.

If people are paying off their mortgages as they go, then the need for deposits to fund borrowing will decline. Maybe Isa mortgages will fill the gap instead, that is until another Government changes the rules again. At least under the qualifying endowment rules, the policy features were pretty secure for the entire term. It is, however, possible that in the UK we no longer have the investment opportunities to absorb more money, so perhaps this problem is imaginary. This controversial nostrum will be the subject of a future article.

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