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MIRAS

The Faculty and Institute of Actuaries have recently published their report of the endowment mortgages working party. The Government and the Bank of England have waged an anti-inflationary campaign which has resulted in a large fall in inflation; investment yields have fallen in line. Inflation has subsidised homebuyers for decades but this is no longer the case. Insurers have been contacting around 500,000 policyholders asking them to save up to £50 a month if they wish to avoid a shortfall on their mortgage on maturity. If a significant number of policyholders do not take out a top-up policy the number of new endowments sold could reduce substantially.



The report advocates the repayment method as the most straightforward and low-risk method of repaying a mortgage. It also warns that endowment policies of less than 10 to 15 years are unlikely to be justifiable as providing good value in the future based on today`s charges and maturity considerations.



Reduction in yield (RIY) calculates the effect of all charges on a policy. The competitive rates vary in practice and are sometimes higher than the maximum rate that would make the policy worthwhile:



10 years – 2% to 2.5% p.a. (worthwhile 1.6% p.a.);


15 years – 1.6% to 1.8% p.a. (worthwhile 1.4% p.a.);


20 years – 1.3% to 1.4% p.a. (worthwhile 1.3% p.a.);


25 years – 1.0% p.a. (worthwhile 1.3% p.a.).



Around 25% of new mortgages are backed by endowment policies compared with 80% in their heyday during the late 1980`s. The report does not condemn all endowments and they could be considered “best advice” in certain circumstances. The charges should be low and level; not high and front ended.



The Financial Services Authority currently approves a new mid-rate projection of 6% a year. The report recommends that this should normally be capped at 5.25% a year, although other rates can be used. If implemented this will result in increased monthly payments for existing endowment policyholders and will damage the sales of new policies.



COMMENT



The report is unique in that mortgage advice in general has so far been outside the scope of the Financial Services Act 1986, although endowment policies are covered as they contain an investment content.



Existing endowment policies are outside the scope of the report. The RIY depends on age, smoker status, general health, need for death and critical illness cover, waiver of premium etc. Accordingly, a variation of 0.25% either side of the capped rate is acceptable if the individual`s circumstances justify this, particularly on longer-term endowment policies.



It is up to the customer and/or the adviser to determine the appropriate provisions based on individual needs, and it should not be assumed that a standard approach must be used.



Individual Savings Accounts should not be overlooked. These can perform a similar function to endowment policies but are not as generous as PEPs. The use of a 1% higher assumed growth rate than on an endowment policy is justifiable given the increased potential volatility. The premiums on any associated life or critical illness policy would have to be included as a cost.


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