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One Tep beyond

The Tep market has moved on recently and they are now seen as an ideal addition to an investment portfolio

Maligned by the media and misunderstood by many in the financial services industry, the traded endowment market has until recently found itself in the back water of financial services.

Misunderstanding has been further exacerbated recently as all the major life offices continue to cut their bonus rates and impose ever higher MVAs.

Despite this, using Teps in an investment portfolio has increased in popularity as pure equity investments have crashed and a low inflation, low interest rate environment prevails. Where else can double-digit returns be achieved with no risk to capital?

As an example of overall Tep performance, anyone who invested in the Traded Endowment Fund plc in July 2000 would have paid £9.50 per share. In July 2002, this figure had grown to £10.22 or 7.5 per cent growth. Compare this to a market fall elsewhere of as much as 40 per cent.

The Tep market has evolved rapidly over the last few months with dramatically increased liquidity as a result of increased endowment sales.

The FSA decision to force life offices to make customers aware of their right to sell, coupled with the higher than average surrenders because of consumer fears about long-term growth prospects of with-profits and continued disposals because of divorce or other personal financial issues, has led to a market that offers much better value.

This liquidity has enabled Shepherds to offer current customers an extra 10 per cent free for any new investment and an additional 5 per cent for all new customers.

Our rigorous market analysis has concluded that the relative current value of Teps and their future value, given current and possible future market conditions, is positive. We believe that with-profits funds are now at, or close to, their lowest possible returns given the prevailing market conditions and the implicit smoothing within the funds.

I would be a liar if I said Teps, in their most basic form, are as exciting as taking a punt on an emerging market. But, equally, there are currently few other investments around that offer a similar capital protection and performance track record.

Leaving aside some hedge funds, with their inherent risk, and some with with-profits funds, which lack any capital guarantee, Teps are unique in the market.

However, Teps are not an investment panacea. As with any other investment, care and attention is needed. Purchasing single Teps provides for a crude investment strategy. It can leave you open to the vagaries of a life company&#39s tactics, as has been seen with the recent bonus rate cuts from Standard Life and others.

As a market we are of the opinion that the real returns from life offices have reached near to if not as low as they are going to go. However, it is also important to recognise that some companies may be affected by events that are not predictable at this moment in time so a balanced approach is more prudent.

As I have stated, Tep plans are almost unique in their gearing capacity as British clearing banks will match pound for pound any individual&#39s investment. Banks are prepared to invest alongside the primary investment on a matched basis in the form of an investment loan. The interest to the bank is then paid by the plan.

The maturity value from the Tep repays the bank&#39s interest, the capital sum and all charges for the plan and also the interest on the total investment.

For example, assuming a client wants to invest a £100,000 capital sum in a 10-year plan, it could be geared in the following manner: £100,000 client&#39s money plus a loan of up to £110,000 provided by the bank.

The bank loan is charged at typically 1.5 per cent above base rate and the whole amount required is agreed prior to the commencement of the plan. The loan is secured against the surrender value of the Teps at the time of purchase and the loan will usually be no more than 75 per cent of that value before payment of interest and premiums.

As Teps are regarded as secure investments, the bank does not require any other form of security or personal guarantees. Interest is rolled up and added to the loan to be paid from the maturity proceeds. Until the bank has been repaid at maturity, the Teps are charged to the bank as security for the loan.

Advisers may feel that borrowing increases risk but it must also be noted that the risk of underperformance is reduced because a larger portfolio of policies is bought.

In addition to the interest, a number of other charges are made. An arrangement fee will typically be 1.5 per cent of the total investment to cover the cost of the credit broker, bank and legal processes of arranging the loan. An annual administration fee is typically 0.56 per cent.

Teps retain the same basic taxation form as endowments in that the insurance company does not make deductions for personal tax before paying out the proceeds from a Tep as tax is deducted from the company&#39s underlying investments before the bonus rates is declared.

For UK residents, Tep proceeds (whether at maturity, on death or on resale of the policy), are only normally liable to capital gains tax. If a “non-qualifying” Tep is chosen a higher-rate taxpayer may be liable to income tax on the proceeds instead of CGT. For overseas residents, tax treatment depends on the laws of their country of residence at the time the policy proceeds are paid. But the returns are generally tax-free.

Teps also pay out to the current policy owner if the insured person dies before the policy ends. Good Tep plan providers will regularly monitor if a claim for payment of the life insurance is likely to be made. Some, like Shepherds, even make an ex-gratia payment to the estate of the lives assured when a death is reported.

The other clear advantage of Tep plans is that in the increasingly 1 per cent world, they pay a good level of commission.

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