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TEPs: Three Teps to heaven

Even by Tep market standards – and this is a market that has expanded at a fairly impressive rate since the late 1980s – the last six months have been eventful.
Probably the most dramatic change has been the swing in the balance between supply and demand in the market. Of course, this turn-round has not happened overnight.
People have gradually become aware that they are likely to get more for their policy if they sell it than if they were to surrender it to the issuing life office. However, the trend has accelerated recently for a number of reasons.
In August 2001, the FSA announced its consultation paper 106. Building on guidelines already issued by the PIA in regulatory update 85, March 2001, CP106 addres-ses the issue of disclosure rules on Teps.
Life offices are already acting on the recommendation that holders of life policies, when seeking information on their surrender value, should be made aware that they may get more for the policy by selling instead. The obvious consequence of this has been an increase in the number of people approaching marketmakers to sell their endowment policies.
Reputable market-makers will not actually buy a policy unless they can beat the surrender value, so selling a policy represents better value for the seller.
Reduced bonus rates paid by life offices in recent years and the bad press that endowments have received as a consequence have also had an impact on the balance in the Tep market. Many life offices have already reduced their annual and terminal bonus rates for the year ending 2001, with the inevitable knock-on effect on final maturity values.
In fairness, life offices have had every reason to be prudent in their bonus rate declarations. The performance of their with-profits funds has not escaped the effects of declining markets, exacerbated by the events of September 11 – the result has been less of a surplus to distribute among policyholders.
Furthermore, on December 18 last year, the FSA made a statement, addressed at life offices, emphasising the importance of announcing rates that are in line with their ongoing financial soundness, and are a fair reflection of their ability to pay.
Some policyholders, realising they are not likely to achieve the returns they had originally hoped for, have become disillusioned with their endowment policies and made the decision to sell, further increasing supply. The good news for investors is that the increased availability of Teps has resulted in lower market prices.
Paradoxically, recent bonus rate reductions should also be considered as positive news for new investors, as they should ensure current rates will be sustainable in the future. The important thing to remember is that, because of the way Teps are priced, bonus rates need to be consistent rather than exceptional for anticipated returns to be realised.
All bonus rate announcements to date are taken into account when a price is set. And, of course, all the set-up charges will already have been borne by the original policyholder.
It is not surprising that, since September 11, interest in the Tep market has increased significantly. They are more attractive to investors in a time of extreme stockmarket volatility because their secure locked-in value means they offer exposure to equities but with a lower level of risk than a direct investment.
Teps are a particularly good investment in uncertain times, due to the process of smoothing, whereby life offices hold back excess assets during the good times to help maintain bonus payments in the bad times. This is designed to reduce the effect of short-term market fluctuations on maturity payouts.
A fact often overlooked is that real returns on Teps actually increased last year.
This is because inflation fell faster than gross returns on endowment policies.
Investors’ average rate of return on Teps maturing in 2001 was 8.28 per cent while inflation was 2.33 per cent. Thus, the real return (gross return minus inflation) was 5.95 per cent.
This compares with just 4.91 per cent in 1997, when markets generally were much stronger.
The wider choice of policies available makes it easier for an investor to find one to match their own specific requirements. Factors such as the issuing life office, time remaining until maturity, premiums outstanding, and the terminal bonus ratio, should all be considered.
Teps are more diverse than many people realise, and suitable policies can also be selected according to an investor’ own attitude to risk.
The more cautious investor will tend to go for a policy with a higher capital guarantee percentage. This is calculated as the sum assured, plus any attaching bonuses, taken as a percentage of the purchase price plus premiums payable to maturity. In other words, if the capital guarantee percentage is 100 per cent or higher, there is no risk of losing the capital invested.
Take the example of a Norwich Union policy currently available for sale. The life office may not currently be one of the top performers in the league tables but this is reflected in the price of the Tep. It offers a capital guarantee percentage of 100 per cent, with further upside potential.
Another market-wide phenomenon experienced in recent months is the increased volume of re-trading. That is selling a Tep before it reaches maturity. This trend highlights the liquidity of Teps as an investment, something many investors are unaware of. Although the typical investor still buys a Tep to hold until maturity, there is a healthy resale market.
All these factors lead to the conclusion that although this is not an easy time for investors generally, the outlook for the Tep market is very positive.
New investors will benefit from the combined impact of bonus rate announcements, that have taken an element of risk out of the market, and increased availability, resulting in a wider choice and better value for money.

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