Like a lot of investment, traded endowment policies look simple on the surface. Either as a tax-efficient savings vehicle or a low-risk investment, Teps are useful for many medium to long-term needs, including retirement.
But they may not be as simple and efficient as they seem.
Towry Law product research manager Simon Farrant thinks buying Teps and Tep funds is like playing poker with professional bluffers.
He says: “At best, the buyer is up against two other players, the provider and the market-maker. Most providers' actuaries will try to pay asset share, which will only be known at maturity. The market-maker's actuaries know the dynamics of the market. The buyer does not know either of these.”
Policy Plus marketing manager Jo Bridger argues that investors are buying the known past performance of the Teps. She says: “Teps have a guaranteed minimum maturity value, which is the total of the basic sum assured and previously declared bonuses. This is guaranteed to be the minimum paid at maturity, providing premium payments are maintained.
“Tep market-makers provide this information, together with current bonus rate information. They can also provide analysis charts that illustrate returns on specific policies, assuming a range of bonus rate cuts. This allows the IFA to make an informed judgement.”
But Farrant believes that valuing Teps is vastly different from any other type of investment. He says: “For any ordinary equity or corporate bond fund, the prices of the underlying assets are determined by a substantial and reasonably efficient market.
“But the Tep market is a fraction of the size of the UK equity market and this means issues are clouded by the differing financial strengths and bonus philosophies of insurers.”
However, Association of Policy Market Makers chairman and managing director of Policy Portfolio Brian Goldstein says: “To say that this is the case is wrong. Teps are very transparent. When someone takes out an endowment, they have no knowledge at all. But when they buy a Tep, they have more knowledge than many other investments. Not only will they know the purchase price, they will also know the cost of premiums to maturity, as well as what bonuses have accrued.”
The argument goes that Teps are priced in a standard way across the market, based on current locked-in value and bonus rates. Market-makers say that this makes it easy to compare prices.
But Farrant believes potential Tep investors can usually find a better choice of investment. He says clients usually look to buy Teps or Tep funds as a growth investment but Isas, unit trusts and Oeics provide tax benefits that Teps do not. In some cases, they also incur significantly lower charges.
Bridger asserts that Teps still provide a formidable investment option. She says: “Teps provide a unique combination of capital security and long-term growth prospects. Unlike Isas, unit trusts and Oeics, Teps have a guaranteed value that can never fall.”
Farrant takes issue with the argument that Teps are tax-efficient. He explains that Tep funds are usually structured as investment trusts or offshore funds. Sometimes they are bought within offshore single-premium bonds. In either case, there are levels of taxation that are not immediately obvious.
He says: “If they are structured as an investment trust, they are subject to their annual exemption, which means investors must pay capital gains tax at their highest marginal rate of income tax, with no credit given for tax paid by the insurer on disposal of shares or units within the fund.”
If consumers purchase insurance bonds directly, they do not encounter this.
But Farrant says that if Teps are held in an offshore insurance bond, income tax is pay-able at 22 or 40 per cent on gains, depending on the investor's marginal rate at the time of the chargeable event. Again, no credit is given for tax paid by the underlying insurer.
“In short, Tep funds equal an element of double taxation. It is a struggle to see how this is tax-efficient, with any efficiencies achieved being enjoyed by HM Treasury.You could argue that investors are very patriotic, on the basis that they voluntarily support the national finances to a greater extent than is strictly required. If you like giving money to insurance companies and Gordon Brown, this one's for you,” he says.
But Goldstein believes that Teps are tax-efficient. He says while most policies are subject to capital gains tax, gains can be mitigated by using allowances such as the joint allowances available for spouses.
Some Tep funds are marketed as low risk and Farrant agrees this argument is reasonable but he maintains it should be remembered that investment trusts rarely trade at asset share.
Bridger points out this is why IFAs should recommend an open-ended fund, where the share price reflects the true asset share.
Consultant and former National Mutual deputy managing director Graeme Laws is pessimistic about the Tep market's future and is unconvinced of their utility as a recovery vehicle.
He says: “The market will dry up eventually as endowments mature. Because they are all equity-backed, when ratios decline heavily, investors are going to get lower returns.”
Bridger says: “It will continue to expand, eventually starting to contract in the next five years. During this time, investors will be able to pick up some excellent investments.”