How savers miss out on pounds 125m

Selling an endowment before it matures can be much more profitable than surrendering it to the insurer.

Each year, 750,000 new endowment policies are started, many of them alongside a mortgage or to build up savings. They can represent a good way to save, especially if kept to their original 10 to 25-year term. But many are stopped early and a thriving business has now built up selling those policies on to investors.

Last year the market in traded endowment plans or TEPs grew by more than 30 per cent to an estimated pounds 300m, says Tim Villiers, director of the Association of Policy Market Makers (APMM).

Even so, that represents less than a third of the policies that could be sold on to investors rather than surren-dered to the insurer for cash.

The way in which TEPs work is that instead of cashing in their plan, the original owner approaches a TEP market maker and agrees a price to sell at. The APMM estimates that selling-on a policy adds around an extra 12.5 per cent to the cash value quoted by the insurance company, provided that the policy has been held for a number of years.

Alternatively, policies can be sold at auction. Foster & Cranfield holds weekly auctions throughout the country and last year sold pounds 35m of second- hand policies. It charges vendors one third of any gain made over and above the policy's cash value as commission. Either way, for the potential seller, there is no downside - they simply get back more than they would from their insurance company.

Market makers offer potential buyers a range of policies, marked up by about 8 to 10 per cent, or policies can be bought at auction when no buyer's premium is charged. The investor takes over paying the premiums until maturity, when the proceeds are paid to them. "It's a safer way of investing than buying equities, while yielding more than gilts," according to Mr Villiers.

Not every policy is suitable to become a TEP. Most market makers concentrate on the major 30 or so insurers and look for policies with 5-15 years left to run. That will rule out both newer policies and those from smaller insurers. But with policy surrenders now running at over pounds 7bn a year, of which only pounds 1bn is tradable, that still means that an extra pounds 125m could be received by selling a policy rather than simply cashing it in.

Market makers also provide advice, help and paperwork to buyers and sellers and act as a buffer separating the two sides. Sellers could feel vulnerable if their identity were known, especially if large sums assured were payable on death, so two independent referees are appointed to check up periodically that the seller is still alive. If they have died, the buyer can get a windfall profit from the sum assured paid on death.

Provided that the policy is more than 10 years old, or three quarters of the original term if less, then no tax is payable on selling a policy. The buyer will not get any tax relief on the premiums they pay, and will be liable to capital gains tax when the policy matures or is sold on again. That needs to be taken into account when weighing up the likely investment return, as does the trend to reduce regular bonus rates.

Even so, Tim Villiers estimates that returns of around 10.5 per cent a year are possible. That is because after buying a TEP, each year a regular or reversionary bonus is added to the sum assured payable on death or maturity and, once declared, cannot be taken away. As the policy approaches maturity, so the guaranteed return increases.

What really determines the value on maturity though is the level of terminal bonus declared. This is usually a percentage of bonuses and is likely to be a much more volatile figure and could be cut or removed if investment conditions at maturity were poor. Any such moves would affect all policies maturing, not just those held by investors.

The real reason why TEPs work at all is that insurers have always favoured those customers who keep their policies going until maturity. Anyone having to stop before then has not had such a good deal. Part of the reason is that to get the highest returns, fund managers invest in equities but equity markets can be volatile and no fund manager wants to sell investments other than for purely investment reasons.

So a proportion of the fund will be kept in Government gilt-edged stocks and other fixed-interest investments. That way, the fund manager can better match their investments to the need to pay out on policies. As the number of policies cashed-in cannot reliably be forecast, whereas those maturing can, so those who stop should not receive such good value as those that stay.

Cynics argue too that as the market pays more attention to maturity values than to surrender values, so insurers can afford to pay out less to the majority who cash-in early to subsidise the minority whose plans run to maturity. TEPs provide the necessary buffer, increasing returns to sellers while providing a relatively safe investment for buyers.

To find out the name of three Association of Policy Market Makers members who buy or sell polices contact the APMM on 0171 739 3949. Alternatively, policies can be bought and sold at auction. The leading auction house, Foster & Cranfield, also an APMM member, is on 0171 608 1941

Andy Couchman is publishing editor of HealthCare Insurance Report