Money: Don't let your endowment become a liability

In the late 1980s, the word "endowment" had an appealing ring. Pay off your loan and build up a nest-egg when the policy matures, was the cry. Today hundreds of thousands of borrowers risk not having enough money to pay off their mortgages at maturity. An

Although many life assurers have withdrawn from selling them, for an ambitious life company salesman in the late 1980s, endowments were an easy sale. "Don't pay off your mortgage on the drip. Just pay interest and invest your money. Your policy should grow by at least 10.5 per cent every year." What the agent did not add was: "And I get commission on an endowment." This meant much higher, and exceedingly well-disguised, charges on the policy.

Some companies were unscrupulous and suggested investments might even grow by 12 per cent a year. That meant they offered cheaper premiums because the customer would theoretically pay less in premiums to get the same return. Unfortunately, mortgage interest rates are now expected to remain a lot closer to investment returns. In that context, the principle behind endowments is weakened.

As if that were not enough, the rules were on the side of the least competitive life insurers. Those that were good were not allowed to compete by showing the customer how much cheaper they were than their rivals. In fact, Lautro, the insurers' regulator, insisted that everyone show the same set of charges to the customer.

A sorry tale from the late 1980s translates into a problem for endowment holders now. Research by Coopers & Lybrand shows that the real charges were between 50 and 100 per cent higher than the one-size-fits-all charge illustration prescribed by Lautro. The result has been that hundreds of thousands of people have bought policies whose charges are so high they cancel out a large slice of any investment returns they might actually be making.

An endowment holder whose investments grow fast enough may not have a difficulty with charges; many have benefited from booming stock markets since 1987. But there could be a further problem. Most endowment policies were sold as with-profits investments. Whereas unit-linked policies grow or shrink as your investments grow or shrink, growth on with-profits policies depends on what the life insurer's appointed actuary, the bean-counter, decides to share out in the form of an annual bonus. If he (they are all men) is pessimistic about investment conditions and the stock market, bonuses fall.

Bonuses and maturity values were high in the 1980s because companies were competing for custom by pointing to the high final payouts of their products. No longer. As the 1990s have worn on, declining payouts on many policies, particularly 10 and 15-year ones, have meant investors receive less today than they did five or six years ago.

The Institute & Faculty of Actuaries predicts that "asset shares", the key actuarial factor in deciding bonuses, will sink to half their current level by 2009. Coopers & Lybrand points out that if that happens, the assumptions about investment growth, which allowed life insurers to offer lower premiums to their customers, are torn to shreds.

Despite a booming stock market, many life insurers have been unable to produce the fantastic investment growth that policyholders were led to expect when they bought the policies. While 25-year policies maturing now are not likely to be affected (they benefited from the excessively generous bonuses attached to them in the 1980s) those set up later than 1989-90 will be.

So far, concerns have centred around policies maturing now - those with 10- or 15-year terms which may fall short. The best estimate is that around 15 per cent of these policies will fall short of the mortgage target they were aiming for. Concerned policyholders may be blocked from taking corrective action. If an endowment has less than 10 years to go before maturity, premiums cannot be stepped up.

So what should policyholders do?Check with the insurance company to assess the progress of the endowment, making sure they can answer any questions about how the policy was sold, how high its charges really are, and how the investments into which your money has been put are performing. Then ask for an assessment of the likelihood that the endowment might fall short of the mortgage when it matures. If this is likely, consider ways of making up the shortfall.

Robert Guy, an endowment expert with independent financial adviser John Charcol, has a prescription. If premiums cannot be increased, consider converting the shortfall into a repayment loan. Policyholders who are unsure whether they will stay with the same lender in the same property should look at an alternative: a supplementary investment such as a PEP and invest however much is needed to cover the shortfall.