Don't panic, policyholders

The cuts announced in with-profits policies won't be the last. But there are other ways to protect against endowment debt agonies. Paul Gosling reports

This week's announcement by Norwich Union that it is cutting bonus rates on with-profits policies follows similar statements from Scottish Widows, Co-operative Insurance and Eagle Star, and many more are almost certain to follow. Pensions and endowment mortgages could be badly affected, and the ability of borrowers to pay their debts.

Norwich Union's with-profits pensions bonus rates this year will be 5.25 per cent, compared with 6.25 per cent in 2001, and savings policies are 4.25 per cent, against 5.25 per cent in last year. This reduces payouts by more than 10 per cent.

Mike Urmston, the chief actuary at Norwich Union, predicts that things will get worse. "Payouts are likely to fall further in the longer term, reflecting anticipated lower investment returns compared to those people enjoyed in the Eighties and Nineties," he says.

Colin Jackson, managing director of Baronworth Investment Services, publisher of a guide to with-profits policies, says: "It's all bad news so far and it will continue to be bad news. But people should not be panicked.

"The only real value of these policies is at the end of their term. If people took out these policies five or six years ago and surrendered them now, they would get nothing." He advises people not to react by surrendering policies.

If they cannot afford to maintain them they should sell them on the open market through a broker such as his own firm. Alternatively you can make them "paid up", which means you add no more to them but wait for them to mature.

Mr Jackson say that attempting to defer retirement in the hope of achieving higher bonuses is probably futile, as well as impossible for most people. "You will end up now getting a smaller pension, but it won't get better in the foreseeable future," he says.

The announcements emphasise that any product based on equities will produce smaller returns when the stock market hits trouble, even with- profits, which are designed to even out performance over a number of years.

John Turton, life and pensions specialist at the Bestinvest IFA, says: "You can't expect to make a silk purse out a sow's ear. The concern that a lot of consumers may have is from a endowment perspective, that they are not going to have enough money to pay for their mortgage. But in a savings plan, where you are amassing money for a later date, you cannot expect to continue making piles and piles and piles of money when we've had the stock market we've had for the past two years."

Anna Bowes, investor services manager with the Chase de Vere IFA, adds: "These announcements are not unexpected. If investors are in a strong company they are still relatively secure. It makes sense for the companies to reduce annual bonuses." This will ensure they have sufficient reserves to meet their commitments to customers in future years, she says.

Policyholders with endowment mortgages should consider additional savings, to protect themselves against the policy failing to repay the debt. Ms Bowes advises against paying off the capital. She suggests it is better to put the money into a tax-free equity or insurance individual savings account, or directly into stocks. She warns: "The worst thing to do is to hide your head in the sand and pretend this is not going to happen."

Mark Dampier, head of research at Hargreaves Lansdown the IFA and stockbroker, points out that things could get worse yet. "In the 1973/74 recession, a lot of bonuses weren't paid out at all," he says. He too believes people whose policies do not mature for several years should not panic. Instead, they should carry out a worst-case and best-case evaluation of their policies, protecting themselves against disaster with additional savings plans. Mr Dampier is implementing his own advice.

He has three endowment policies maturing over the next 10 years. All his endowments are performing on target and he should have half his mortgage paid off in five years. He believes it is sensible to protect himself by having a savings plan that will pay off the balance if the performance of the endowments suddenly falls badly.

He pays into a Foreign & Colonial investment trust, which requires a minimum £50 contribution monthly, but is otherwise flexible in size of contributions and maturity date. It is low-cost with charges limited to a 0.2 per cent stockbroking fee, 0.5 per cent stamp duty and 0.4 per cent annual management charges. It is professionally managed, with 35 per cent of stocks in the UK.

Whenever Mr Dampier's mortgage payment is cut, he puts the money he saves into the trust as an additional investment. With the latest interest rate cut he saves £30 a month, which goes into the F&C savings plan to take his monthly contributions to £200.

"It won't make me a fortune, but it has grown at a steady 10 per cent per annum for 10 years," Mr Dampier says . "If the market goes down, I put more money in. It's a cheap way of saving."