Mortgages and the endowment policy pay-out risk

The news on payouts is encouraging but the risk has not been eliminated yet

Fears that many thousands of home-owners who were persuaded during the Eighties to take out endowment policies to repay their mortgages would not receive enough to pay the mortgage off in full have "probably" been exaggerated, but it may need another four years of profitable investment conditions before the risk disappears.

The latest evidence to support this conclusion comes from the new figures announced every January by the insurance companies which provide endowment policies. At this time each year they declare the payouts on policies which will mature during the year and the new bonus figures which are added each year to the basic value of all current policies.

Payouts are based on the investment returns fund managers can achieve on the premiums received over the life of the policy, and consist of three elements, the basic sum assured, annual or "reversionary" bonuses credited each year during the life of the policy, and a single "terminal" bonus added during the final year

Endowment policies taken out in the Seventies and early Eighties are not at risk. A man who took out a Norwich Union endowment policy in 1972 aged 30 and paid pounds 50 a month over 25 years would be in line for a payout of pounds 93,179 this year, slightly more than the equivalent payout of pounds 92,535 a year ago. This represents a cumulative annual return of 12.6 per cent a year which compares with an average inflation rate of 8.4 per cent over the period, and implies substantial windfall profits for the policy-holder well in excess of what is needed to pay off the mortgage.

But very few endowment mortgages were taken out in the Seventies. It was not until the Eighties when lenders got wise to the commissions they could earn from insurance companies by getting borrowers to take out an endowment policy to repay the loan in one fell swoop that endowments became the normal way of repayment. Many existing borrowers were also persuaded to swap their regular repayment mortgages for an endowment, which means most policies maturing in the Nineties will only have been running for periods of between 10 and 15 years, not 25.

Unfortunately for endowment policy holders it was also the time when the government began to get inflation under control and the rates of return insurance companies could earn also starting falling. So the same borrower who started paying pounds 50 a month in 1987 will be getting only pounds 9,765 back this year, an annual return of 9.4 per cent against an average inflation rate of 4.5 per cent. In real terms after inflation, returns have been well maintained, but an endowment policy-holder with a set mortgage to repay is, of course, interested in the total return not the real return after inflation.

The new bonus figures appearing show that payouts on endowment policies maturing in 1997 will also be as much as 5 per cent less than an equivalent policy maturing last year received. Few maturing policies will actually fail to cover the mortgage, but the surplus after paying off the mortgage will now be a modest 10-20 per cent rather than the substantial windfalls a full-term 25-year policy pays out.

Future payouts depend on the annual bonuses credited to endowment policies and especially the terminal bonuses added in the final year. The longer the policy runs the larger the value of the bonuses and especially the terminal bonus, which can be 10-30 per cent of the payout after 10 years, and 40-60 per cent after 25 years.

At General Accident, for example, the sum assured is 52 per cent of the payout on a 10-year endowment policy maturing this year, the annual bonuses are 31 per cent and the terminal bonus just 17 per cent. After 25 years the sum assured represents just 12 per cent, the annual bonuses 33 per cent and the terminal bonus 55 per cent of the payout, which is why it is best to hang on to policies and not surrender them.

So what are the prospects for the future? The reduced payout on a 10- year policy maturing this year is because the good returns in 1996 were offset by better returns in 1986, the year which has dropped out of the latest calculations; 1987 was not a good year (although less of a disaster than memories of the Great Crash in October would suggest) so it ought to be easy for 1997 to beat it in time for next year's figures. But 1988 and especially 1989 were good years so the pressure will stay on 10-year maturities for another four years, when the negative returns on investments in 1990 will drop out of the equation.