Endowments investment or albatross?

The maturity value of endowments

Both conventional endowment policies and “with profit” bonds are affected. So called “low cost” endowments, used in connection with mortgages are also offering lower returns, making it unlikely these policies will be able to repay mortgage debts, but different considerations will apply, because part of the premiums are used to provide additional life cover.

As equity markets have been rising more or less steadily for several years following a difficult period during the first third of this decade, it can be difficult to understand why endowment maturity values are still falling.

In fact, there are several reasons for this. Firstly, “with profit” funds do not pass on short-term market fluctuations to their policyholders, but apply what is called “smoothing” to the returns. This means that the insurance company looks at the returns achieved by the fund over a period of years and modifies the amount it adds to policies each year (in the form of bonuses) so that a relatively consistent amount applies. This means that in any one year the fund may actually grow by more (or less) than the amount indicated by the bonus rate declared.

Of course, “with profit” funds do not only invested in equities; they will also hold property, gilts and cash. This means that investment returns are not entirely dependent on what happens to equities; so while the FTSE100 has not yet recovered to the 6,930 points achieved at the very end of 1999, “with profit” funds may have been achieving positive longer term returns in other areas. As a result (according to data collected by Money Management) the average annualised growth rate for with profits funds over the last 25 years is actually 8.5%, with even the lowest return being 5.7% a year; well ahead of the current rate of inflation.

One of the main adverse factors to have hit “with profit” funds is that, when equity markets fell dramatically during 2000 to 2003, they had to sell equities at the worst possible time, in order to protect their “solvency margins” this is the excess of assets over liabilities that they are legally required to maintain. Indeed, had the Financial Services Authority not quietly relaxed the rules at the height of the bear market, things today could have been far worse, as “with profit” funds would have taken far longer to recover their position.

One of the fundamental problems with this form of investment is that, in order to provide the “smoothed investment returns” charges and the way reserves are generated within a “with profits” fund are far from clear and make it difficult to compare one fund with another.

Insurance companies try to ensure equity between each group (or cohort) of policyholders who have invested over similar periods, so that all receive a fair return on their money. This means that if some are allowed to take out their investment before the “due date”, it can disadvantage those who remain. In order to minimise the impact of this, a penalty will apply. This will, for regular premium policies, be a reduction on the sum assured and bonuses declared to date; for with profit bonds, it can take the form of a “Market Value Adjuster” which varies the return to allow for current market conditions.

So what are your options, if you feel that your policy is not performing as well as you might wish? It is important to be aware that future performance will bear no relationship to the past. However, with profit policies include guarantees at certain points and the closer you are to one of these, the more carefully you should consider matters before surrendering your policy.

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