Pensions Advisers
Mortgage Advisers Ethical Advisers Long Term Care Female IFAs
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Pensions Advisers
Mortgage Advisers Ethical Advisers Long Term Care Female IFAs
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Archives Endowment Mortgages: 'Do Not Panic' by Independent Financial Adviser Neil Melton. Endowments have become headline news recently. Many life assurance companies have mailed their policyholders letters with figures suggesting that their investment intended to repay the mortgage and provide a modest nest-egg is now likely to fall short of its goal. There has been a surge in the number of policies being surrendered or sold on the strength of the figures in the review letters. Many Independent Financial Advisers have been asked to clarify the often-confusing letters. Changing circumstances The majority of the "problem" policies were taken out between the late 1980's and early 1990's. This was the time when interest rates were high, averaging between 10% and 12%. Inflation was also high (compared with today) at approximately 6%. Double figure investment returns could be expected, but markets were extremely volatile. Back then endowment illustrations assumed annual returns of between 7.5% and 9%, which were reasonable expectations in the economic environment of the day. A mortgage of £50,000 conducted on the endowment basis would then have cost approximately £417 amonth, with an endowment premium of around £70 - £487 altogether. A repayment mortgage holder would have had to pay about £562 a month. Today, interest rates are considerably lower, with mortgage base rates at around 7.75%. More importantly, inflation is dramatically lower at around 3%. Changing the rules for projections In this environment, economic growth is likely to be slow but sustained, meaning that the returns will not be as high year-on-year as in previous times. It necessarily follows that the returns on investments such as endowment policies are likely to be lower. The same mortgage of £50,000 today is likely to cost approximately £323, with the endowment premium still around £70. This amounts to payments of £393 a month. In comparision, a repayment mortgage now costs just £382 a month. As investment performance is likely to be lower, the Financial Services Authority has reduced the growth assumptions that can be used in illustrations. For the foreseeable future an annual rate of just 6% is seen as a reasonable figure. If you now take an endowment originally set up assuming 7.5%-9% and re-project the maturity fund using 6%, it is almost guaranteed to show a shortfall. Unrealistic expectations It could certainly be argued that in view of the savings most people were making on their mortgage payments since they set up the original mortgage, some of this money could be used to mitigate any potential shortfall, and they would still be far better off than before. In fact I would say it is unrealistic to assume a policy set up in the late 80s, early 90s will perform at the same level today. The review highlights the perils of the "swings and roundabouts" economy. Whilst some endowment policies may have been set up using a questionable growth rate, the majority of policies were started using rates that were appropriate at the time. A financial adviser cannot realistically be held responsible for a reduction in investment returns. And the review process has its own limitations in respect of how the projections are calculated, which can cause a poor situation look even worse. Don't panic This offers no comfort to the policyholders that have had horrendous projection letters. And in any case, where there is a projected shortfall, the correct advice is not to panic. Remember that surrendering a policy is usually the worst course of action you can take. The key is to consult your financial adviser, explain your concerns, and they should be able to advise you on the correct course of action that is right for you. One of the positive points raised by the review is that it highlights the need to regularly review your financial arrangements, as the earlier a problem is identified, the quicker a solution can be found. Neil Melton is a registered individual at Park Hall Insurance Services, a small Independent Financial Advisers office based in Mansfield Woodhouse. Source: www.parkhall.co.uk email: Neil@parkhall.co.uk
Article taken from the BCC News Website. September 29th 2000
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