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FOOL'S EYE VIEW
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January and February used to be great months for owners of endowments, investment bonds and other products that invested in with-profits funds. At this time of year, the major life assurers would proudly announce the annual bonuses to be added to policyholder's pots. In the good old days, policyholders would be delighted to learn that our delightful mortgage endowment plans were now worth as much as 13% more. What's more, maturing policies would always pay out more than the basic sum assured (usually the amount required to pay off our home loans), giving us a tasty tax-free windfall. By popular agreement, if you didn't take out an endowment mortgage, you would miss out on some serious money. Sadly, the heydays of the Eighties and Nineties are now but a distant memory - and endowments have been revealed as the dreadful investments they really are. In recent years, partly thanks to three years of falling stock markets, life assurers have been madly slashing annual bonuses. Despite a rebound in share prices last year, life assurers keep on cutting. That's because with-profits policies 'smooth out' unpredictable investment returns by holding back money in the good years to subsidise the bad years. This means that payouts are likely to be subdued for many years to come. First out of the blocks this year was Norwich Union, one of the giants of UK life assurance with 3.3 million policyholders. It has cut bonuses four times in two years, slashing bonuses on most policies to a pathetic 0.5% - or even zero. (Can a bonus of 0% really be called a bonus at all?!!) What's more, life assurers have been systematically cutting final bonuses (also known as terminal bonuses), which are added to maturing with-profits policies. Many Norwich Union policyholders receiving a payout this year will see their terminal bonuses slashed by a tenth (10%). All this means that a typical Norwich Union 25-year endowment has returned 6.4% a year after tax, which is an utterly disgraceful performance from a long-term savings product! Here are six problems with endowments (I will refer to endowments in the past sense, because hardly any are sold any more and several companies no longer sell them, thank Goodness!): 1. Shamefully high charges The smooth-talking, shiny-suited salespeople who sold endowments expected to be paid handsomely for their efforts. Frequently, these payments came to thousands of pounds per sale. The life assurers themselves fancied making a pretty penny, too. The result was products loaded with charges and commissions that ate up our money, leaving a lot less to be invested. In addition, some of these charges were 'front-end loaded', which means that, typically, they swallowed up all of the first two years' premiums. Of course, this was necessary in order to give chunky upfront commissions to salespeople. Other charges trimmed annual returns by several percent, which dramatically cut overall payouts. These charges meant that it took many years for endowments to be worth more than sum of the premiums paid. For example, it took over ten years before my endowment was worth more than I'd paid in. No growth for over ten years - some 'investment' it turned out to be! Amazingly, the company still expects me to keep paying over £1,100 a year into my policy, in the vain hope that my plan will meet its targets. Well, I've got some bad news for one life company... 2. Inflexibility As endowments were 'qualifying' life assurance policies, payouts from these plans were tax-free, which meant that even higher-rate taxpayers had no more tax to pay on their payouts. However, this benefit came at a price: cancel your policy - or stop paying in - and you could be hit with a tax bill when you withdrew your money. In addition, a charging structure that made policies worthless for several years locked in many policyholders, whether they liked it or not! Hence, thanks to these high charges, it was unwise to bail out before your policy matured. Nevertheless, in 1998, the Financial Times Quarterly Review of Personal Finance estimated that a staggering seven out of ten policies failed to reach maturity! This trend benefited those policyholders who held their policies until maturity, because they received the lion's share of the bonus pot. 3. Expensive life cover As life assurance policies, endowments included an element of protection, as well as investment. This life cover would pay out the sum assured (usually your mortgage balance) if you died during the life of your policy. Guess whether this cover was keenly priced or expensive? Yup, you got it in one: companies would over-charge customers for the life assurance cover as well. Instead of an endowment, you'd have been much better off finding cheap stand-alone life cover and a low-cost stock-market investment, such as an investment trust (or a lovely low-cost index tracker, which is one of our favourite financial products, but sadly didn't take off until the late Nineties). 4. Mortgage shortfalls This combination of high charges, low investment returns and expensive life cover was a toxic cocktail. Since the turn of the millennium, shocked policyholders have been discovering that their up-to-now precious endowments are, in fact, turning out to be letdowns. Some policies are paying out less than the amount needed to pay off related home loans, which means extra saving - even hardship - for some policyholders. This situation is going to get worse. If today's environment of low inflation and interest rates persists, the majority of current endowments will fail to meet their targets. 5. Complexity Life assurers did us no favours by introducing with-profit, unitised with-profit and low-cost endowments. These products were complex enough in themselves, but the underlying with-profits funds were even more mysterious. Companies never explained to policyholders how they calculated their bonuses, or applied the 'smoothing' process, making these funds particularly opaque. Indeed, many policyholders had no idea what our money was invested in (it was usually a combination of shares, bonds, property and cash). As long as our funds did well, we didn't really care. However, given the 25-year life of most mortgage-linked endowments, we'd have been miles better off if every penny went into shares, which normally beat all other conventional assets hands down over the long-term. 6. Mis-selling Also known as the 'sin of commission'! The Consumers' Association, publishers of Which? magazine, estimate that around five million of the eleven million endowments currently in existence have been mis-sold! The lure of fat commissions proved too much for many financial advisers, both independent financial advisers and tied agents. Instead of giving their clients 'best advice', as the regulations required, they were 'economical with the truth', sold dodgy endowments and happily pocketed our cash. Many salespeople didn't warn buyers about the risks associated with endowments - and failed to mention their high charges. Frequently, customers were told - falsely - that endowments: So, in conclusion, the widespread sale of endowments is a national scandal, costing homeowners and investors tens of billions of pounds. Don't buy another endowment ever again - they're probably the Fool's most hated product! If you have an existing policy, these articles will help you to decide what to do with it: More: Visit our Mortgage Centre | Learn to Invest | Endowment Action. The author has a poorly performing with-profits endowment with Standard Life.