What should you do with your endowment policy?

It has been reported that with-profits endowment policies are failing to deliver the sort of returns that tempted people to buy them in the eighties and nineties, and the returns are predicted to continue to fall all the way to 2020. Millions of people still hold these policies that were sold on the expectation that would pay off a mortgage debt and leave you some extra cash in hand, but they have fallen foul of high costs, low returns, dubious selling practices and hefty penalties for those who cashed them in early.

The reason the returns are falling behind so badly is that some years ago, when the stock market was struggling fund managers transferred much of the holding in the policies into fixed interest securities and cash, and have therefore missed out on the stock market’s rise in the last few years. It now looks too late to invest in the market which might be nearing its cyclical peak.

There are critics who say that insurance companies should close all with-profits funds and hand over the money held to investors. Insurance companies argue that the investment environment has changed and it is not down to over-optimistic illustrations when the policies were sold. Pay-out rates were far too high in the nineties, using cash and raising future expectations. The Financial Services Authority (FSA) has also been blamed for persuading fund managers to switch to fixed-interest securities, a charge which deny, claiming they only told companies to bolster their portfolios and make them more realistic.

With funds switching to fixed interest securities, their prices rose, making them more expensive for followers. Even worse, as interest rates rise – as they have been doing in the last year – the value of fixed interest securities falls, thereby hitting fund values harder.

Some insurance companies have sold off their with-profits funds. With no new money coming in, some new managers have claimed they can run them better and improve returns. One firm, Resolution, owns funds originally sold by Alba Life, Britannic Assurance, Century Life, Phoenix Life & Pensions, Abbey National Life, Scottish Mutual, Scottish Provident and Royal & Sun Alliance, and now has £61bn worth of assets on behalf of 7m customers.

A useful thing for policyholders to do is find out how much of their fund is invested in equities (shares). Such information can be found in your annual information sheet, or on the company’s website. Anything less than 50% invested in equities and property is seen as poor; it should be more like 60-70%, but the sector average is only 47%. Royal London holds 60-70% in equities and property (and still sells endowment policies); Norwich Union’s figure is 70-75%; Legal & General (still selling) has 71%; and Wesleyan comes out top with 72% in equities and 14% in property.

Fun returns have fallen alarmingly leading to red, amber, green warning letters in recent years. Some people have taken action to ensure that they will be able to pay of their mortgage at the end of the term. If your endowment policy is still expected to fall short of what you need to pay off you mortgage what can you do? You have three options.

You can stop paying money into you policy, by simply ringing the company and making the policy “paid up”. Your contributions to date will continue to be affected by the fund performance and you will receive your payout on maturity date.

You can cash in your policy. You can do this in two ways: either by accepting the company’s surrender value, or by selling the policy to the second0hand or traded endowment market. Before you do this you need to consider that an endowment policy also gives you life cover, so you would need to seek alternative arrangements; you should check if there are any guarantees that go with your payout that make it more attractive over full term; and you need to know whether there is any form of exit penalty, or market value adjustment (MVA). You also need to know the asset allocation, between fixed interest and securities, and equities and property as these will affect your policy’s value and may override all other considerations.

If you policy is nearing maturity date, it is almost certainly best to hold on, as terminal bonuses can often represent the largest part of payment, reaching 50% or more in some cases.

Keep an eye on your annual valuation and projected values (if given) – are they improving or worsening each year?

There is some suggestion that some insurers are looking at an additional distribution of the assets some funds hold in excess of requirements.

A policy sold on the traded endowment market can usually give you around 15% more than the surrender value, and levels of 20% are not unknown. However, it is best to seek independent advice and consider all options.