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Doing the maths

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  • 14/01/2002
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Although selling an endowment policy should be viewed as a last resort, in most cases clients will yield a better return than surrendering back to the life office

Over the past decade the number of people cashing in their endowment policies prior to maturity has reached new heights. One result has been the expansion of the traded endowment policy (TEP) market, which buys policies and then trades them on the open market.

However, many policies suitable for re-sale on the TEP market are still being surrendered back to life companies because policyholders are unaware they could get an average of 15% more by selling their endowment to a market maker.

It is estimated that every week more than 1,000 people surrender their endowment policy back to their life company instead of selling it on. Given that advisers can earn up to £360 commission on an average endowment policy of £10,000, this means that over £18.5m worth of commission is lost each year (based upon 2000 figures).

However, advisers need to be aware of the sales process and the reasons why a policyholder may choose to sell their endowment.

Over the past 18 months, thousands of policyholders have received letters from their life company warning them that their policy may not cover the cost of their mortgage. For many policyholders the shortfall may run into several thousand pounds. Many endowment policyholders are worried and confused.

As well as this group, there are many people who choose to get rid of their endowment policy for more mundane reasons. The most common are remortgaging, moving home and divorce. Advisers are often in the position to advise clients in these situations. For instance, an endowment policyholder may have already changed the mortgage repayment method and no longer need the endowment. Alternatively, policyholders may find themselves with an unwanted policy through a divorce, or because redundancy has left them unable to pay the premiums required to maintain the contract. Some policyholders may have already redeemed their mortgage and found that an endowment no longer fits with their financial portfolio. In all these scenarios the adviser should take the lead in getting the policyholder the best deal.

First things first

So, what is the best course of action to take? The first thing to remember is that selling an endowment should be seen as the last resort. Any policyholders worried about their endowment covering their mortgage should look at alternative options open to them. These could include taking out additional investments such as an Isa, or topping up their contributions. In the past, the knee-jerk reaction of most policyholders has been to phone the life company and surrender the policy direct to them. However, this does not always produce the best result for the policyholder.

Life companies do not usually offer endowment holders the perceived full market value of the policy. Instead they offer the policyholder a figure that is below market value to protect the investment fund for other endowment holders. Policyholders may also find that in light of current market conditions and falling bonus rates, companies are reducing the amount offered as surrender values.

Alternative solutions

Until recently, there was no requirement for life companies to make policyholders aware of the alternatives. Usually the only other alternative offered by life companies would have been to make the policy ‘paid-up’ ‘ in other words, to stop paying premiums. However, earlier this year, the Financial Services Authority issued guidelines requiring all life companies to state all of the alternatives available to a policyholder and not just highlight the benefits of surrendering a policy.

The alternative is to offer the endowment policy for sale to a market maker. This strategy presents many advantages. The main advantage is that market makers are able to offer substantially more than the life company, and in some cases policyholders may receive an uplift of around 35% on the surrender value proposed by their life company.

Before advising a client to contact a market maker it may be worth considering if the policy is eligible for sale. As a rule the policy needs to be:

• Whole of life or with-profits.

• In force for at least five to seven years.

• Be worth at least £1,500.

If the policy fulfils each of the above three points then it is likely that it will be eligible for sale to a market maker.

Selling to a market maker is easy. Market makers tend to be able to complete the paperwork in the same time that it would take to surrender a policy. Also, market makers tend to have an experienced legal department that can deal with the reassignment paperwork at no extra cost to the policyholder.

There are four distinct stages to selling a policy:

• Stage 1: Request a surrender figure from the life company. A policyholder can use this figure for comparison purposes with the amount offered from the market maker.

• Stage 2: Obtain a quotation from a market maker. Some companies offer an instant valuation service on the internet. Using such a service saves time and will provide an instant quotation for comparison purposes. Alternatively, the policyholder can telephone a market maker to receive a quotation via the post. Either method will provide the policyholder with a reasonable idea of the value of the policy on the open market.

• Stage 3: Upon receipt of the offer from the market maker the policyholder needs to decide whether they want to accept the figure proposed. Once the policyholder has made a decision all they then need to do is sign the necessary forms and return them to the market maker who will handle the remaining paperwork, including reassigning the policy.

• Stage 4: All the policyholder needs to do is wait for the cheque to arrive.

Selling an endowment policy is not a difficult process and can result in the policyholder being substantially better off than if they had sold to a life company.

The reason market makers are able to offer higher values for policies is that they sell them on to private or institutional investors. The purchaser then becomes liable for future premiums until the policy matures.

Keeping it simple

Policies which are traded will have usually run for at least five years and will have remaining terms of anything between two years and 20 years. Many investors choose policies with maturity dates to coincide with special events in their life, such as retirement or to fund school fees for children. Investors generally choose to invest in endowment policies because they consider them to be low risk due to the diversity of investment within the fund, not to mention the significant capital guarantees and the potential tax advantages that can be offered through endowments.

With the demand for endowments growing in an increasingly unstable world market, policyholders will find that market makers are keen to purchase their policy. However, this does not mean that there is now a sellers’ market. Advisers may wish to manage the expectations of clients when suggesting they approach a market maker, as not all policies are tradeable and the amounts paid will depend on the age of the policy and a number of other factors.

Once the decision to sell has been made by the policyholder it is crucial that the adviser is fully aware of the options open to the policyholder. So next time a client mentions they are unhappy with their endowment and are considering surrendering, it is worth remembering that they may be better off approaching a market maker.

sales points

Over 1,000 endowment policies are surrendered each week, rather than sold on to a third party for an improved return.

Advisers can earn up to £360 commission on an average endowment policy of £10,000.

Advisers must manage client expectations as not all policies are tradeable and amounts paid depend on a number of factors.

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