It is perhaps understandable, as we trudge through the swamp of the worst investment market for a generation, that so many have turned against the speculative in favour of the guaranteed. Add to that the genuine scandals such as the mis-selling of personal pensions and the slow sinking of Equitable Life and you can condone almost anything in defence of those who have found themselves victims.
Endowment mortgages have received a battering over recent years. This is not justified and much of the problem lies in the depth of understanding by those involved.They are not hugely dissimilar to many popular products such as unit trusts or investment trusts. A full endowment policy is a contract with a sum assured that is the same as the debt and, when most products were with-profits, bonuses would then be added to increase the sum ‘ hopefully ahead of inflation.
The problem stems from the introduction of low-cost endowments to meet the boom in home ownership among the middle classes. In this case the guaranteed maturity amount is set much lower in the hope that, when all the bonuses are added, they will be enough to cover the loan. So they always were a risk ‘ if the bonuses fell short, so did the policy. Yet the appeal of endowments was for the little bit extra at the end and perhaps, in a few cases, for the idea of portability ‘ taking the policy from property to property.
No pain no gain
So why should people who expected a bonus be surprised when they have a shortfall? Surely every adult can be expected to understand risk and reward when it comes to financial transactions? Add to that a meeting with an adviser, mountains of paperwork and literature and the regulatory framework that is ridiculously biased in favour of the consumer, and you have to consider anyone to be surprised that the policy may fall short as being slightly challenged in the intellectual department.
Then there are the arguments against unit-linked plans. The usual clamour is that these are heavily loaded for commission purposes and that recent poor stock market returns have severely undermined many plans.
Whereas most of the traditional with-profits contracts, although lacking in transparency, displayed a reasonable return over time, many of the unit-linked contracts looked poor value in the early years. It could be argued the free market de-selected these long ago.
If you look at the better value plans, where is the problem? Take a £100 endowment taken out in 1999 at the very peak of the market which is set to run for a period of 25 years. This contract will see £30,000 invested on a monthly basis. As we stand today, the client will have paid around £3,000 or 10% of the total. If the market has fallen, good job ‘ because 90% of the funds haven’t been invested yet. If you advised an investment client back in December 1999 to hold back 90% of their funds they would be happy now.
The law of pound cost averaging would work, even if it takes 10 years for the markets to return to their former glories. This should be a positive point for many. Admittedly, there are questions for policyholders close to maturity where there may be cause for concern but it should only be those with five years or less as really vulnerable ‘ and many of those clients have enjoyed nearly 20 years of bull market returns.
That leaves those poor unfortunates that have been investing for 10 years and are maybe looking at poor returns. Cashing in or auctioning will turn out to be a bad idea. How else could you explain the growth in the second hand endowment market ‘ these policies are clearly worth buying.
The debate over whether interest-only or repayment mortgages are necessarily better, and also over which particular product should accompany the loan is far from clear, despite the protestations of the media and regulator since 1998.
Most of the argument against interest-only loans seem to be centred on the premise that unrealistic growth rates have been used and when these are not achieved then consumers run the risk of facing a shortfall and not being able to repay their loans when the time comes. Yet the argument doesn’t stand up to scrutiny. Clearly these are not loans, with fixed payments, but investments with high return potential. It is surely prudent to assume a lower growth rate and have a higher upside than to see the investment vehicle as a way to save costs?
This may have been the root of the endowment problem. Many people compared a repayment mortgage with an endowment mortgage on a cost basis. However, the low cost endowment became diluted further with premiums increasing over five or 10 years. In short, there is an inherent contradiction between saving money in cost terms and investing for the future in growth terms.
This Government is set on a course to stabilise and strengthen the ‘Nanny State’ by protecting potential endowment customers from themselves. It is not a future that many are looking forward to.
It is still true there is a significant percentage of borrowers with an interest-only mortgage and more worryingly, no investment vehicle to go with it. Many have discontinued endowment policies, some had Peps they have never converted to ISAs and many more did nothing to save money. The question is how many of these borrowers fully understand that they are not making any impact on their level of debt?
It must remain the duty of the adviser to include mortgage planning as part of a holistic financial review. Yes, many will have been turned off endowments and maybe even ditched ISAs because of poor returns, but they must be made to understand that the loan must still be repaid at some stage ‘ or we will face another potential scandal.
Also worrying for the industry as a whole is the fact that only about two in 10 new applicants take out an interest-only mortgage today, according to our figures. That is almost the exact opposite of 10 years ago. This may mean that education has taught borrowers to think more prudently and repay debt rather than to speculate ‘ but that still leaves the 50% or so of existing borrowers who have interest-only mortgages and either no vehicle in place or a shortfall.
When it comes to pensions, ISAs, investment trust mortgages or anything else, the question for the client is do they want to pay off the debt or build up a fund? Over 25 years in a low interest rate environment with the cost of borrowing so much cheaper, it may actually be bad advice to rule out endowments, at least as an option. Yes, growth will be slower than before and yes, the returns of the 1990s may be a long way off ‘ but they will return, if the laws of economics are to be believed.
If that is inside a quarter of a century then it may just turn out that those who took the risk and plumped for the speculative over the guaranteed may well be the ones who are smiling in the end.
Steve Buttercase is a financial adviser at Lamensdorf IFA Group
Only two in 10 new applicants take out an interest-only mortgage ‘ the opposite trend to 10 years ago.
Borrowers with five or more years left to run on their investment should see higher returns ‘ meeting their mortgage debt.
It is impossible to compare repayment with interest-only loans as you cannot compare saving money on interest with potential future growth of investments.