Financial markets are facing testing times due to the volatility of stock markets, and the traded endowment policy (TEP) market is no exception.
The TEP market has been growing steadily over the last few years as the problem with endowments became clear. However, the market has experienced a shake-up and many TEP companies are re-evaluating their strategies because for the first time in years, it is no longer set in stone that a policyholder can sell their endowment on the TEP market for more than the surrender value. However, this has not stopped investors queuing up to get involved and by next spring it is confidently expected to be showing strong growth again.
The TEP market has existed since 1843 and over the years it has provided thousands of policyholders with an alternative to surrendering their endowment policy back to the issuing life office. A typical with-profits endowment policy runs for 25 years and while the intention is to see the policy through to maturity, only 30% of policies are thought to actually mature under the original owner. While it is usually in the best interest of policyholders to see their policy through to maturity, there are numerous reasons for choosing to surrender or sell a policy.
A change of mortgage when moving house is one of the main reasons for discontinuing a policy. Many homeowners will find the endowment policy they had originally taken out is no longer as relevant in their current situation. Other possible reasons include divorce, the need to raise capital, or simply becoming unhappy with the policy.
Trading in an endowment policy has traditionally created more value for the policyholder than simply surrendering back to the life assurance company. And following the highly-publicised problems in the mortgage endow- ment market, the Financial Services Authority (FSA) introduced a new ruling in September that requires life offices to inform policyholders about the TEP market, which is intended to help consumers realise they may get a better price for trading in their endowment, rather than surrendering it.
The FSA has now published a consultation document on relaxing time bars for mortgage endowment complaints, which should again raise public awareness of possible problems. Brian Foster, principal at Kingswood Mortgage & Investment, says: ‘Due to the FSA’s ruling all life offices will now discuss TEPs in relation to members of the Association of Policy Market Makers (APMM), but this comprises just seven firms and the market is almost three times this big.’
Many homeowners with mortgage endowments were informed earlier in the year they could be expecting a shortfall on their endowment policy upon maturity. This has undoubtedly caused further submissions to the TEP market. The Association of British Insurers has now sent projection letters to around one million homeowners. Figures indicate 34% of policyholders have been sent ‘red’ letters, a warning that their policy is unlikely to cover the cost of their mortgage. An additional 26% have been sent ‘amber’ letters, informing policyholders to take precautions against a possible shortfall.
Life offices have also adjusted the surrender values of policies recently to reflect the current investment environment and this could mean many policies maturing this year will return less than endowments maturing in the same period last year, and this is likely to have prompted more policyholders to think of discontinuing their endowment.
Contributing to the problem is the fact that many policyholders are now reacting to all the negative press by surrendering or selling their policy. They are discounting the fact that, according to the FSA, around 84% of endowment policies are still producing good returns despite the fact that they may not be meeting initial projections.
Foster says: ‘There are some who are needlessly cashing in their policies, but they are more likely to listen to the press and the Consumers’ Association, which has recently set up a website to deal with endowment complaints, than advisers. Mis-selling should be dealt with, but mis-performance is a completely different issue.’
Kevin Paterson, director of Park Row Independent Mortgages, agrees: ‘To a large extent the problems are mainly media hype. If endowments are so bad, then why is there such a huge market in traded endowment policies?’
It is worth noting most long-term investments are expected to produce lower returns in the future as interest rates are at the lowest levels for many years, whether they are endowments or otherwise. The fact that around 70% of policyholders do not see their policy through to maturity has allowed the TEP market to exist. Market makers have frequently been able to offer policyholders who own with-profits or whole of life endowment policies more than the surrender value offered by the life office. These policies are later sold on to private or institutional investors who take on all legal rights and will also receive all gains associated with the policy, as long as the policy matures under the new owner.
However, Paterson says: ‘It is a massive generalisation, but only a limited number of policies are applicable. If the borrower has a unit-linked policy most investors are not interested, and these tend to be the policies going wrong. They are interested in with-profits, but by and large they are not the ones causing the problem.’
Despite this, TEPs are becoming an increasingly popular form of investment for many, as they are relatively low-risk in most cases.
Although stocks and shares are noted for producing higher returns than other forms of investment, they also represent a greater level of risk, and in today’s volatile market, investors appear to be looking for a safer alternative.
An attractive investment
TEPs are attractive due to the smoothing element and the spread of investments. With-profit funds are invested in a mix of stocks and shares, property, fixed interest securities and cash.
Since the basic sum assured and any bonuses made at the time of purchase are guaranteed, it is possible for the investor to buy a TEP at a discount to the guaranteed sum, insuring the capital invested is not lost. The investor could get back more than the guaranteed amount, but this will depend on the annual and terminal bonuses issued by the relevant life office.
Buying a TEP requires the investor to pay a lump sum for the policy and then they simply need to continue paying the regular premiums until the policy matures. The original policyholder will have paid all the necessary start-up costs when the policy was first taken out, allowing the new owner to benefit from the growth in the latter years. In effect, the TEP purchaser is acquiring all future benefits resulting from the policy with all early expenses paid by the original policyholder.
As a greater number of policies have been sold on the TEP market in recent years, the range of TEPs available for purchase has also noticeably increased. Looking for the most suitable TEP investment is easier now there is more choice for investors. Policies can be searched using a number of criteria.
A key advantage for investors when purchasing a TEP is the ability to select the maturity date of the policy. Investors may want to choose a TEP that matures at a set time in order to fund a particular event such as 18th and 21st birthdays and anniversaries. They are also popular when planning ahead for school or university fees, retirement plans or holidays.
Investors will usually have a maximum price they are willing to invest and can search for policies that fall within their specific price range. The broad selection of policies currently on the market means TEPs can be purchased at various price levels. Policies are available from around £1,000, allowing those with only a fairly small lump sum to invest in TEPs.
The policy type can be selected along with issuing life office. In addition, investors can choose the premium amount that will be payable, for example they may prefer to pay a greater lump sum at the start with lower premium levels or a smaller lump sum with higher premiums.
It is also encouraging to know the task of finding the most suitable TEP is no longer time-consuming or difficult. In the past, several individual market makers would need to be contacted to establish what policies are available and match these to the investor’s requirements.
Web-based technology now allows policies to be identified rapidly, using a single list that holds policies from leading TEP companies.
If investors are looking for a higher risk and potentially higher return, they may wish to consider the option of gearing. UK banks and financial institutions can usually lend up to 75% of the TEP surrender value, this allows investors to purchase a broader range of policies than would otherwise be possible, however borrowing against TEPs also increases the risks associated with TEP investments.
TEPs fall into two categories for tax purposes. Most TEPs (qualified policies) are subject to Capital Gains Tax (CGT). These gains can be sheltered by the Capital Gains Tax Allowance, especially if TEPs are bought by more than one person, for example, a husband and wife. Other policies (non-qualifying) are taxed as income tax for the basic rate tax-payer and these gains may be tax-free. This is a complicated area and it is best to seek specialist tax advice.
TEPs are often chosen as an investment because they offer flexibility with low risk, as well as the prospect of good returns. This is an attractive combination for investors and one that should not be overlooked in current market conditions.
With no sign of recovery in the stock market as yet, the TEP market is set to become even more attractive for investors, and so if a client is concerned about their endowment and their policy is suitable to trade then there is a ready-made and rapidly growing market.
Irene Loucas is marketing manager at The TEP Exchange
Only 30% of with-profits endowment policies are believed to run their full course with the original owner.
TEPs are seen as a relatively low-risk in most cases due to the spread of investments.
Investors can choose the maturity date of the policy, which can help with forward planning.