The Endowment Problem
What is the problem?
If you took out your mortgage with an endowment policy, the aim was that the policy would grow in value. However, as the value of most policies is linked to the performance of the stock market there is usually no guarantee that the policy value will be sufficient to repay the mortgage at the end of the mortgage term.
Where the expected value of your policy is less than the mortgage amount this is known as the projected shortfall.
By now you should have received a letter from your endowment company telling you:
- whether or not your policy is still on track to raise the amount needed to repay your mortgage at the end of the term;
- the amount of projected shortfall, if any;
- the options open to you; and
- what further action you need to take.
Your re-projection letter - key information
Many consumers who bought an endowment mortgage will have already received their second re-projection letter. Many will have now received their third, with the FSA information sheet Your endowment mortgage - have you acted yet?. This information sheet is designed to help you decide what action (if any) you can, or need to take.
Answers to questions you might have
1. Why are firms using projection rates of 4, 6 and 8%?
These rates are prescribed by FSA rules. Firms have to use them when calculating projections - but see Q4. The rates are intended to be long-term rates that take account of current and possible future economic conditions. They give policyholders an indication of the possible outcome of the policy if these rates are achieved. We believe they are reasonable for this purpose at this time. Of course, what happens in the future may be very different as the performance of a policy depends on future investment performance. Actual rates of return, particularly in the short term, can be very different from these assumptions.
2. How did the FSA decide on these rates of 4, 6 and 8%?
The rates are set after consultation, including input from economic analysts and actuaries to reflect long-term expected returns. These rates have applied since 1 July 1999 and were reviewed in 2003. A background report detailing the 2003 review is on the FSA website:
Rates-of-return for projections - a background report detailing the 2003 review. (.pdf, 1.94Mb, 118 pages - opens up a new browser window)
3. My insurance company is using different rates - is this allowed?
Yes, if the firm feels that 4, 6 and 8% would overstate the investment potential of the policy, it can use lower rates, but it must state what these are. A firm may use its own recommended rate depending on its investment strategy. You can ask your firm to explain why it has chosen different rates.
4. How are the illustrations worked out?
The illustrations are worked out by taking into account the following:
- the current policy value (generally this will be the surrender value, unless the firm believes that another figure more fairly represents the current policy value);
- the premiums that you will pay up to the maturity date;
- the stated annual rate of return (usually 4%, 6% or 8%), which is assumed to remain unchanged until the maturity date; and
- the charges and expenses expected to be deducted before the maturity date.
5. My policy is with-profits - do the projections take terminal (final) bonus into account?
Yes, since the illustration is the total projected sum at maturity. Such a sum could be made up of a guaranteed sum assured, annual bonuses and a terminal (final) bonus.
6. Is the FSA going to change the projection rates?
At present the rates are reasonable, since they look to the future not just the present. We are aware they need to be regularly reviewed, informally and formally, using independent analysis. We conducted one such review in 2003 and this confirmed that the rates were appropriate for long-term investments.
What action should I take?
Six-Step Guide
If you have an endowment mortgage and are worried - don't make any hasty decisions. Check the facts first. Never cash in your policy or stop your payments without taking proper advice. You could lose out if you do.
Key points to consider if you are worried that your policy won't pay off your mortgage:
- Don't ignore it - things could get worse if you don't act now.
- Consider your options - there are various ways you can make up the shortfall:
- Switch the amount of the projected shortfall to a repayment mortgage;
- Ask your lender to convert your whole loan from an interest-only to a capital and interest-repayment loan;
- Repay part of your mortgage early if possible, or by overpaying each month;
- Start an additional savings plan to make up the shortfall;
- Extend the term of your endowment policy and loan; or
- Top up your endowment plan.
For more information, refer to our factsheet Your endowment mortgage - find our where you stand - available for download from the FSA’s consumer publications page. - Speak to your lender - discuss the situation with them.
- Take advice - talk to a financial adviser.
Surrey Financial Advice can help you here. We can listen to your history and your experience at time of sale, check the policy and your mortgage details and then advise on the best way forward for you, then arrange it. Remember that our initial consultation meeting is free of any charge or obligation.
If required, we can help you to lodge and word an official complaint. Then we would chase and administer it through to conclusion. This process can be done on either an agreed fixed fee basis (normally £350 at present) or, on a ‘no win- no fee’ basis for a percentage of any compensation paid (normally 10% at present). - Protect yourself - If you decide to move to a repayment mortgage, you may need to buy separate life cover.
- Don't delay if you need to complain - If you think you have been badly advised when you bought your endowment, you must complain within three years of becoming aware of the problem.
