Alarm bells for endowment mortgages

A year ago Norwich Union and Standard Life made a promise to about 2 million customers who had with-profits endowment policies with them. Provided the average investment return over the life of the policies was at least 6 per cent, they would produce enough to pay off the mortgages linked to them and the firms would meet any shortfall.

But last year investment returns were zero at best, and this year is looking much worse. The stock market is down almost a quarter, and though neither fund will be wholly in equities - Norwich Union has a third in cash, bonds and other investments - without a dramatic stocks recovery a return of minus 20 per cent is not unlikely.

Both firms insist this is no big deal. The promise was based on average returns, so a few good years can make up for the bad ones; that, after all, is the whole point of with-profits policies.

But to produce an average of 6 per cent over a 10-year period, the next eight years would have to produce an average of 11.5 per cent; over a full 25-year term the average would have to be 7.4 per cent. That may look easy enough, given the good returns we all became accustomed to in the 1980s and 1990s. But everyone, from the Financial Services Authority downwards, warns that low inflation means we must accept that investment returns will be lower than in the past. Norwich Union and Standard Life's promises do at least give their policyholders some protection, as they will cover any shortfall down to that equivalent annual return.

Beyond that, as Norwich Union's David Riddington puts it - 'the shortfall has to be met in some other way' - that is, from the policyholders own pockets.

Other firms offer no such guarantee, so a sharply increasing number of borrowers have to cover the entire shortfall themselves.

Last year's policy reviews, which uncovered 6 million policies that were not on track to cover mortgage repayment, were based on the projection of 6 per cent returns for the life of the policies. Companies now have to conduct reviews at least every two years.

Even if the FSA leaves the projection rate unchanged - and there are suggestions it will be cut - stock market losses mean that the policies now have a lower starting point for projections.

Endowment policyholders should, therefore, prepare themselves for the worst. Use whatever spare cash you have to pay down your mortgage, if you can do so without incurring penalties, or consider saving through an Isa to make up any potential shortfall.