Endowment life raft may not stay afloat

A new scheme which claims to offer a lifeline to people worried about endowment mortgage shortfalls was this week being probed by investment watchdogs.

Midlands-based company Mortgage Paid For Sure (MPFS plc) hired a London hotel on Monday to unveil its "pioneering and unique" solution to the endowment crisis. It offers homeowners worried their policy may not be on track to pay off the mortgage a guarantee that it will make up any shortfall in return for a fee of £175.

But the scheme has prompted concern at the Financial Services Authority, the main City watchdog, which believes that in its present form it may breach the rules covering insurance business. As a result, the company has suspended its activities while an investigation is carried out.

The MPFS scheme would, for a one-off flat fee of £175 irrespective of the size of the policy or how long it had to run, guarantee to make up any shortfall. But if there was a surplus when the policy matures, the firm would take 25% of this. And if the policy is surrendered before maturity, MPFS would take 10% of the surrender value.

However, it is understood the Financial Services Authority believes the firm may not have the necessary backing from an authorised insurance company as required under the Insurance Companies Act. If a firm carries out this sort of business without authorisation it risks committing a criminal offence and any contracts it issued would be invalid.

MPFS managing director John Webb says he was unable to find a Lloyd's syndicate or insurance company to underwrite the deal. Instead, he says, the plan was it would operate its own "reserve fund" from which any payouts would be made.

He also disclosed that the Staffordshire-based company is not regulated by a watchdog such as the Financial Services Authority. Mr Webb said it did not need to be regulated because it is not giving financial advice.

So one obvious question was: what happens if the firm goes bust in a few years' time, before my policy has matured - do I lose my money? Mr Webb's reply was that if it was to shut down, "the worst case scenario is that the most anyone could lose would be that [£175] fee".

In other words, the answer to the question was quite possibly yes. On Wednesday night, Mr Webb said he had suspended the company's activities while the Financial Services Authority looks into the matter.

The controversy comes as letters from insurance companies have been going out to millions of people, many of whom are being told their policies may not be on target to repay the mortgage. The Financial Services Authority has estimated that as many as 3m of the 10m policies may be in shortfall.

What now look like over-optimistic assumptions about investment growth are at the heart of the problem. During the late 80s and early 90s, some insurers sold the policies using projections of future growth of up to 12% a year.

But industry watchdogs now say these projections were too high. Last year investment watchdog the Personal Investment Authority set a new projection rate of 6% future growth per year.

Many people are being told that their policies are probably on target if the old projection rate is used, but may fall short if the 6% growth figure is used.

However, some commentators - particularly independent financial advisers - insist that a projection rate of 6% future growth per year is way too low.

They point to a survey in Money Management magazine in April which revealed that for 25-year endowment policies maturing in February this year, the average gross annual yield was 13.1%. The magazine studied 34 different companies and found that even the worst performer in terms of yield, Equitable Life, achieved 11.9%.

Some independent financial advisers say this shows that the 6% figure is very conservative indeed. But other experts argue that good performance in the past does not mean good performance in the future.

People concerned that they may have been given poor advice regarding an endowment will be watching closely the case of a couple from London, who may be set to receive a payout from insurer Legal & General on the grounds that they were wrongly sold an endowment.

The case is currently with the Personal Investment Authority ombudsman, who has just issued a preliminary decision on the dispute in the couple's favour, and is understood to call on Legal & General to repay all their endowment payments plus interest on the grounds that the salesperson did not properly explain the risks involved with investing in a stock market-linked product.

Legal & General can now either agree to pay up or can reject the decision - if it takes the latter route, the case will go to the ombudsman for a final decision. A Legal & General spokesman says that as the matter has not yet been resolved, it does not wish to comment.

If the couple win the case, it could open the floodgates to a spate of similar claims from people who say they were victims of mis-selling.

What you can do

If you are worried that your endowment policy may not pay off the mortgage, there are a number of things you can do.

The number one piece of advice from the Financial Services Authority, the chief investment watchdog, is: "Don't make any hasty decisions." It says you should never cash in your policy, or stop making payments, without taking advice. This is because endowments often involve high charges in the early years, and if the policy is only a few years old you will probably end up getting back less than you've spent.

After taking advice, you may consider one or more of the following options:

• Do nothing. While the predictions are for lower investment returns in the future, nobody can really be sure what will happen. You may be happy to cross your fingers in the hope that the policy makes the grade, particularly if your policy only just fails to hit the target using a projection rate of 6%, or if the potential shortfall is fairly small.

• Increase your monthly payments into the policy. While this will probably delight your insurer, you may feel this amounts to throwing good money after bad. Also, with some companies it may involve you having to pay extra charges.

• Contact your lender and arrange to change part of your mortgage to a repayment loan. This could be a much better option. For example, if your mortgage is £60,000 and the potential endowment shortfall is £10,000, you could rejig the mortgage so that £50,000 continues on an interest-only basis and £10,000 is converted to a repayment loan.

• Set up a separate investment that can be used if necessary to meet a shortfall. One good way of building up a lump sum might be to go for an individual savings account. However, check carefully to see what the charges are. With many stocks and shares Isa providers, the minimum monthly investment is £50 but in a few cases is as low as £25.

• If you have a spare lump sum, and your lender allows it, you could make extra capital repayments to your lender to reduce the amount you owe on the mortgage loan. Check for early redemption penalties.

• Arrange for the policy term to be extended. "This is not likely to be a good idea if the policy will continue after you have retired, unless you are sure you will still be able to afford the payments," says the FSA (www.fsa.gov.uk).