Endowment misery that goes from bad to worse

Millions of homeowners will have winced this week at headlines bemoaning the worsening mortgage endowments crisis. With good news on endowments as rare as a Wimbledon without rain, long- suffering endowment policyholders were lashed by a positive deluge of glum tidings.

On Monday there was a warning from the main City watchdog that thousands more homeowners, relying on endowments to pay off their mortgages, are likely to be told the policies are unlikely to produce the cash they need. That same day, Standard Life revealed at least 75% of its 1.4m mortgage endowments are facing some kind of shortfall.

Then on Tuesday, Norwich Union announced final payouts on many old-style "conventional" with-profits policies, such as endowments and pensions, are being cut by up to 5%. This comes on top of cuts of up to 20% announced in January.

So what exactly does the warning from the Financial Services Authority mean? The FSA believes life insurers that have transferred investments out of shares and into less risky things such as bonds, may be overstating the potential returns to investors going forward.

It published a study showing that over the longer term, shares tend to outperform government bonds (aka gilts) by 3%-4% each year.

Under current rules, the so-called "re-projection letters" - which tell endowment holders whether their policy is on track - must show how much the policy will be worth if it delivers 4%, 6% and 8% growth a year. But these figures assume that a chunky 70% of the with-profits fund is invested in shares and property. The FSA says companies that have reduced the amounts invested in shares, and which expect to remain heavily weighted towards bonds, will have to quote lower rates of return.

That would mean more people receiving warning letters - and some who have already had letters being told the situation had worsened.

Simon Farrant at independent financial adviser Towry Law says the FSA announcement is a positive move, "but it's not going to feel like that to consumers when they are told the shortfall is bigger than they thought".

Some insurers have already acted. Earlier this year Royal & Sun Alliance reduced the rates applying to its traditional with-profits mortgage endowments to 4%, 4.75% and 5.5%. Mr Farrant says Norwich Union is among the strong insurers he believes will stick to 4%, 6% and 8% - a view confirmed by a call to NU. Likewise, Standard Life says it has no plans to reduce its projection rates, pointing out that it has a heavier exposure to equities than many rivals.

One company that will almost certainly have to reduce the rates it quotes is pensions specialist NPI, which has 650,000 with-profits policyholders and this week announced it is closing to new customers.

NPI has already warned those people in the National Provident Life part of the business, who took out their policies before 2000, that it has sold all the shares in its with-profits fund and invested the proceeds in bonds and gilts.

The other bit of the company, NPI Limited - comprising those who bought policies after January 2000 - has said its fund will have an asset mix of 70% bonds and gilts, 5% cash and just 25% shares and property, says Tom McPhail at IFA Hargreaves Lansdown.

He adds that going forward, investment performance is likely to be modest at best. "We believe everybody should give serious consideration to whether it is still appropriate to hold investments with NPI," says Mr McPhail.

What to do in the crisis

For some, just thinking about their endowment will be enough to bring on a case of the vapours. So what can worried policyholders do?

As a general rule, if your endowment is still some way off maturity, you should consider switching at least part of the mortgage to a repayment loan. Some people may want to go the whole hog, and move their entire mortgage.

If you can afford to switch and continue with the endowment, that is the ideal solution.

Or consider making extra payments into the mortgage - that is, to the lender, not the endowment - to reduce what you owe. Many lenders allow borrowers to make overpayments without penalty; others, however, will sting you. Remember that if you decide to get rid of your endowment, you must either switch to a repayment mortgage or set up another savings scheme.

Cashing in your endowment early is still pretty extreme - not least because there is usually an exit penalty for bailing out. Some people may be able to make more by selling their policy to a traded endowment policy (Tep) firm, which will then resell it to another investor. See the Association of Policy Market Makers website for more details.

You can also make the policy "paid up". This means you stop paying the premiums. It will still mature on its set date and you will receive bonuses on what you have paid in.