How bad is it?

Judith Parker had hoped to pay off her mortgage by August 2005. Like millions of others, she is relying on an endowment to cover the loan, and believed the policy, taken out with Standard Life in 1980, would comfortably meet its target. Now she's not so sure.

"Standard Life was a household name," she says. "I'm a cautious investor and don't know enough about the stock market to take risks, so an endowment seemed ideal. Even three years ago it was well on track to pay off the loan and provide a bit more besides. Now I may have a shortfall on the mortgage and I simply don't know whether to cash in the endowment now, or wait until it matures. Either way, it looks as though I'll lose out."

Ms Parker is not alone. In recent weeks, a host of "household names", like Norwich Union, Scottish Widows, as well as the biggest mutual, Standard Life, have all slashed bonuses and maturity payouts. Policyholders now face shortfalls on their mortgages and insufficient funds in their pension pots.

So, following on from the Equitable Life debacle, just what is going on and why are with-profits investments in such crisis?

What are with-profits funds?

Policyholders share in the profits through the addition of annual (or reversionary) bonuses. At the end a terminal bonus is usually added, although this is at the company's discretion. Until recently, the unique selling point of with-profits funds was that they were meant to protect tentative investors, like Ms Parker, from direct exposure to the volatility of the stock market, because companies "smoothed" out returns over the term of the contract to avoid sharp variations on bonuses.

In the 1980s and 90s with-profits investments became so popular that, now, nearly 11 million people have a stake in with-profits funds for major lifetime savings schemes, like endowment mortgages and pension plans.

Why is there such a problem now?

Most endowments were originally sold when the stock market was riding high, profits were rising and inflation falling. It was believed endowments would work because annual growth was greater than the mortgage interest. But, since December 1999, the stock market has fallen by half and the value of with-profits funds has dropped accordingly. Most of the major life insurance companies have reacted by cutting annual and terminal bonuses.

Although with-profits policies have always been criticised for the poor value they offer those who surrender their policies early, bonus cuts mean many investors who have sustained a policy for 20 years or so are now realising their endowment is insufficient to pay off their mortgage.

To add insult to injury, some long-term investors could have received considerably more if they had surrendered their policies slightly earlier, because of recent bonus cuts and the imposition of severe exit penalties.

And, there is double-misery for an estimated 200,000 endowment mortgage holders who topped up their policies in recent years and now find, not only will their original policy miss its target, the same problems will also apply to their top-up.

So, should I stay, or should I go?

This, like all other major financial issues, depends entirely on each individual situation and financial experts urge all endowment policyholders to take professional advice before making any decision.

If you have several years of your policy to go, most financial advisers suggest you consider switching at least part of the mortgage over to a repayment loan.

However, if like Ms Parker, you are nearing the end of your loan term, the situation could be trickier. Conventional wisdom was always to advise policyholders to stay and gain from the terminal bonus. But with cuts of up to 15 per cent on final and annual bonuses, if you stay you could, in some cases, find the projected maturity value is worth less than the current surrender value. But, if you do go, you will be whacked by draconian exit penalties of up to 25 per cent.

Is it all doom and gloom then?

"Not necessarily," says Donna Bradshaw, of independent financial advisers, Fiona Price and partners. "You have to keep everything in perspective and, over the long term, with-profits still have their place. You may be getting less, but overall returns are still reasonable and better than savings.

"Any investment is a gamble and getting the best out of with-profits, as with any other investment, is a balancing act. All the current doom and gloom is based on the market continuing to drop, but no-one can say you will get more now than in three years time," she continues.

Meanwhile, Judith Parker has decided to stay put, at least for the moment: "The general consensus is that I should stick with the endowment until it matures. But I am certainly not confident it will cover the mortgage, far less provide anything in excess," she says. "With the benefit of hindsight, I wish I had chosen a conventional repayment mortgage."