The cash threat to a home's foundation

Over the next six months, millions of Britain's homeowners will receive a letter from a life insurance company. For at least half a million - largely those who bought their homes between 1988 and 1995 - it will make nasty reading. The letter will show the results of an urgent review, prompted by regulators in the summer, to check if endowment policies are on track to repay mortgages.

For hundreds of thousands of people the review will show that their endowment has gone off the rails - and that they may now have to cough up an extra £25-£50 per month to get it back on track. A Jobs & Money survey this week of all the major endowment providers (full details overleaf) reveals a substantial number will be writing to you cap-in-hand over the next few months.

• Standard Life says 150,000 of its 1.2m with-profits policyholders will be in shortfall on their endowments. Letters began going out this month. For someone with a £50,000 mortgage taken out ten years ago, it is suggesting that the £50 per month endowment premium should go up to £74 - an extra £24 per month - if the homeowner wants to be sure at this stage that their policy will provide enough money to pay off their mortgage.

• Allied Dunbar is currently writing to 109,000 homeowners warning them that their premiums will have to rise by around 20% - even though it is using a less robust test of its endowments than other providers.

• Scottish Life, which came into the endowment market heavily in the late 1980s, is applying a strict test to its 200,000 policies - and says between a third and a half are likely to be in shortfall.

• Norwich Union says the review is likely to show that more than 10% of its 730,000 endowment holders are off target. Mailings to its policyholders begin in November.

But why have endowments - which worked perfectly well in the 1960s and 1970s - gone so disastrously wrong? After all, most have been invested in shares at a time when stockmarkets have scaled peak after peak. The answer lies partly in a mixture of commission greed by the salesmen, the unholy alliance of big building societies and life offices who pushed endowments on to home buyers to the almost complete exclusion of 'old-fashioned' repayment mortgages, high charges (often 10% of every premium paid) and the withdrawal of mortgage tax relief, which has undone one of the chief reasons for buying an endowment.

But the biggest reason why the begging letters are going out is a little-noticed change to 'projection' rates ordered by the Personal Investment Authority, which took effect in July this year. When endowments were sold in the late 80s and early 90s, the financial salesmen promised future returns of 8-10% a year - even though they were no more than a crystal-ball guess about what might actually happen.

The higher the projection rate used, the easier it was for salesmen to push an endowment - and pocket a neat £1,000 commission - because high supposed returns in the future meant you only had to pay a low premium now. Hey presto, the endowment looked a lot cheaper than repaying the mortgage in the traditional way.

But now that we have moved to a low-inflation, low-interest rate economy, the regulators say that projecting future returns of anything above 8% is misleading. It has set out a new projection regime, forcing endowment providers to forecast returns only at 4%, 6% and 8% - with the clear implication that 6% is the mid-point, prudent way forward. The switch downwards from 8-10% to 6% results in a sharp increase in the premium on an endowment.

HSBC has now pulled out of selling endowments altogether, because it says there can be no way that they make financial sense for a homeowner. Spokeswoman Victoria Leigh says: "We do have to take a prudent position. At the end of the day, what you are talking about is the roof over people's heads." HSBC knows that endowments don't work - because a review of its 80,000 policies is indicating that they may have to go back and ask for an average additional premium of £20 per month.

Unfortunately, mystery shopping surveys by the Consumers' Association reveal that other mortgage advisers are still presenting a misleading and biased picture aimed at persuading customers that endowment mortgages are better than repayment mortgages. "The industry is still keen to persuade borrowers to sign up to endowments because it makes seven times more commission out of them than it does out of repayment loans," it says.

Worst offenders in a recent survey were NatWest, Barclays and Abbey National. The new 6% projection rule doesn't apply just to the sale of new endowments. In September the Association of British Insurers (ABI) put in place a new code of practice in which all those policies sold at the old projection rates will have to be reviewed using the new rates, and customers informed of the results, prompting the flood of letters arriving on doorsteps in the next few months.

But the code is riddled with holes, according to industry insiders. It gives life offices a choice of testing their endowment policies by using either (a) two projections, one 4% and one 8%, or (b) one projection which is a 'reasonable rate' between the two levels. This allows life offices using method (a) to send out letters showing either a zero or negligible shortfall at 8%, and a large shortfall at 4% - which can be dismissed by referring to their past record.

The more prudent life offices are opting for reviews using method (b), and are setting the test for endowments at 6%. That is how Standard Life and Scottish Life are carrying out their review - and why they appear to have a higher 'failure' rate than the others.

Endowment sellers also face a grilling over the next couple of months from the Treasury Select Committee, focusing on whether there was widespread mis-selling of endowments. The Metropolitan police are also rumoured to be investigating the issue. Regulators say that by contrast with the pensions review, they will not be able to force the life companies to pay compensation, but you can make complaints to the PIA Ombudsman if you believe you were mis-sold a policy. But the final nail in the coffin for endowments may come next Tuesday, when the actuarial profession - the boffins who sit at the top of life offices - issue what is expected to be a damning report on endowments.

Astonishingly, 25% of mortgages are still sold with the backing of an endowment - but the life expectancy for these controversial policies appears shorter than ever.

The price of an endowment depends upon how much you estimate that future investment returns will be. The higher you guess that future returns will be, the lower the monthly premium.

In the early 90s projections of up to 12% per year were used (although 8 or 8.5% were the most common), which had the effect of making premiums very low. Now nearly all companies use projection rates of 6% (except Allied Dunbar which uses 7%), pushing up the price of an endowment substantially.

An endowment has also become very expensive in relation to the mortgage repayments. Ten years ago a £100,000 mortgage cost £1,200 to service, and the endowment, at £120-£130, added only an extra 10%.

Today the same mortgage costs about £600 to service, but the endowment, at £180-£200, adds a third to the cost of paying off a mortgage.