The Gazette 1993

APRIL . 1993

GAZETTE

original loan. This is why endowment policies should never be cashed and new ones entered into when moving house. 2. Cash lump sum. On average a return of around 5% p.a. on invested premiums will secure the sum borrowed. Provided returns are reasonable and in excess of this there will be a cash surplus. We have seen that if an investor is prepared to pay extra during the course of his mortgage he will often be better off than if he had saved the money separately, provided we assume that the return on the invested money is equal in each case. However, this person would also Find it more convenient if he maintained personal control over his savings plan by keeping it separate from his mortgage. 3. You already have a good savings plan. For those who are already good savers before they buy their house there is some really good news. If you have started your endowment early you may be able to reduce the cost of buying a house very substantially. We have seen that the expense lies in interest payments and if you can reduce the period of time over which the money is borrowed by a policy payout within the 20 year period this means big savings. 4. If you already have reputable endowment arrangements for some years and wish to change now, savings in outlays may not be feasible. Although there are savings in outlays to be made in switching from an endowment to a repayment, unless this is done in the early years it may not be possible if the original mortgage term is to be preserved. Summary As with most things there is a time and place for endowment type arrangements but they should not be applied across the board. The endowment is a sophisticated financial instrument and must be respected for what it is. As far as consumers are concerned utmost caution should be employed as they will be offered, from some quarters, endowments which are unsuitable for house purchase because they are in essence largely speculative investments. •

into the life of a mortgage the value of the endowment equals the sum total of the premiums then paid in, that plan requires a return of 11.14% compound on premiums invested in order to reach the targeted sum, let alone a surplus. For every year growth is delayed this figure rises substantially. Bear in mind that the 11.14% does not make allowances for expenses and charges and when these are taken into account the growth in units required will be higher. Endowments that contain guarantees do not face the same problems. Their structure ensures that there will be growth provided the savings contract is allowed to run its course. This growth has its origins in annual accretions and does not rely upon a last minute spurt to record a decent return (but may rely upon a Terminal Bonus to boost its value to the aspired levels). Personal views on this matter are not really within the remit of the mortgage advisor. The prudent will not count on an improvement in the equity markets for some considerable time and the holder of a managed fund endowment plan will not seek the kind of returns they had hoped perhaps for another fifteen or twenty years from now. Is an endowment ever justified? Yes. I believe there are good reasons for having an endowment:- 1. Moving house. Estate agents will tell you that people move house on average every seven years in Britain. In Ireland this figure may be more like 10 years or so. Despite the higher cost of the initial endowment mortgage it will almost certainly be cheaper for a borrower to bring the original endowment with him to the new house (or houses) and enter into fresh borrowing arrangements for any top up loans required than to pay off a repayment loan and have to reborrow for a new amount over a new period of time. This is because the total net cost of borrowing money is greater the longer the period of time over which that money is borrowed. A maturing endowment policy ensures that capital is available to repay a loan within the intended term of the

Dangerous endowments If there is a shortfall in the

endowment policy at maturity, then the balance will be due from the borrower to be met from other resources. This is the risk element in all save the most costly endowment type loans. However, the risk does not fall evenly upon all endowment policy holders. It depends upon two main factors:- 1. The amount of the total endowment premiums invested (ie. the level of expected investment growth). 2. The type of policy in question. Clearly, the "cheaper" the endowment the higher growth it will have to achieve to meet the loan. Lenders are aware of this and for some time have refused to accept growth projections of more than 7% p.a. What may not have been as clear to the lenders and seldom to the borrowers was that the type of policy could be relevant. Some policies offer guarantees (the "with profit" types) and some do not (the "unit linked" managed fund types). Of those commonly used neither guarantee to pay the loan off at maturity. The reader will recall the days when it seemed that on the whole the markets of the world seemed to be in perpetual boom; in particular the equity markets showed continuous growth for not just years but decades. How things have changed! Until confidence returns the markets may not show the kind of growth we once took for granted. The impact of this observation on those managed fund endowment policies which do not carry guarantees is immediate. Many people have this type and some of them will have experienced negative growth on their savings to date, perhaps for as long as five or 'six years. For them the important questions are:- 1. How much growth is now required to achieve the amount borrowed? 2. What are the chances of the markets achieving this new level of growth within the time left? A calculation reveals that if ten years

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