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GAZETTE
APRIL
.
1993
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
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
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.
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