Endowment crisis as up to 99% fall short - July 2009

More than three million home-buyers have been warned that their endowment policies are unlikely to pay off their mortgages.

Some insurers have just one in 100 mortgage endowments on target, a Money Mail investigation has revealed. They include Standard Life, whose endowments were sold in huge numbers to homebuyers who borrowed from the Halifax in the Nineties. In all, 735,000 policies, 98% of its total, are likely to fail, while 1% are in a perilous position, leaving just 7,500 on target. With-profits endowments were supposed to build up a pot of money for investors over 25 years by adding 'bonuses' each year to the money saved, plus an extra big bonus at the end.

Homebuyers were told that this would smooth out any erratic stock market movements, ensuring their investment would meet its aim of repaying the mortgage and giving a lump sum on top. Despite this, more than nine out of ten endowment policies run by Clerical Medical, Co-op, London Life, Friends Provident, National Provident Life, Aviva (formerly Norwich Union) and Scottish Widows are predicted to pay out too little to cover the mortgage they were supposed to repay. More than 4.3m mortgage endowments are still in force. The final figure for shortfalls might be higher than we suggest because some major endowment sellers such as Scottish Mutual and RSA (the former Royal & Sun Alliance) refused to disclose figures.

Insurers blame falling stock markets last year, but investors are asking what happened to promises to smooth out falls. Many also want to know how endowments that were previously on target can suddenly fall far adrift only a few years before maturing. Last year, for instance, only 19% of Prudential's 164,000 endowments were at high risk of falling short. Now, that figure has jumped to 74%. At Co- op, the figure has leapt from 25% to 95%.

Endowments come to an end at the worst possible time.  The bad news comes in a year when a massive number of endowments are due to come to the end of their term. Tax changes brought in 25 years ago abolished tax relief on monthly payments, and there was a 'buy while stocks last' sale by companies to encourage homebuyers to take out policies. Aviva alone has 59,000 maturing this year and Standard Life 55,000. Prudential has 15,073 policies maturing, of which 4,025 are not expected to meet their repayment target. The expected average deficit is £1,130, while the expected average surplus is £3,000.

'The fall in the fund, down 15.8% last year, has resulted in many policies turning red,' says a spokesman for Prudential. 'But the figures quoted are projections, and the final value won't be determined until an individual policy actually matures.' Another reason for the rise in failing policies is that insurance companies devised a new way to lure homebuyers in the late Eighties and early Nineties by selling 'low-cost' endowments. These demanded lower monthly payments from homebuyers, but needed greater investment growth to hit their targets.

Nearly all of these endowments show a shortfall. 'There are three main problems with with-profits endowments,' says Professor David Blake of Cass Business School.

• 'The policies sold years ago promised returns of 9% a year, but they have actually delivered much less than that.
• 'Second, policyholders who are still in the fund could well have subsidised the payouts of those whose policies matured years ago.
• 'Finally, the bonus policy of a typical with-profits fund has all the clarity of an actuary peering into a black box in a dark room. Investors have no idea how the bonus relates to the underlying performance of the fund.'

A Standard Life spokesman says: 'Many policies that were on target have matured, but the major factor has been the turbulent market conditions we have experienced in the past 18 months or so, for example, a drop of over 30% in the FTSE All share Index in 2008 alone. 'These have had an impact on plan values and, in turn, on the number of policies not on target.'

Why endowment holders are seeing red Under a traffic light system set up by the Financial Services Authority (FSA), life insurance companies must tell policyholders on a regular basis where they stand with their endowments.

• Red means there is a high risk that your policy is not on track. The investment fund in which your monthly premiums are invested must rise by at least 8% a year for the rest of the term to cover your mortgage.
• Amber means there is a significant risk it's not on track and must grow between 6% and 8% a year. •
• Green means your policy is on track, as long as it grows by 6% a year.

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