More than a decade ago, Guardian Money led the way with a warning that with-profits endowments were going to be a disaster. Endowments were sold to homebuyers as a way of paying back a mortgage, with a bonus promised on top. But while they paid big commissions to advisers, banks and insurance companies, many left customers with the prospect of serious shortfalls when it came to paying off their mortgage.
Today, billions of pounds remain in with-profits funds, and not just to cover mortgages. The funds feature in savings plans and pension schemes as well, but many now earn nothing from year to year despite holders paying in each month. With-profits funds were also massively sold to older people as lump sum bonds, leaving millions of savers with an investment whose average return, according to financial group Skandia, is under 1% a year.
What should you do if you have a with-profits policy? Cash it in, or keep paying? Our guide to with-profits tells you all you need to know.
What is a with-profits endowment?
It is a complex cocktail of two opaque financial products. The endowment is the regular savings plan, while the "with-profits" bit is simply the mix of investments the money goes into. Endowments were mainly sold as 25-year plans that promised to pay off a home loan and give the holder a "tax-free" lump sum profit as well. Each monthly payment is identical. In the early 1990s, more than three-quarters of mortgages were endowment-based. But endowments were also sold to savers typically for 10 years.
They appealed to savers fearful of stock market volatility. The supposedly low-risk concept behind with-profits, known as "smoothing", involved insurance company actuaries holding back some investment gains in good years to hand them out in poor years.
But that was not all. When the policy matured, there would be a "terminal" bonus. This was not guaranteed but was, buyers were told, based on the overall investment experience over the life of the policy.
What went wrong?
Almost everything. Over-optimistic assumptions about investment growth and high commissions were the nub of the problem. Some companies projected investment growth at 12% a year. High projections allowed salespeople to quote low premiums on endowments, making them appear cheaper than traditional repayment mortgages and earning themselves commission of up to £1,000 a policy.
But those projections became untenable as the stock market stalled and interest rates fell. Endowment companies were forced to tell customers that their policies were unlikely to pay off their mortgage, and issued "amber" and "red" warning letters.
Where are we now?
Throughout the 1990s, Standard Life was reporting that someone who had taken out an endowment 25 years earlier, paying in £50 a month, was getting a bumper payout of at least £100,000. These figures tempted many into taking out an endowment. But the last decade has seen a calamitous fall in payouts. By 2004, Standard Life's payouts had dropped towards £60,000 for the same policy, and this year it was frozen at just £28,900. The company has warned that 96% of customers with endowments are in the "red" zone where they won't grow fast enough to pay off mortgages.
Ten-year policies have fared little better. A 29-year-old man investing £50 a month over 10 years in early 2001 into a with-profits plan a total £6,000 ended up with £5,106 at London Life or £5,914 at Clerical Medical. While tiny Sheffield Mutual produced a table topping £10,826, the average was just £6,612 a year-on-year gain of 1.7% and virtually the same, according to financial number crunchers Morningstar, as the bank and building society 90-day deposit rate.
Most of the 100 firms that offered endowments either no longer sell them, or have been swallowed up by vulture funds such as Phoenix or Resolution. At the same time, the proportion of equities, which tend to outperform bonds and cash, in the funds has declined. Funds that had 70% in shares in 2000 now have as little as 10%.
Morningstar reckons the mix of shares, bonds and other assets in a with-profits fund is similar to a "balanced managed" unit trust. It says a monthly £50 irrespective of age, health or gender into an average trust produced £8,397 over 10 years far better than with-profits funds.
What should you do now?
"Investors never really knew what they were buying," says Graeme Currie at IFA Alan Steel Asset Management, the firm that rang alarm bells over Equitable Life years before it hit the rocks. "Everything went wrong, from bad investment decisions to insurance company cash reserve rules, forcing them into low-return government bonds. If a client comes in with a with-profits investment, warning lights flash they are likely to be a disaster, sold on the wrong basis by sales staff who had little idea what they were doing."
The choices are to stick with the plan, surrender, or leave what you have until the policy maturity date (a process known as "paid up").
Whether an endowment, savings scheme or pensions scheme, an annual bonus rate close to zero means you are throwing good money after bad. With inflation at 5%, your money needs to run hard to stay still. Ask about the ratio of shares to other investments anything below 40% is bad news.
Whatever you do, you may still have a mis-selling case, say many claims management firms. You can go to the financial ombudsman within three years of becoming aware of a problem with your policy if you were misled over guaranteed gains, told the plan was risk-free, or told you had to buy an endowment to get a mortgage.
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