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Insurers are in the money once again … so why are endowment bonuses still down?

Millions of homeowners might be forgiven for feeling a bit confused right at this moment.
On the one hand, insurance companies are sending out letters boasting of the high investment returns their funds have achieved in the past 12 months. On the other hand, payouts on the with-profits endowments they took out to pay off their mortgages have dropped yet again.

Last Thursday, Standard Life became the latest company to announce cuts in the final maturity value of its mortgage endowment policies, compared with the previous year. A 25-year policy maturing last week would pay £45,043, compared with £54,975 just 12 months ago, a fall of almost 18%.

Last week Trevor Matthews, chief executive of UK life and pensions at Standard Life, warned: “We’ve said that, all other things being equal, we expect bonus rates to keep coming down, so we will almost certainly announce lower bonus rates than before at the next couple of declarations.”

Standard Life’s announcement is not unique. Scottish Widows, now owned by Lloyds TSB, recently said that its with-profits fund grew by 15%. Yet the insurer’s mortgage endowments will pay out about 8% less than comparable policies in 2004.

A £50-a-month, 25-year mortgage endowment from Scottish Widows maturing this year will pay £40,820. This compares with £44,410 for the same policy last year.

Meanwhile, hundreds of thousands of policyholders with Scottish Amicable, the Stirling-based insurer now part of Prudential, are being sent letters telling them that despite growth of more than 13% in 2004, the bonuses added to various elements of their policies are an apparently miserly 0.8% to 1.5%.

David Riddington, senior actuary at Norwich Union, says: “It can be quite difficult to see the connection between the return on the fund and the bonuses declared. Policy holders say: ‘If you have earned 10% to 13% has the underlying value of my policy gone up?’ They expect things to be transparent.”

The reality, according to the UK’s biggest insurers, is that what we are seeing is an inevitable consequence of some key events influencing returns on with- profits endowments.

The first, which everyone recognises had a critical effect on the health of millions of endowment policies, was the stock market collapse after 1999. In the subsequent three-year period, the FTSE 100 index of leading UK companies dropped from 6900 to about 3270 by March 2003.

This sharp fall has had a devastating effect on with-profits endowments. In good years, smoothing means companies hold some money back, thereby ensuring that policyholders do not suffer as much in the bad years. However, a 20% to 25% share price fall inside 12 months meant companies were forced to cut maturing payouts not just once, but sometimes twice a year, as Standard Life and Scottish Widows have done.

The second problem is that although policyholders compare what they get with previous years’ figures, the returns they earn are based on the entire 25-year investment period. Riddington says: “Too much emphasis is being placed on this year’s returns compared with last year’s, whereas they are different things.”

Richard Ungless, senior actuarial manager at Scottish Widows, explains: “At the beginning of the 1980s, investment returns were massive. Those were boom years for the stock market. Throughout that decade, the average annual return on our with-profit fund was over 20% a year, better than we are earning in a good year today.”

Therefore, someone who invested 12 months further on in that decade will miss out on one of the “supercharged” performance years – and will have to make do with last year’s relatively lower growth figure.

Insurers want policyholders to try a novel way of examining performance: compare the surrender value of a policy 12 months ago with its maturity value today. The difference between both figures, minus additional contributions, is the amount it will have grown in the interim period.

Using this yardstick, John Gill, managing director of finance at Standard Life’s UK life and pensions arm, is able to say: “Most pension and endowment customers who reach the end of their policy terms this year will have experienced an increase in the value of their policies over the last year.”

One criticism of some insurers is that throughout the late 1980s they competed for business by deliberately inflating the amount they would pay out on maturing policies. The aim was to rank higher up the performance charts used by financial advisers recommending endowments to their clients.

Tim Purdon, managing director at Paladin Financial Services, financial advisers in Kilmarnock, says: “[Some insurers] are having to catch up with the fact that, in the past, they were paying bonuses out of their reserves. Since 1999 they have not been able to do that.”

At Scottish Widows, Ungless admits: “Certainly there was a period when companies and the market placed a lot of emphasis on comparison tables. Clearly, if a particular company did not have lots of policies actually maturing, it was a cheap exercise to pay more than had actually been earned. It gave a boost from a new business point of view.”

He adds that companies like his own, which had high volumes of maturing policies even then, were less able to afford to artificially inflate returns.

Andrew Taylor, actuarial manager at Prudential, the company that now owns ScotAm and manages its funds, says: “I suspect there is an argument about the impact of marketing pressure in the 1980s. Today, when setting bonus rates we have to take a long-term view. Bonuses are set conservatively, on the basis of future assumptions about performance.”

A question mark remains over what happens to endowment returns in future. To benefit from share price rises, a with-profits fund must – by definition – invest in shares.

But financial watchdogs have told insurers to boost holdings in less volatile bonds to match promises made to policyholders. In the past two years most funds have been forced to dramatically reduce their equity content, from an average of 65% in 1999 to 30% today. The unintended consequence of reducing risk – by selling equities – is likely to be reduced returns.

It is highly probable that millions of policyholders will continue to face that seeming contradiction of higher investment returns in their funds and lower maturity payouts, for some years to come.

Ignore the upbeat headlines. Insurers may be back on the road to profits but customers will have to wait for their share.
Nic Cicutti reports

07 August 2005


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