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How bear market spreads misery

By Neville Bennett

Friday 4th July 2003

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Hundreds of thousands of UK homeowners have been devastated by a failure in repayment schemes. In a nutshell, more than half of all endowment mortgage holders are facing loss.

It is estimated at least five million householders are in difficulty. It is a cautionary tale but it is also a warning to all investors to have another look at their insurance policies, especially life policies "with profits."

Some of the biggest household names in insurance have been fined by the Financial Services Authority (FSA) for mis-selling policies. A recent example is Royal & SunAlliance, which was fined £950,000. It is contacting thousands of customers to inform them of their rights to complain and apply for compensation. Many other householders face similar losses but have no rights of redress ­ they were told markets are volatile but they banked their houses on the markets going up.

How did this arise? A rather crude scenario goes something like this: Mr and Mrs Smith ask about mortgages. An adviser says, "Have we got a scheme for you." The adviser says mortgages are well and good but the savvy thing is to pay them off indirectly. The Smiths are told it is smarter to take out an endowment scheme, which will pay off their mortgage. There may be tax advantages. But the profits made on the insurance policy would make the mortgage much cheaper to pay off.

Perhaps it was a good idea during the 1980s and the 1990s when equity markets were booming. Householders would get a reassuring statement their bonuses were growing. Many could envisage being mortgage free and having a nice little nest egg when their policy matured.

Insurers are now obliged to write to endowment holders every two years explaining if the policy is on track to repay the mortgage or whether it is heading for a shortfall. Those in the red actually get a letter on red paper. The FSA bans insurers from giving advice in the shortfall letters. Most independent advisers do not recommend taking out another endowment policy or "throwing good money after bad." They advise straight repayments.

The financial ombudsman has been inundated with claims and has compensated thousands of people who have successfully claimed they were told the endowment would pay off their mortgage when they retired, or that they did not understand the risks at the time they bought the policy.

Recently the FSA has issued other warnings against homeowners switching their investments from shares to bonds. The authority warns this could lead to lower growth over time.

Norwich Union has announced a 5% cut in endowments and pensions after July 1. It also announced cuts of 20% earlier in the year. They mean that the value of a maturing 25-year Norwich Union endowment will have almost halved in the past five years.

Norwich predicts further cuts in values even if there is a large stock market recovery. It is "managing down" returns, having paid out more on many policies than they have earned. Norwich is also hurting pension subscribers. A 20-year plan, which produced a return of £137,417 at the beginning of the year, has fallen 4.8% to £130,851.

Norwich's woes are general. A Royal London policy that was yielding £246,351, now yields £199,464. A Scottish Life policy fell from £241,000 to £203,000. Prudential says values will be down "by no more that 12% for pensions and 10% for other products."

This is a sad tale. Most of the affected people have been obliged to re-mortgage their property. It raises many issues and points to the need for some consumer protection.

It also forcibly reminds investors to be vigilant in making commitments. There are few guarantees: even the notion that if you invest for 20 years in the stock market you are sure to make excellent returns is often unjustified.

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