Personal Finance: To profit from endowments you need a policy of no surrender

For holders of with-profits savings plans and pensions, the annual round of bonus declarations is a bitter-sweet ritual.

Announcements by insurers of how much they will be paying policyholders whose plans mature this year also offer a clue as to how much the rest of us stand to get in a few years' time. The news is both good and bad, as Andrew Verity explains.

For those who have held endowments or self-employed pensions for the last 25 years, this year's season may the sweetest ever. When policies were bought in 1973, the stock market was about to hit its lowest point of the last three decades. But since then, a long bull-run has produced spectacular returns which should make those policyholders very glad they bought their with-profit endowments.

A policyholder who started a pounds 50-a-month, 25-year endowment with GA Life in 1973 would this year collect a stunning payout of pounds 120,784 - on contributions totalling just pounds 15,000. That is 5 per cent more than last year's record payout. It is equivalent to an annual interest rate of 14.2 per cent, every year since 1973.

Friends Provident, Norwich Union and Scottish Provident have also announced payouts on 25-year policies which equate to paying 13 per cent in interest every year. Why does anyone hold long-term money with a building society or bank, paying less than half of that rate?

But for savers who started a policy recently, the sweet taste of this year's bonus begins to sour. Holders of with-profits policies get an annual bonus - a guaranteed percentage of their money resembling an interest rate - based on the growth of the with-profits fund which holds their savings. It is high bonuses in the past which have allowed life offices to pay out record amounts this year.

But for future savers, the picture is not so pretty. With the FTSE growing by 22 per cent last year, policyholders might be forgiven for thinking they should receive healthy annual bonuses. Yet this year, against expectations, almost all life offices will cut them. Despite growth of 20 per cent in the with-profits fund last year, GA's annual bonus on life policies falls from 6.75 to 6.25 per cent. Norwich Union's falls to 6 from 6.5 per cent. What, a policyholder might ask, is going on?

The life offices do have an explanation. Actuaries, the powerful figures who decide how much money to distribute, will only pay guaranteed annual bonuses if they think they can be supported by strong investment growth in future. Almost universally, the actuaries now say that double-digit growth can no longer be expected.

The reasons are two-fold. First, life insurers have now lost faith in the dazzling returns of the 1970s and 1980s. Actuaries point to the drop in long-term yields on gilts (government securities) to their lowest level for decades of 6.25 per cent; that reflects the market view that entering monetary union will mean lower inflation, lower interest rates and lower investment growth over the next 15 years.

Second, life insurers have in recent years kept bonus rates higher than the long-term returns on their funds appear to justify. So much so that cautious offices such as Sun Life last year accused competitors of maintaining insupportable bonuses in an effort to entice new customers.

The downward shift in bonuses is already shown in maturity payouts to 10-year policies. Here, returns equate to an annual interest rate of 10 per cent rather than 13 per cent. Actuaries predict that in future these will become even smaller.

Richard Harvey, chief executive of Norwich Union, explains: "Our view of the long- term investment outlook has led us to reconsider the level of annual bonus payable. We believe annual bonuses need to be at a level which we can reasonably expect to achieve in the future."

With annual bonuses at 6 per cent or less, a policyholder might be forgiven for thinking an account with Standard Life Bank, or Tesco's, or Direct Line would pay better. But for those who are sure they can afford to save over a long time, this is not true. While life offices are cutting their annual bonuses, terminal bonuses - the extra amount paid if a policy gets to maturity - are going up.

Unfortunately, more than a third of policyholders with endowments surrender their policies before five years are up.Less than 20 per cent keep up payments for 25 years. For the hundreds of thousands who surrender policies early, the terminal bonus is a phantom.

If the policy is instead sold to someone else, a higher value can be had by selling the endowment through a market maker. For policyholders forced to cash in their policies, the message is straightforward. With endowments, you should never surrender.

Payouts on 10 and 25-year endowment policies

*

Life Office 10-year Equivalent 25-year Equiv

annual yield yld

GA Life pounds 10,305 10.4% pounds 120,784 14.2%

Norwich Union pounds 10,063 10.0% pounds 100,247 13.0%

Friends Provident pounds 9,919 9.7% pounds 106,188 13.4%

Scottish Provident pounds 9,508 8.9% pounds 94,820 12.7% *with payments of pounds 50 a month, maturing in 1998