Whoa! Advisers must stop flogging dead endowments

By Sam Dunn

For years, they've caused misery for millions, exposing a financial services industry riddled with shabby sales practice.

Yet amazingly, endowments, one of the most maligned financial products of the past 20 years, remain on offer in the UK. Best known as savings vehicles tied to interest-only mortgages, they're still on sale, still being sold by some financial advisers, and still inappropriate for many who buy them.

You could be forgiven for believing that these policies - a mix of life insurance and investments - had died a death after being thoroughly discredited. But in the first six months of this year, some 5,000 new mortgage endowment and 34,000 savings endowment policies were sold, according to the Association of British Insurers. Although these numbers are small compared with just a few years ago (in 2000, a total of 750,000 endowment policies were sold), their very existence is enough to cause concern.

"I'm gobsmacked," says Justin Modray of independent financial adviser (IFA) Bestinvest. "In an era when endowments are proving themselves to be about as useful as a chocolate teaspoon, how on earth can providers and advisers justify the continued sale of these products?"

With-profits funds - a mix of equities, bonds and cash, which back most endowment policies - have struggled in recent years, he says, and are best avoided for new investments. In addition, endowments typically carry big up-front charges funding high commission for advisers.

Mr Modray goes on: "There really is no reason to consider buying these products. I fear the vast majority sold in the first half of this year were unlikely to have been best advice - a clear example of advisers not treating their customers fairly."

Gill Cardy of IFA Professional Partnerships is equally concerned. "I can see no real reason why anybody would buy or be sold an endowment policy," she says. "They aren't flexible, yet some [advisers] are still selling them [as investment vehicles to save] for school fees, which is outrageous. If they're not good enough for a mortgage, why are they good enough for schools?"

In the 1970s, endowments were a roaring success. They were linked to mortgages as a life insurance policy and sold as a way to repay the capital value of a property after 25 years.

Their popularity was due largely to high stock market returns, tax-free growth and high inflation, which eroded the original debt. Many policies maturing in the early 1990s paid out more than the sum assured, giving homeowners a cash bonus.

Endowments also became popular as standalone savings products, used as long-term vehicles to build up funds for school fees and care home costs.

However, the real driver in the 1980s and early 1990s was the generous upfront commission paid by life companies to advisers and brokers. This ate into investors' returns which, despite the optimistic projections, began to decrease in size.

Endowment policies were usually invested in with-profits funds, designed to smooth over the bad years by using the returns made during good runs on the stock market. When markets fell with the bursting of the dot-com bubble in 2000, annual bonuses began to wither and shortfalls showed up in what endowments had been projected to generate. Householders received letters warning them that their mortgages would not be paid off at the end of the term.

As mis-selling claims began to mount up from consumers who realised the risks involved hadn't been properly explained to them during the sales process, endowment policies swiftly fell from grace.

So the question remains, when an estimated 10 million policyholders continue to wrestle with their existing underperforming endowments, why is anyone still buying them?

These rigid vehicles penalise you for leaving early and carry high charges that can eat into any tax breaks. In any case, it is rarely wise to keep your cash with one company for such a long time.

Sales staff often claim that endowments are better than unit trusts because they give you a tax-free lump sum when the policy matures. But, says Ms Cardy, unit trust investors can avoid capital gains tax simply by selling off parts of their investment over the years.

These days, endowments are rarely if ever recommended by lenders as appropriate vehicles for homebuyers. The 5,000 policies that were sold this year linked to mortgages are likely to be either top-ups to original policies or long-term insurance policies for those in poor health who can't get cheap cover elsewhere.

But endowments continue to carry heavy charges.

For example, IFAs who sell Scottish Friendly Society's Prosperity savings plan earn generous commission.

Spokesman Calum Bennie explains: "On a 10-year [savings] plan, the initial commission will be 25 per cent of each monthly premium for 16 months." After that, so-called trail commission is paid every year to the adviser, working out at 2.5 per cent of premiums.

Mr Bennie maintains customers are "comfortable" with the product as a savings vehicle. "At least they get a bonus added regularly," he says, although this bonus has fallen recently.

Endowment policies are often touted as useful ways of developing a savings habit. But you can also save regularly into an equity unit trust - and face none of the downsides, says Ms Cardy.