What the quotation means

Required Reading


What the quotation means

`The rest' is the important bit, as far as you are concerned, and is likely to be the main reason why you took out an endowment mortgage in the first place. Table 12 shows a recent quotation for an endowment policy and, as you will see, the 'bottom line' (which is the only bit most people read) shows a worthwhile surplus which belongs to the policyholder alone.

1 The projected sum payable will depend on the bonuses earned in the future. Bonuses once added cannot be taken away.

2 The terminal bonus figure assumes that the current rate will be in force at the time of payment. Since terminal bonuses are dependent upon market conditions it is not possible to guarantee future rates.

This quotation is for a low-cost endowment policy. Low-cost policies are a clever idea that has worked well in practice, although they do involve a theoretical risk. This is because it came to be realised that a policy which had a 'sum assured' of, say, £110,000 was likely on past performance to produce a maturity value of two to three times that amount, assuming the life company had invested the premiums in a reasonably capable manner.

The building societies (and other lenders) are, therefore, willing to lend money to a house-buyer on the security of an endowment policy which has a sum assured of considerably less than the amount of the loan. They are confident that, over the years, the value of the policy will grow enough to pay off the loan, with a bit to spare.

The majority of house-buyers who use the endowment method to pay their mortgage use the low-cost version. The full endowment mortgage has a sum assured which is equivalent to the value of the loan; it can be expected to produce at least twice the surplus, and will cost at least twice as much.

The building societies are taking a bit of a risk with low-cost endowment policies -but it's a small one. Life companies are fairly conservative creatures; they would rather produce results which show a steady growth rather than something that is wonderful one year and terrible the next, and they have built up large reserves to enable them to do so.

They have been so successful in pursuing this aim that practically no major life company has ever -so far -cut its reversionary bonus rates. The terminal bonus is another matter: in theory at least it can be changed freely from year to year.

What building societies (and other lenders) do is to take 80% of the current reversionary bonus rates applicable to an endowment policy and use this as the basis for the amount they are willing to lend.

The policyholder, therefore, needs only to rely on the life company producing results equivalent to 80% of its reversionary bonus rates to provide a sum sufficient to pay off the loan. The building societies, obviously, feel that this is a reasonable risk to take. But is it?

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Bonus rates and first time buyer discounts

Setting premium levels is only one side of the expertise of life companies; the other is their investment capabilities. The amount that you are paid out from your endowment policy at the end of the day is going to depend largely on how well they have invested it for you.

Some people have accused life companies of drawing a mysterious veil over the whole business of their investments; and the matter is not helped by the way the insurance companies describe the investment returns they have made. Every year (usually) the life companies declare the 'bonus rate' on their policies which reflects the investment performance achieved.

Once the bonuses are declared, they cannot be taken away, and so the life company has to be very cautious before . . .... see: Bonus rates and first time buyer discounts

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