Endowments - Where did it go wrong?

tartanterra

On the face of it, endowments should have been a good savings vehicle for uneducated investors. (Although I never really understood why anyone would want one as a vehicle to pay off their mortgage)

The principle is sound: A guaranteed sum at the end of the term, topped up by bonuses. Bonuses being sustained by "smoothing" the profits, i.e. using the excess profit from good years to pay bonuses in the bad years. It doesn't get much simpler.
It should mean that whatever economic cycle we are in, decent sums should be paid on maturity - even in an economic downturn.

As we look at the recent financial meltdown, I think it's appropriate to look back at where endowments went wrong.
1. Commision - outrageous levels of commision made many F.A.'s recommend inappropriate products to customers, especially the many people who would have been far better off with repayment mortgages. These commisions also depleted many with profits funds.
2. Unrealistic expectations - too many fund managers used all the profits to drive up bonuses, and therefore gain a good position in the performance tables. All this did was ensure that there was very little in reserve to cover the "lean" years. This also caused future profit forecasts to border on the realms of fantasy, as levels of growth became unsustainable.
3. Clarity - even at the so called mutuals which are supposed to be owned by their members, very little information was disseminated to policy holders about how with-profits funds were being run. Also, as proven by the amount of mis-selling claims that have been made, policies were being pushed onto customers who clearly had no idea what they were purchasing. (Again - back to the commission issue)

Basically, poor regulation, a lack of accountability and a good sprinkling of financial mismanagement, ruined a safe and simple, if somewhat unspectacular, financial product.
I, for one, was not surprised when the pension mis-selling debacle occured, as it almost directly mirrors what went wrong with endowments.

What does shock me, is that we are now in a global financial meltdown for many of the the same reasons i.e. lack of accountability, poor regulation, mismanagement etc., yet many people are paid top whack to heavily regulate the financial industry. All the lessons were there from recent history, yet our financial masters just blundered down the road to financial ruin.

Just my thoughts............!

hearts

You've said pretty much everything. The main reason GREED ;-)

Kantankrus_Mare

Well I for one am so pleased we took the plunge a couple of years ago and got rid of our 2 endowments.

Granted we have had to add another 5 years onto the length of our mortgage to afford repayment but its well worth the peace of mind and stops the yearly panic when endowment updates come through yearly and show a bigger and bigger margin of shortfall.

We would have been all payed up in 2013 but hey ho. :rolleyes:

lisyloo

The main reason GREED ;-)

I think greed is a little harsh.
A lot of ordinary unsophisticated people took these.
When I got mine I was told it was a very "safe" product both by the advisors and the concensus belief among ordinary people.
I did not perceive it as a huge gamble or a greedy move.

I admit that I was naive about these things (when I was 22).
I think a lot of people are naive and didn't understand it fully, but greed is a bit harsh.
I went along with what I was told rather than attempting to understand it.

dunstonh

Pricing was a major issue. They were priced on the basis of a boom/bust economy with higher inflation. The move away from that brought returns down but also meant that the charges remained high in real terms a lot of the time and ate into the returns. Whereas on the old economy, the charges in the later years would have seemed quite small.

The other thing is the increasing regulation and financial requirements led to a lot of insurers closing their doors and switching their with profits funds to focus on solvency as the priority. This brought returns down even more.

I think the most common failure relating to advisers though was using target growth rates that were not low enough to cover poor periods. I remember using 4.4% target growth rates which were much lower than the norm. However, I recall seeing the options to use much higher target growth rates. These brought the premiums down but meant they had to grow more to compensate. Good advisers would use low target growth rates. The not so good ones would use higher growth rates. Early endowments usually didnt give the choice to the adviser and had higher rates by default to reflect returns at that time.

Of course, a lot of this is easy to say with hindsight. For decades endowments paid out massive surpluses and complacency set in. As so often it does in anything that involves risk but doesnt suffer a risk event for a long period (not just financial but anything in life). Just look at mortgaged buy to lets as a modern example of where risk was ignored because it was easy to make money for a sustained period even if you didnt know what you were doing.

Based on my experience though, the most common reason for someone to do an endowment was not future potential or worries about shortfalls but the fact that in most cases the monthly cost on an endowment mortgage was cheaper than a repayment mortgage. If also has to be said that the size of most shortfalls at maturity is not that great when you consider that the things that caused endowments to fall short have increased our wealth by far more in other areas (house prices for example).

tartanterra

lisyloo wrote: »

I think greed is a little harsh.
A lot of ordinary unsophisticated people took these.
When I got mine I was told it was a very "safe" product both by the advisors and the concensus belief among ordinary people.
I did not perceive it as a huge gamble or a greedy move.

I admit that I was naive about these things (when I was 22).
I think a lot of people are naive and didn't understand it fully, but greed is a bit harsh.
I went along with what I was told rather than attempting to understand it.

I think they meant "greed", in reference to the financial industry as opposed to the actual customers.

tartanterra

dunstonh wrote: »

Of course, a lot of this is easy to say with hindsight. For decades endowments paid out massive surpluses and complacency set in.

As I mentioned before, many people were well rewarded to regulate the industry. Their job was to prevent complacency setting in!

tartanterra

dunstonh wrote: »

Pricing was a major issue. They were priced on the basis of a boom/bust economy with higher inflation. The move away from that brought returns down but also meant that the charges remained high in real terms a lot of the time and ate into the returns. Whereas on the old economy, the charges in the later years would have seemed quite small.

The other thing is the increasing regulation and financial requirements led to a lot of insurers closing their doors and switching their with profits funds to focus on solvency as the priority. This brought returns down even more.

I think the most common failure relating to advisers though was using target growth rates that were not low enough to cover poor periods. I remember using 4.4% target growth rates which were much lower than the norm. However, I recall seeing the options to use much higher target growth rates. These brought the premiums down but meant they had to grow more to compensate. Good advisers would use low target growth rates. The not so good ones would use higher growth rates. Early endowments usually didnt give the choice to the adviser and had higher rates by default to reflect returns at that time.

Of course, a lot of this is easy to say with hindsight. For decades endowments paid out massive surpluses and complacency set in. As so often it does in anything that involves risk but doesnt suffer a risk event for a long period (not just financial but anything in life). Just look at mortgaged buy to lets as a modern example of where risk was ignored because it was easy to make money for a sustained period even if you didnt know what you were doing.

Based on my experience though, the most common reason for someone to do an endowment was not future potential or worries about shortfalls but the fact that in most cases the monthly cost on an endowment mortgage was cheaper than a repayment mortgage. If also has to be said that the size of most shortfalls at maturity is not that great when you consider that the things that caused endowments to fall short have increased our wealth by far more in other areas (house prices for example).

I also noticed that whilst replying to the majority of my post, you haven't mentioned the "Commission" word!

Now why would an IFA miss that out!!!!:rolleyes:

dunstonh

I also noticed that whilst replying to the majority of my post, you haven't mentioned the "Commission" word!

Now why would an IFA miss that out!!!!:rolleyes:

Because like many IFAs, I am am fee based . (it will be all IFAs by 2012 as commission wont be an option any more - not that it really is nowadays on most investment products).

I also dont think commissions had a lot to do with the reason for failure. Plenty of naff products pay little or no commissions and plenty of first rate products pay more than the normal. Commission is not a measure of quality or cost to the consumer.

tartanterra

dunstonh wrote: »

Because like many IFAs, I am am fee based . (it will be all IFAs by 2012 as commission wont be an option any more - not that it really is nowadays on most investment products).

I also dont think commissions had a lot to do with the reason for failure. Plenty of naff products pay little or no commissions and plenty of first rate products pay more than the normal. Commission is not a measure of quality or cost to the consumer.

I did mean it lightheartedly!!!!!!;)

Although......I do have to say, commission is a cost to the consumer.
If, say, a mutual paid high commissions to advisors, then the mutual would bear the cost of this. This would have the effect of reducing their funds, which directly affects the payouts to members (i.e. the consumers).
Also, not all IFA's are are professional as yourself. Could you put your hand on your heart, and say that no IFA has ever pushed a product based on commission?
100% fee based advice (which you already do!) is long overdue as standard industry practice.

Tom_Kelly

tartanterra wrote: »

I did mean it lightheartedly!!!!!!;)

Although......I do have to say, commission is a cost to the consumer.
If, say, a mutual paid high commissions to advisors, then the mutual would bear the cost of this. This would have the effect of reducing their funds, which directly affects the payouts to members (i.e. the consumers).
Also, not all IFA's are are professional as yourself. Could you put your hand on your heart, and say that no IFA has ever pushed a product based on commission?
100% fee based advice (which you already do!) is long overdue as standard industry practice.

I have read this thread with a sense of amused incredulity. I am afraid that the only source of the facts quoted seem to have been articles from the 'Mail on Sunday' rather than anything of greater substance or accuracy. I am not an IFA but even I felt like rising to the bait offered.