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The Actuary The magazine of the Institute & Faculty of Actuaries

Actuaries blamed for endowment shortfalls

The report of the Treasury Select Committee published 11 March concluded:

‘Low-cost endowment mortgages became popular in the 1980s and 1990s, taking over 80% of the mortgage market at their peak. There are still around 8.5m policies in force. These mortgages carry with them the risk that the endowment policy might not repay the mortgage. As inflation and interest rates collapsed through the 1990s it became clear that actual investment returns were likely to be much lower than those originally assumed, implying that many policies would indeed fail to pay off the associated mortgage. The industry nevertheless responded slowly to the changing investment climate until regulators stepped in. This slow response raises questions about the role of appointed actuaries within insurance companies. It is important that the FSA’s proposed reforms of the actuarial process within insurance companies succeed in delivering more proactive and independently minded actuarial advice.

‘The insurance industry has a poor track record for asset allocation and generally failed to cut back its equity exposure as the equity bubble inflated. The industry has thus been caught out by the recent fall in equity markets, forcing many companies to switch into low-risk, low-growth portfolios dominated by bonds. The result is that around 80% of endowment policies are now unlikely meet their target of repaying the original mortgage, with an average shortfall across policies of £5,500. The shortfall on policies is likely to grow over time, but the current figures nevertheless suggest a collective shortfall across the endowment mortgage market that is already approaching £40bn.’

Lessons for the future

‘Endowment mortgages have damaged public trust in the financial services industry. Many large retailers now have a higher level of public trust than some of the UK’s largest financial institutions and there is an overriding need to rebuild public trust and confidence in the long-term savings industry. Reforming the way the long-term savings industry conducts its business should also help defend the UK’s position as a major financial services centre.

‘Central to rebuilding trust is reforming the business model used by much of the industry. The debate on the Sandler price cap illustrates a continued focus on commission and sales that is unlikely to benefit the consumer. The challenge for both the industry and government is to develop a fee structure that rewards good investment returns and client retention rather than simply paying out high rewards for client acquisition.’