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This article was published in the Law Society Gazette as its Opinion column for Volume 89/18 of Wednesday, 13th May 1992

Is 'best advice' the safest?

Philip Gegan, Solicitor, reminds solicitors to take care when advising clients on low-cost endowment policies

Solicitors have always had to aspire to the highest standards and comply with strict rules concerning the provision of independent legal advice and the handling of clients' money. Now that similarly high standards are being imposed on non-solicitor independent financial advisers under the Financial Services Act 1986, their numbers are dwindling. Yet the need for genuinely independent financial advice has never been stronger, and extra vigilance is called for if a repetition of the bad advice supplied in the past to the public is to be avoided. The problems caused by this bad advice are now beginning to appear.

The mortgage boom of the late 1980s was facilitated by clients being sold mortgages that in many cases they could only just afford. Now the chickens are home to roost in the form of a record number of mortgage arrears and repossessions and another problem is beginning to appear. It concerns low-cost endowment mortgages which for many years have been the most popular kind of mortgage available. They were first introduced in the days when with-profit endowment policies paid handsome bonuses and the eventual payout easily exceeded the basic sum assured. Such policies, however, were expensive in relation to the sum assured and in order that they could be incorporated in a scheme that would successfully compete with repayment mortgages the basic sum assured was reduced to allow lower premiums. Interim and terminal bonuses have been relied on to provide a sufficient amount to clear the mortgage.

However, in December 1991 a leading life office announced that it was reducing reversionary bonuses on its endowment policies by about 9%. So a client who was advised to take out a life policy with that office on which to depend to repay his mortgage may now have to increase his premiums or find some other way to repay the shortfall. This is a problem that is likely to become commonplace in the next few years as more life offices follow suit. Many house purchasers approaching retirement will have to move downmarket or take out further loans to repay their mortgage. People with private pensions will find their benefits cut, and those who have mortgaged their lump sums may have enjoyed the tax benefits of having done so but will then face a similar problem, with their income cut as well, compounding their difficulties.

It would be easy to blame financial salesmen for bringing this about. But the rules of LAUTRO, the regulatory body governing tied agents, do allow them to supply illustrations of endowment and pension policies based on projected growth rates of 7% and 10.5%. Even solicitors giving financial advice based on these projected growth rates are deemed to be giving best advice under the Investment Business Rules provided, of course, that other criteria are also met. So what are the growth rates of funds managed by life offices in the UK? They vary, of course, from fund to fund, and from one period of time to another. Insurance funds can be invested in a variety of ways, in different countries or regions or in specialities such as property, gilt-edged bonds or equities, and are 'managed' to try and produce the best return.

This cannot be an easy task in a country with an economy weakened by recession and a stock market that is by its very nature volatile. So it is hardly surprising that the average growth rate of all life office managed funds has in recent years shown signs of declining sharply. The highest has averaged 10.25% and the poorest performing funds have actually been losing money. The average growth rate required to raise a given sum through a low cost endowment policy is 7% to 8.5%. No wonder that problems are beginning to appear.

Who can now say that advising a client to rely on an endowment policy or pension scheme to repay the capital on his mortgage is safe or 'best advice'? It may be professional negligence at least not to warn clients in writing of the potential dangers. The financial institutions were largely responsible for the artificial mortgage boom of the late 1980s. Let us not allow ourselves to be implicated in any further irresponsibility. They stand to gain large commissions. We stand to lose in the form of increased compensation fund contributions.

Some form of life assurance is, of course, most advisable for clients purchasing a house on mortgage. But a level term assurance or mortgage protection policy is perfectly adequate in conjunction with a repayment mortgage. It is true that when the client moves house he has to start the term running again, and that in the early years the repayments consist of interest rather than capital. However, avoiding the dangers of what might be called 'fund performance shortfall' and the vagaries of the stock market more than compensate. At least the client knows his mortgage will be repaid without further expense and the approximate date this will happen.

For clients concerned with investment unconnected with mortgages, there are more funds to choose from. For example, 'tracker' funds are beginning to appear which may ultimately render all conventional managed funds obsolete. These are funds which reflect, for example, the FT-A all share index which has steadily grown on average over the years (although still prone to fluctuation). Other funds claim the best of both worlds, buying into equities on a bull market and switching into fixed interest securities when the rise is finished.

With the benefits of modern computer software, some of these funds are making quite remarkable claims about their performance capabilities. It will be interesting to see if these claims are justified, Meanwhile, it must be the duty of all of us to monitor the performance of all funds with great vigilance.