Alternate Fixed Interest Investing

Many people want to invest in fixed interest, primarily for the security that good fixed interest investments should offer.  Surprisingly, a number of these investors have no need for the income stream that fixed interest investments normally have.

This situation often arises in the last few years of a persons working life.  They may be at the stage of life where their income has peaked, they are no longer supporting children, and their mortgage has been repaid.  They are at the strong accumulation stage.  Yet some may feel that they should pull back from investing in higher risk growth assets.  But if they invest in income producing assets, they end up paying 39% of the investment income received as tax.

With the current nervousness in the fixed interest market, it is perhaps timely to look at alternative fixed interest investments, which offer capital protection and growth.  Traded endowment policies (TEPs) do just that.  They are not a new concept, and have been offered in New Zealand since 1994.

Essentially traded endowment policies, are endowment policies on someone else life.  Most have originated as traditional whole of life insurance policies.  For some reason, the owner of the whole of life policy either no longer requires whole of life insurance or more likely has a need for cash.  Instead of simply surrendering the policy to the insurance company, sells it to the life policy exchange, invariably for more than the surrender value of the policy. 

The policy is then converted to an endowment policy with a known maturity date, and all premiums are fully paid to maturity.  The policy is then available for on-sale to investors as a fixed term investment offering capital security and predictable returns.  Each TEP offered has a ‘Locked In’ Maturity Value that, in most cases, covers the amount invested.  The ‘Locked In’ Maturity Value is an amount that the insurance company is required to pay out under the terms of the endowment contract taken out with them.  For this reason only policies taken out with reputable and well-established companies are sold.

Each TEP also carries with it an Estimated Maturity Value, being the amount that the investor will receive if the current earnings (or bonus) rates set by the insurance company are maintained over the investment term.

The earnings rates for TEPs can, and do fluctuate over time, meaning the investors return may also fluctuate.  However, notwithstanding potential movements in the earnings rate, returns from Traded Endowment Policies are still relatively predictable.  After all, the forecast returns have been modelled by actuaries, who are naturally very conservative in the forecasts that they allow insurance companies to use.

The investments are being sold with a forecast yield of 5.8%-6.8% after tax.  The pre-tax equivalent returns range from 8.66% to 9.51% for investors on the 33% tax rate and 9.51% to 11.15% for investors on the top 39% tax rate.  This makes them a particularly attractive investment for investors on the top two tax rates who would like low risk fixed interest, but who have no need for the income.