The Equitable Life debacle has unfairly tarred all with-profits products with the same brush as high...
The Equitable Life debacle has unfairly tarred all with-profits products with the same brush as high risk investments, say many investment experts, which, they add, is very far from the truth.
Brian Dennehy, managing director of Dennehy Weller & Company, says with-profits funds are in fact an appropriate way for investors who cannot tolerate the risk of stock price fluctuations to gain access to the world of shares.
Why is this the case? Because with-profits bonds do not simply pay out all the gains they make each year, nor do investors suffer from the level of absolute loss the bond may suffer in bad years. This is different to unit or investment trusts, whose unit or share price is a fairly good guide (for investment trusts) or perfect guide (for unit trusts) as to how well their investments are performing. If the market falls 17% as it did last calendar year, investors in these funds fall with it.
With-profits bonds pay out annual, or "reversionary", bonuses, and then a terminal bonus when the bond is encashed. The annual bonus, added to the policy value, cannot be removed from the policy once it has been made, and is made from reserved profits from good years, thus smoothing out the bumpy ride from equities. (For more on how with-profits bonds work, see the breakout box). The level of the terminal bonus is known to the investor from the outset of the bond.
Unfortunately, as products of life companies with-profits bonds cannot be put into Maxi Isa wrappers.
Figures from the Association of British Insurers show that, in 2001, maturing with-profits policies showed an average rate of return of 8.6%, compared to 7.6% from the average unit trust and 3.9% from the average bank or building society account. The tables below display the average growth over distinct time periods from unit trusts and with-profits funds, statistics that compare quite favourably for the latter.
Over the past 10 years 10-year with profits have yielded 11% per annum, net of tax, and analysis shows that the average 25-year with-profits endowment policy maturing on 1 September 2001 returned 12.8% from 1990.
The effect of the smoothing out of returns via annual, or reversionary, bonuses is shown by the fact that the worst performing policy over this period returned 11.1%, while the best returned 14.5% per year.
The advantages of with-profits funds over unit or investment trusts may not be clear when markets head north, but may become clear when markets tumble.
The ABI notes, "Unit-linked funds do very well when the stock market is rising. But if the period when you are saving, and especially when you want to get your money back, happens to coincide with a stock market fall, such as the past two years, then the smoothing of with-profits funds means they do better than managed ones."
The Association continues, "On average, with-profits policies show less year-on-year volatility compared with unit trusts. Average unit trust returns varied between 7.6% and 16.7%, whereas with-profits policies varied between 8.6% and 14.5%.
"With-profits policies gave better returns than unit trusts in six of the 12 years. Average returns of with-profits policies have been greater than equity unit trusts during 2001 when the stock market took a significant downturn and the effects of smoothing can be identified.
"Unit trust performance is more variable for any given year than with-profits policies. For example, in 1992 unit trust performance varied between 16.7% and -3.5%, while with-profits policy returns were between 10% and 15.5%.
"In difficult times during 2001, unit trusts performance varied between 24.0% and 1.7%, while with-profits policies delivered between 6.8% and 12.6%.
"If the policy is surrendered, rather than held to maturity or ended by a death claim, the regular bonuses are not guaranteed. The insurance company can reduce the total paid out on the policy by applying a "market value reduction" if the current value of the underlying investments is substantially less than the face value of the policy after allowing for smoothing. The purpose of this is to protect the interests of the remaining policyholders."
This should not hide the fact, however, that even with-profits bonds have found the going tough recently.
Colin Jackson, director at Baronworth Investment Services, says some providers of with-profits bonds have been reducing their reversionary bonuses recently due to poor stock market conditions.
David Carrington from Policy Plus, says providers such as Commercial Union, General Accident and Norwich Union have all reduced the value of their annual bonuses, thus cutting the maturity of a standard, 25-year policy by 9.56%, 10.42% and 9.88% respectively.
Friends Provident cuts have reduced the value on their product by 12.03%. Scottish Life's cut has reduced the value of standard policies by 18.15% and Royal London's by 15.2%.
But Carrington says these two remain "two of the top performing with profits funds and while the cuts are more severe than the average so far, they will end the bonus season at the top, or very near, of the performance league table."
"A key aspect of the Scottish Life declaration," he adds, "is that the additional reversionary bonus that formed part of the demutualisation payout has not been declared. This comes on the back of the controversial decision last year to exclude all policyholders, whose policies had been assigned, from demutualisation payouts."
Carrington says Scottish Life has "some serious questions to answer" as they had said policy holders would receive an extra bonus for voting for demutualisation.
If you policy with them had not been assigned to a lender tied to a mortgage, then you received £500, Carrington says, "and on top of that everyone was told they would get an additional reversionary bonus from a kitty of £160m."
"But Royal London have managed to buy (Scottish Life) for £500 per member for only half the policy holders and nothing else," Carrington says.
While some bonus reductions have seen final policy values take hits of up to 18%, Carrington says some have bucked the trend of severe cuts.
He says Standard Life's 9.43% reduction in policy value is a "sign of how the biggest with profits fund in the market can ride through tough market conditions. Looking purely at the Footise, which is the measure most use, it fell by 16% (in 2001) on the back of a 12% fall before, so for a with-profits fund to fall by only 9.4% is a sign of financial strength."
In the coming month are expected announcements from Prudential, Scottish Amicable, Scottish Mutual (all on 22 February), Marine General Mutual and National Mutual (28 February). A dozen firms have not yet announced their decision for this year, including Equitable Life, Scottish Provident, Phoenix, Royal Life and Royal&SunAlliance.
Robin Lloyd, managing director with Eastbourne based IFAs Robin Lloyd Associates, says the Prudential is expected to cut its bonus on 26 February. As annual bonuses account for about 60% of policies' total value, cuts here can hurt.
Lloyd says income hunters should aim for providers who pay terminal bonuses up-front, rather than waiting five or more years to add it to a policy's value.
He adds, if such investors choose an inappropriate product, growth in the policy value may not even reach the annual 5% they can withdraw from the life product, so they are eating into capital. Prudential and MGM are two bond providers Lloyd recommends hunting. The smaller size of MGM as a provider could help them manoeuvre portfolios more nimbly without moving share prices in front of their trades, as may be the case with the Pru.
The Pru and Sun Life, who announced a 15% cut in bonus from 80% of growth earned to 65%, remain some of the more consistent bonus payers, Lloyd says, but he emphasises even smoothing "cannot defy gravity."
Lloyd adds investors may do better to avoid providers offering higher introductory bonus rates, for example an extra 2%, or who offer nil charges for entry, as lower rates may result further down the track to pay for the special offer at the start.
He adds that, despite recent bonus blips, terminal bonuses should revert to normal levels as stockmarkets recover.
To find out what each company has so far declared as this year's with profits bonus rates and what this will mean to the client, click thru the right hand for all the company figure as well as with-profits performance rates on unit trusts.
David Walker is deputy editor of Investor's Week, sister publication to IFAonline and part of the Incisive Media Group.
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