Under attack from key industry figures, the with-profits policy, which has allowed many investors to share in the rapid growth of the stock market, must change or face extinction
With-profits works - I have never met a client who was unhappy with the proceeds of their policy. This is my experience as an adviser and that of most intermediaries who have seen policies mature.
Why then is the concept under attack? Take the words of Sir Howard Davies earlier this year. 'The with-profits policy has allowed many investors to share in the rapid growth of the stock market over the last 25 years and many with-profits policies held for 25 years continue to provide high levels of payout relative to the actual investment returns achieved,' he said.
'But set against these clear attractions come some serious disadvantages. In the first place, the annual costs to the investor of with-profits policies can be high, certainly by comparison with, say, an indexed tracking fund. Furthermore, because of the nature of the returns to with-profits policies, any investors who need to cash in early have typically earned a return well below the market average and sometimes, if they cash in very early, even below what might have been earned on deposits.'
Could this kind of attitude be the death knell for the with-profits policy or a call to action for product providers to design a clearer, more understandable investment vehicle?
The with-profits investment concept has been around for many years now, providing an attractive solution to millions of investors:
l Exposure to investment markets
Most consumers do not, for various reasons, have access to a stockbroker. The with-profits concept allows these individuals access to professional investment management albeit at an unknown cost.
l Smoothing of investment returns
Fluctuating markets, with the resulting peaks and troughs of the likes of unit-linked investment, do not appeal to many consumers. The smoothing of investment returns, keeping back some of the performance in a good investment year to make up less than expected returns in other years, is very attractive to many.
This gives a consistent return over a period of time, and reduces the risks associated with other investment forms. This is the ace in the with-profits pack and is particularly relevant to annuities.
Particularly for savings products ' initial minimum payouts, sums assured or minimum benefits at retirement exist.
l Perceived low cost
With-profits products provide all of these benefits for a low cost, which I will call a perceived low cost, as the real costs are often unknown to the consumer.
Balanced against these advantages are many features that make the with-profits investment concept unattractive and opaque in nature.
The key challenge facing with-profits product providers centres around the increasing public profile and concern that has focused on the concept over the last year. The bad side can be summarised by the scope of the FSA With Profits review that is currently in progress.
Charges are, in effect, an open cheque. But even worse, they are not disclosed to policyholders. With most with-profits annuities mortality losses can be passed to the policyholder pool. What is worse, the client generally is not told.
l Early encashment
The Market Value Adjuster (MVA) has been highlighted as a major concern, heavily penalising those who move from with-profits investments before their expected maturity date. This is an example of poor explanation. If the MVA were defined as a negative terminal bonus, the reality becomes clear ' it is dependent upon stock market values.
The major issue centres on how an adviser can decide how risky a fund is? While a 5% bonus rate may sound low risk, when unknown charges and smoothing are added, the return to support the bonus is a lot higher and fundamentally alters the risk profile of the fund.
Linked to transparency, the FSA has described the annual statements provided as less than helpful.
As with many financial products a large amount of terminology and jargon exists. As Howard Davies has been quoted as saying, 'Why can't a reversionary bonus be translated into English?'
As can be seen, the bad clearly outweighs the good and leads to a feeling that the cards are too heavily stacked in favour of the life company. Whether this is true or not is irrelevant as perception is reality.
The simple fact is that the opacity of the concept means that it is easy to criticise the concept. Remember, with-profits grew up over the last century in an era where life companies were trusted and consumer awareness of investment was considerably lower. It is too easy to criticise the current concept as is evidenced by attacks from consumer organisations and the press.
So, has with-profits reached its sell-by date?
As an investment concept, with-profits has a huge amount to offer. People are attracted to the opportunity of equity investment, with investment returns being smoothed over time. As I have already said, this is the ace in the pack and it is time to re-engineer the concept so that it can continue to serve people in the twenty-first century.
In many ways, this may be the end of one era, but the beginning of another. Going back to Howard Davies, he recently said: 'Traditional with-profits business, in its present form, with its opaque superstructure, obscure marketing and high charges, will not loom large in the long-term savings environment in the next 20 years, as it has in the past 20.'
While with-profits will continue as a concept, it must become one that addresses the issues and concerns of the industry and consumers.
Using our recently launched With Profits Pension Annuity as an example, it is possible to meet the various challenges offered by with-profits.
The Britannic product has an annual management charge that is capped at less than 1% a year and guaranteed not to alter for the life of the annuity.
With similar charges applying to investment products, such as Isas and stakeholder pensions, we feel that such a charge is right for the time.
Our marketing literature is clear and we are more than willing to disclose key features of the product. In addition to the annual management charge, we also disclose top-line fund performance ' if the underlying with-profits fund grows by 20% or -5% a year, we will tell the client and the amount will be either taken from, or added to, the top-line performance in respect of smoothing.
As a result of these factors, we will confirm the resulting actual return to the client and how this affects their income for the coming year.
The client has one return ' we have removed the jargon of reversionary and terminal bonuses. This means that the return is the amount earned less smoothing, making the risk profile easier to define.
We are also guaranteeing mortality, which means that if future experience differs from our assumption, we will not reduce the returns to the client as a result.
In addition to clear literature and annual statements, an independent person (an actuary or auditor) will review the operation of our product and certify that we are meeting our commitments and the promises made regarding the transparency of the product.
Although with-profits as a concept has been around for many years, key industry bodies are now concerned that these products do not meet the needs of the modern consumer.
The challenge is now open to the industry to develop products for the future that make the numerous concerns obsolete.
With-profits policies are under attack by much of the financial services industry.
Among the with-profits problems is the fact that charges are not disclosed to policyholders.
To survive, with-profits policies must be more transparent in design.
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