With-profit fund reversionary bonuses have been falling in line with the gilt yield curve, despite h...
With-profit fund reversionary bonuses have been falling in line with the gilt yield curve, despite having as much as 75% in equities funds.
Paul Tinslay, an IFA with Wentworth Rose Independent, said the annual bonuses for with-profits used to be around 20% in the late 1980s and has steadily fallen to an average of 5.5% to 6% for most groups. This is similar to what has happened to gilt yields. Most funds over that time period have been building up their equity content relative to bonds. Research by Wentworth Rose provides a snap shot of the with-profits fund preference for heavier equity holdings as of the end of 1999.
It shows Prudential's with-profits fund holding 72% in equities, CGU Life, Scottish Mutual and Standard Life all at 70%, Norwich Union at 63% and Scottish Widows at 57%. By far the most heavily equity weighted with-profits fund is AXA Sun Life's Equity & Law with-profits with 78.8% in equities, split between a 57.3% UK and 21.5% overseas exposure.
Fixed interest holdings are 10.8% in AXA Sun Life, 12% for Prudential, 19% for CGU, 20% for Scottish Mutual, 25% for Norwich Union, 24% for Equitable Life, and 28% for Scottish Widows. Property holdings have a varying degree of importance in the funds with Prudential and Norwich Union holding 11%, CGU 9%, while Scottish Mutual has only 4%. At the same time the fixed interest holdings have also been moving away from traditional gilts and more into corporate and high yield bonds.
The life offices justify these holdings by quoting studies, such as the Barclays Gilt Equity Study 2000, which show equities historically outperforming fixed interest over all periods, with bonds having only occasional years of outperformance. Some retain a more cautious equity stance, however even those who do so are holding historically high levels of corporate debt.
Standard Life and Clerical Medical both promote a very strong equity message in their with-profits fund, however, Scottish Widows has made a point of cutting its exposure and switched more assets into bonds during 1997 and 1998 when it became cautious about both UK and overseas equities. The decision to hold a higher proportion of equities requires the ability to cover potential market crashes. In free asset ratios, Wentworth Rose research estimated Prudential has a ratio of 35%, compared to CGU at 40%, Scottish Widows at 28%, Norwich Union with 25%, Scottish Mutual at 17%, and Equitable Life at just 7%. Paul Green, head of corporate communications at NPI, said the trend for lower bonus rates has been caused by Government accounting standards requiring bonuses paid to policy holders to be listed as liabilities. This brings down the fund's free asset ratio, the main measure of a fund's ability to cover risk.
He said: "The effect of paying out larger reversionary bonuses would be to increase the liabilities of the fund. This would mean either that the free asset ratio goes down or, if you wanted to maintain that, you would have to move slightly out of shares and into cash which would trim the performance of the fund.
"Another contributing reason for the decrease is that the reversionary bonuses are guarantees and they have to be backed by gilts. As yields have been falling it has been prudent for the reversionary bonus rates to come down as well."
While the reversionary bonuses have been falling, in most cases terminal bonuses are increasing, although this amount is up to the discretion of the product provider and in certain cases the levels of have been decided in order to boost sales.
Brian Newbould, senior manager for pensions development at Skandia Life, said there was no guarantee that the higher terminal bonuses would continue. Currently, he said, they had been paid on a comparatively small number of policies, perhaps 3% of all those created but in the future they might not continue to be paid at such high levels when greater numbers of policies mature.
He said: "When the reversionary bonuses go down then the one thing you do know is that your guaranteed assets are increasing more slowly than before, and you are relying more and more on the terminal bonus which is purely discretionary."
Newbould said that the impact a downward turn in terminal bonuses would have on payouts would be enormous.
He estimated a 20% increase or decrease could mean much as 3% added onto or taken off investment performance per annum.
He suggested it was impossible to tell whether the upward trend in terminal bonuses was not just temporary window-dressing.
He said: "You just can't tell what will happen in 20 years time. You are leaving it all purely to the discretion of the life offices, which in this day and age is unbelievable. It is like smoking. If it was invented today it would be banned."
Stephen Acheson, head of corporate pensions at Standard Life agreed that a certain amount of free-advertising has gone on with some life companies paying terminal bonuses at high levels to boost themselves to the top of industry lists.
Acheson said: "For some people it is a marketing decision, and they have openly admitted to using their terminal bonuses as free advertising. If you don't have very many policies maturing in a year, you can boost terminal bonuses in the few policies that are. It shoves you to the top of the table and it makes you look good."
Tinslay said IFAs face difficulties in advising clients on which with-profits funds to invest in. He said Wentworth takes account of various factors in advising clients including bonus structures and historical levels at which they are paid, service and administration standards, and Standard & Poor's ratings.
The group also looks at free asset ratios. That is particularly important as Tinslay said a high ratio allows funds to maintain higher equity holdings and stand a better historical chance at outperformance than funds heavy in fixed interest h
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