Germans and Austrians get excited about it, yet in the UK we either take with-profits for granted or...
Germans and Austrians get excited about it, yet in the UK we either take with-profits for granted or it has been forgotten as new investment products have been developed and marketed.
Yet the investment demand for this once forgotten concept is at an all-time high and the number of advisers looking for with-profits options is increasing all the time. In many ways this back to basics approach is no surprise.
The last year or so has created some difficult choices for investment advisers as cash returns have fallen, other low risk options, such as gilts, have continued to disappoint and direct equity investment continues to be only for those with strong nerves.
It is against this background that traded endowment policy (Tep) funds have flourished either for direct investment or as a key element of a personal portfolio bond.
Following the demise of traditional with-profits at the end of the 1980s unitised products began to proliferate and in the investment market the with-profit bond became a best seller. This was no surprise as with-profits disappeared, not through lack of demand but because of the high cost of providing guarantees throughout the life of the policy.
This point is one of the key reasons why Tep funds are so popular. Life Offices may not like long term guarantees yet investors love them and, as they are so rare, money has flooded into Tep funds.
Of course guarantees on their own are not the attraction. It is the combination of strong guarantees and solid, consistent performance which is so difficult to find, which has fuelled the rapid growth in investment in Tep funds over the past 12 months or so.
It is worth recalling the structure of a with-profits policy in order to display the quality of the guarantees. The chart shows a typical low cost endowment policy with a guaranteed sum assured (GSA), annual bonuses and finally a terminal bonus.
The GSA is provided in full from payment of the first premium and is the platform on which annual bonuses are paid. These two elements create a locked in value that in a typical policy which has been traded is considerable and usually exceeds the purchase price and future premiums.
In other words whatever happens to bonus rates between now and maturity the value of the underlying investment can not fall.
Why, though, would anybody want to invest in a product that has been subjected to derision by most commentators as the mortgage scandal gathered pace.
The first point here is that the problem with with-profits is not the performance of the product. It is the projections and assumptions that were used to price the product in the first place. While at the time these projections seemed reasonable, 15 years or so later they appear adventurous or even reckless.
It is also the case that the problem has been exaggerated as the Life Offices have used the surrender value of the policy as the platform on which to base the projections. As the surrender value is the value of the policy if the policy is stopped today a more realistic scenario would have been to use the asset share value of the policy. The asset share value is the value of the policy today assuming premiums are maintained through to maturity.
By using the surrender value the life offices have created the impression that far more policies have a shortfall than we believe to be the case.
The actual results of with-profits policies demonstrate that performance is not the central issue. A 25 year Standard Life policy maturing at the end of last year gave an annualised return of 13.6%. This was in an investment where your money was not at risk and life assurance was also included.
The challenge of a mortgage endowment is that it has to hit a fixed target on a fixed date. In an environment of low inflation, low interest rates and generally falling investment returns it is easy to see why some policies will not deliver the original expectations.
Once moved the policy can stand on its own two feet and the investment performance competes strongly.
The Tep market started to develop about 10 years ago and the first of the Tep funds appeared about five years later. The early funds were typically closed ended and bought policies which matured within a few months of the redemption date.
During their lifetime most of these funds have traded at a premium due to the limited choice of funds available. They have produced investment returns which, combined with the degree of security, have been outstanding.
This choice has widened in more recent times with the introduction of a range of open ended funds, all based in low cost yet high quality offshore centres such as Dublin.
As well as offering advisers greater choice the open-ended funds can purchase a wider range of policies as they are not tied to one specific maturity period. This approach, of course, allows the adviser greater flexibility in investment planning and the fund manager has a greater choice of potential policies to purchase.
The third generation of Tep funds has now started to emerge with investors being offered active management of policies for the first time. Rather than leaving policies to stagnate we can now retrade policies at the optimum time in order to maximise returns.
There are a number of other elements that should form part of the decision process on which Tep fund is chosen:
The current high level of demand for Tep funds has created, in some cases, a problem of policy supply with some funds actually having to close to new business while they redress the balance between cash and policies.
Potential investors should be looking at how much of a Tep fund is invested in Teps and h
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