The long-established mainstay of the life industry is out of date and those advisers who continue to recommend the with-profits option should question their motives as it is unlikely to meet client requirements, says David Ferguson
In a sector in which scandal and mis-selling are never far away could it be that the next port of call for the legal eagles will be offshore with-profits bonds?
I really cannot fathom why providers persist with this outdated, paternalistic and simply archaic proposition in 2005. Whatever the supposed merits of the asset class they simply do not support the principles of openness and transparency that are demanded by consumers in these post- various scandal times. Have all the efforts to educate on themes such as financial planning and asset allocation really fallen on such deaf ears that a one-size-fits-all approach is likely to carry some appeal?
Given that I can log on to a website to design my own holiday, is it really appropriate to assume that I am content to have my investment requirements lumped in with the rest of the general population?
It actually surprises me hugely that with-profits has had such an important role in the offshore market as I tend to believe that the advisers operating in this market have greater expertise than a typical middle-of-the-road adviser. Seems like I have been wrong all along. Maybe some advisers believe that the supposedly low risk profile of with-profits funds are appropriate for all manner of cautious investors who may have chosen the offshore route for purely taxation reasons.
There is, or has been at least, another major market for offshore with-profits 'solutions'. The lovely, but dodgy, market in geared investments has spent some time courting with-profits investments as advisers have apparently believed that the risk borne by the client is a fair price to pay for 21% or 28% commission. Now I am not one to dismiss the notion of geared investments as for some investors such an approach may be perfectly appropriate. I do, however, have a major issue when with-profits funds are used as the underlying asset class.
It was bad enough when quarterly rolling funds were all the rage as backing for the loans - whatever their failings, at least one could easily establish and even predict their asset allocation at any point in time. How advisers can justify flogging an asset class with completely unknown and probably unpredictable asset allocation as backing for a potentially significant loan is beyond my comprehension. Given that we have already seen many with-profits funds become heavily invested in bonds and products invested in such funds have little or no chance of outperforming cash (after charges) who can possibly say that a geared investment has a decent chance of avoiding disappointment?
Quite how many investors and what sums of money are invested in geared with-profits arrangements is not clear to me, but I do know that there are several companies shaking in their boots at the potential issues associated with treating customers fairly. In the end analysis, some offshore life offices have colluded with advisers to drive business volumes at the potential and increasingly likely expense of investors. Not good.
Similarly, it was probably acceptable when bonus rates were consistently in excess of 5% for advisers to use with-profits bonds as a vehicle for income seeking investors. In those days there was a reasonable chance that the income demands could be met while preserving the value of the initial investment. Sadly market conditions have combined with horrendous mismanagement to ensure that this is no longer the case.
Are with-profits good for business?
While it is probably true that the asset call has the potential to outperform cash, even after allowing for tax and charges, this is not actually the point. The question providers must ask themselves is can these products provide a meaningful return while being sufficiently open as to ensure that customers are being treated fairly? With-profits only works when it is opaque. As soon as one opens up the structure, the underlying fund is exposed to selection and clients can elect to leave as soon as their surrender value exceeds asset share. Indeed it would be the best advice an adviser could give to switch out in such circumstances. Of course the odd client behaving in this way is unimportant but a whole group or cohort exercising their right could cause a destabilisation of the entire fund, to the detriment of remaining policyholders.
While I have never been a fan of with-profits funds, I can see the attraction where the life office is either bearing some investment risk or at the very least is managing some investment risk on behalf of the client. This is a worthy area in which the industry can contribute and one in which value is clearly being added to the client proposition, even where this is at the cost of reduced long-term returns due to the nature of the asset allocation required to manage any guarantees. Where I run into serious problems is in the consideration of next generation with-profits. These are simply managed funds seeking to leverage the historical popularity of a now dying asset class.
Of course this argument is not peculiar to offshore with-profits as exactly the same analysis can be applied to the onshore version. Given the utter collapse of onshore with-profits bond sales could it be that some offices have been guilty of trying to perpetuate the with-profits myth by allowing the product to drift offshore? If so, is it perhaps the case that the offshore market is now realising the problems that might exist and that is what has led to a fall in offshore with-profits sales in the last year or so.
An uncertain future
I would expect that sales of with-profits bonds will continue to fall as both the failings of the asset class continue to be exposed and as quality advisers continue to develop their financial planning and asset allocation skills. It is only in these areas that an adviser can demonstrate to clients that they are truly aligned with their clients' interests and therefore begin to exhibit the much talked about - but sadly infrequently delivered - professional approach to long-term financial advice.
Where providers have the capital and the conviction to provide proper investment guarantees that really add to the customer proposition this will be valued and we may see shoots of recovery. That said, I think such shoots will quickly be killed off as advisers come to realise that for every new product feature there is an associated cost, either in terms of product fee, or reduced long-term performance due to more cautious asset allocation.
Advisers must consign with-profits to the past and embrace more sophisticated approaches to asset allocation. Whether this is by employing internal resources to determine appropriate strategies or whether it is by making use of external agencies to assist the message must be that one (pretty flawed) solution is unlikely to meet the requirements of even one client, far less all clients.
Quite how long this market adjustment will take is unclear, although it does seem that the journey started some time ago. What is certain, however, is that for every day that passes until the market dries up completely, another adviser will have taken the easy option and opted-out of ensuring their client has a tailored investment proposition that has been cut to meet the financial goals, requirements, risk profile and risk horizon of that client. As long as advisers such as these are willing to place the value of their client's portfolio in the hands of an actuary whose interests are inevitably more aligned with corporate goals, there will only be one group missing out.
Many with-profits funds so heavily invested in low risk assets that they cannot outperform cash.
Do not use with-profits as an income vehicle, bonuses are too low.
New generation with-profits contain many of the faults of the old style contracts, they are not a suitable replacement.
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