Life offices are facing criticism over lacking transparency while calculating fees and charges. In response, life companies are hailing with-profits products the safest and most secure investment on the market
Offshore with-profits policies have come under fire in the UK's Sandler Review, criticised for lacking transparency on fees and charges. The process calculating potential returns has also come under scrutiny for misleading investors, while endowment type with-profits policies have also left some home owners caught short when paying off loans. In response, life companies claim offshore with-profits products are safe, secure investments and life offices still believe there is a place for them in the market.
According to Chris Holland, communications manager at Royal & Sun Alliance International, the Sandler Report is likely to change the way offshore with-profits products are marketed. Although the Sandler Report examined the savings market in the UK, its proposals may have an impact on offshore with-profits products.
The gross return on a with-profits policy is composed of four different components: the underlying investment return; smoothing of this return either up or down; the contribution from participation in the provider's other business; and the charging of costs.
According to Sandler, although policyholders can see what the overall return on their money has been, they do not know how these four components have contributed to it. They are unable to determine whether a good return has been as a result of superior investment performance, or whether, in fact, their underlying investment return has been poor and has been smoothed up using the fund's reserves.
Charges are also not routinely reported to customers and there is no clear notion of how to compare the price of one with-profits product with another.
Sandler has called for an increase in the transparency of these products, so investors have a clearer idea of how investment returns are made.
Holland says investors are likely to see a rise in the transparency of offshore with-profit products if the lead is taken onshore.
Axa Sun Life has already gone down the road to market its offshore with-profit products through the plain English campaign.
Peter Webb, press relations manager at Axa Sun Life, says the company is behind the proposals outlined in the Sandler report to improve the transparency of offshore with-profits policies.
According to Neil Lovatt, director of marketing development at Scottish Life International, if the proposals suggested by Sandler are adopted, investors will now be able to more easily compare offshore products against each other and feel more secure in knowing what they are investing in.
The major criticism of with-profits policies in the past has been due to reduced bonus rates. They have come under scrutiny over misleading investors about future potential returns.
Holland says the market is more sceptical about high bonuses and people are more suspicious about investing in these types of products but if you look at the market sensibly with-profit policies still have a lot to offer.
Mike Smith, international business development director at Scottish Widows International, says most of the bad publicity surrounding with-profits has focused on endowments used to pay mortgages and has just focused on the end result.
new models, new rules
The proposal for the increase in transparency by Sandler is not a new issue for with-profits policies.
However, not all life companies have agreed with Sandler in his criticism of the participation by the shareholders of proprietary (for example, non-mutual) providers in the payouts from the with-profits fund to policyholders. Currently the most widely used model is 90/10. This is where shareholders receive 10% of bonus distributions, with the remainder going to policyholders. The Sandler Report has called for this to be changed to the 100/0 model. This is where shareholder returns are instead funded by way of an explicit charge to the fund.
The justification for the shareholder benefit is that they are the ultimate providers of capital, if necessary. Sandler says this should be related to the amount of capital provided and the level of risk involved. An arbitrary figure of 10% of bonus declarations is clearly not the result of a well-thought out pricing process; nor is it clear why the payment should be related to fund payouts. The result of this structure is further obscuring the financial performance of the fund. And, in practice, shareholder funds are generally not committed to underpinning with-profits funds, as these tend to have built up sufficient internal capital.
Webb also thinks some questions need to be answered if there was a move away from the 90/10 model to the 100/0 model and he would like to know more detail in how this would work.
Life companies have also questioned Sandler in his approach to the 5% rule for offshore with-profit policies.
Currently, UK residents who hold offshore with-profits policies can withdraw 5% out of the fund per year tax free.
Sandler claims the 5% rule for life policies distorts the market because it is a feature that does not apply to non-life policies and can distract attention away from charges and investment performance.
He also has proposed that the 5% withdrawal should be abolished because it is only favourable to high rate payers. Sandler claims high rate taxpayers use the 5% withdrawal to avoid tax.
However, Lovatt says in practice it does not work that way. He says it would be a shame to see the 5% withdrawal go and does benefit low rate taxpayers as well as wealthy.
Life companies believe there is a continuing need for offshore with-profit policies for the market.
While R&SA International has not had an offshore with-profit offering for the past couple of years the company is considering launching one following its merger with Friends Provident. While no exact details have been announced, the product is likely to be a with-profits bond or an existing link to a bond and not an endowment product.
Holland says there is a market for it as the stock market is declining and this type of product provides the investor with some kind of safety.
Offshore with-profits policies have come under fire in the UK's Sandler Review, criticised for lacking transparency on fees and charges.
In response, life companies claim offshore with-profits products are safe, secure investments.
The Sandler Report is likely to change the way offshore with-profits products are marketed.
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