Aviva Quietly Reduce MVRs

Aviva have reduced their Market Value Reduction (MVR) factors this month. I know this because it says so in the right hand column of their with-profits page: http://www.aviva.co.uk/savings-and-investments/with-profit.html. I've checked on a client's investment and it's a reasonable reduction of about 2%.

In the past this sort of "good news" has been announced with a fanfare. For example last time they reduced their MVR rates they issued this press release with a full list of rates depending on different dates of investment: http://www.aviva.com/media/news/5487/.

This time around, there's no announcement and there's no details on the website of what these reductions are or on what day in May they came into force. I've written this blog simply because I'm puzzled by the silence and lack of information. I spotted the website change Monday morning and I've waited to see if an announcement will follow but this looks like the second day of tumbleweed.

One of the great criticisms of with-profits is the lack of transparency. In the absence of clear information it's inevitable that people will speculate with conspiracy theories. And to get you started here are just a few potential theories that might explain the silence:

Conspiracy Theory 1/ The reductions are so small that everyone will criticise and give up hope of a recovery.

Conspiracy Theory 2/ The reductions are so large that everyone wonders why and questions whether it's a ploy to reduce the No-MVR carry-forward promise that they've made on Aviva (ex CGU) With Profits Bonds reaching their 10th anniversary.

Conspiracy Theory 3/ They're unsure how to communicate and justify the 4.8% MVR rate applying on the three Special Bonuses they made in January 2008, January 2009 and January 2010.

Conspiracy Theory 4/ The decision to improve rates were made when the FTSE looked steady at 5,700 but now that it is 7% lower at 5,300 the pressure's back on for a quick change back again.

Conspiracy Theory 5/ Improvements in MVRs typically signal an opportunity for people to consider divesting and they don't want people to know.

Of course the most obvious explanation is that they've not got around to it just yet. Let's hope we hear some news in the next couple of days.

Rationally Assessing your With Profits Bond

It turns out that we don’t always make rational decisions. Our brains are genetically wired for a far more simple life than we live today. When faced with sophisticated financial products we often struggle to make logical and rational choices.

Studying the way that the irrational human mind affects financial decision making is called behavioural economics. The level of debt that individuals and countries in Western economies have built up, the faulty financial instruments at the heart of the credit crisis and the spectacular failure of banks are good examples of our flawed human economic behaviours.

There are a number of biases that affect our judgment. Here are four examples of investors’ irrational behaviour which I believe are preventing With Profits Bond holders from easily making the rational decision to cash-in on their 10th anniversary guarantee;

Representativeness. People assume commonality between objects of similar appearance and investors tend to assess situations based on superficial characteristics rather than underlying probabilities. The With Profits Bond appears to be an investment that only rises, like a deposit account. This disguises the reality that the investment assets of a with-profits fund fall as well as rise.

Conservatism. In this context, conservatism means that investors cling to prior beliefs in the face of new information. This issue more than any other is critical to overcome. The false belief for With Profits Bond investors was that their investment was worth what it said on the statement. The new information is that insurance companies actually base your investment’s value on your fair share of the fund known as “asset share.” It is the difference between your asset share and the value on your statement that at the time of writing makes the 10th anniversary guarantee so valuable for so many people.

Loss Aversion. Investors are gripped more by the fear of losing money than of gaining it. As odd as it sounds, investors’ motivation for gaining the windfall from calling on the guarantee by cashing in is tempered by the fear of losing their investment by making this decision.

Frame dependence. This is where the form of presentation of information can affect the decision made. In this case the presentation of information is wrapped in insurance company jargon like “Market Value Reduction” making it hard to understand.

If you have a With Profits Bond and a 10th anniversary guarantee, you need to challenge these feelings, weigh up the facts and make an informed and rational decision.

Shareholders to Profit from the Unwind of Guarantee Costs

Aviva PLC's annual accounts don't usually interest me greatly, but the following paragraph caught my attention:

"On an ongoing basis, profits will arise from earnings on the re-attributed estate (estimated at £45 million per year on an IFRS basis), the financial unwind of guarantee costs, the movement in value in any un-hedged assets backing the guarantees, and any demographic profits /losses (e.g. lapses) resulting from policyholder action." - page 6 of Part 2 of Aviva FY 2009.

Initially I was drawn to the estimated annual profit from the reattribution of the CGNU Inherited Estate in 2009. Having paid £450M in the reattribution, £45 million a year represents a 10% annual rate of return. In approving the reattribution scheme the FSA stated that they calculated the Internal Rate of Return that Aviva might expect to enjoy in assessing whether the offer from shareholders to policyholders was fair, although they would not disclose what they considered fair (see FSA's Second Report, paragraphs 77 to 81). It seems that a 10% return is fair. Hmm, in the post credit crunch world and 0.5% per year base rates, I'm struggling to see a 10% return as fair.

But actually the point I think policyholders should really note in Aviva's paragraph is "profits [to shareholders] will arise from earnings on...the financial unwind of guarantee costs." This issue should be at the very heart of how you assess your policy. The sad reality, as evidenced by this statement, is that Aviva KNOW that on the whole, policyholders don't take advantage of their guarantees and that a large chunk of the funds reserved to pay for guarantees will eventually unwind back to shareholders.

Right now there are tens of thousands of Aviva (CGU) With Profits Bond policyholders who have passed their 10th anniversary and are eligible to claim these guarantees. Unless they act, the value will unwind and what would have been profit to policyholders will revert to profit to shareholders.

Policyholders in an Aviva CGU With Profits Bond who are in any doubt about the value of this guarantee can read our Aviva Aluminium Report. Please contact me at Fraser Heath Financial Management if you have any questions.