Phoenix With-Profits Scheme and the Quiet Revolution

I’m surprised by the apparent indifference in our media towards Phoenix Life Group’s Scheme of Arrangement proposed to over 50,000 with-profits pension policyholders earlier this week. In my opinion this Scheme has the potential to transform with-profits and to improve the financial prospects of millions of with-profits savers.

In my discussions with Phoenix over the last few weeks while I’ve been studying and analysing this Scheme in depth (see my website www.phoenix-scheme.com), I’ve learnt that other insurance companies are paying very close attention. If it’s successful, and due to the way the voting is structured it’s hard to imagine it won’t get a majority yes vote, I think we could see other with-profits funds with weak balance sheets following suit. The impact of this innovative and imaginative solution to the problem that Guaranteed Annuity Rates present to both insurance companies and policyholders alike could be huge.

Guaranteed Pension Rates are bad news for shareholders who have to tie up capital to meet these liabilities. But they are not entirely satisfactory for policyholders either, especially where policyholders are unable to meet all the policy conditions required to fully maximise their benefit. Even those policyholders who can meet the conditions often find the compromised options they have had to take to be inconvenient, and this is an inconvenience they will live with for the rest of their lives.

As a general rule, Guaranteed Annuity Rates are usually extremely inflexible and can require the policyholder to;
• Retire on the specified retirement date and not earlier or later
• Take a non-increasing pension offering no inflation protection
• Take a single life annuity that ceases on death even if they are married
• Not take a lump sum because the lump sum is not as valuable as the guarantee

In addition, many clients don’t really like traditional annuities and prefer drawdown or some form of investment linked annuity, but obviously don’t take this route on a plan with a Guaranteed Annuity Rate.

And due to cautious asset mixes required in order to meet the guarantees, and with high extra charges now applying to meet the guarantees, policyholders are likely to get just the guaranteed minimum and no more, and the effects of inflation of course erode the real value of the guarantee each year.

By getting a cash uplift in return for giving up the Guaranteed Pension Rate, all of these shackles disappear. While there’s a small chance of the pension at the policy retirement date being lower than the guaranteed value, there’s a high probability of a superior income PLUS you get to choose when you retire, whether it should increase, how you invest it (if you transfer), add a spouse’s pension at retirement, amalgamate with other plans to buy a pension income other than a traditional annuity etc.

In my opinion, that’s a really positive transformation in retirement prospects.

Importantly It also makes perfect sense to the insurance company too. While it aims to be “embedded value neutral”, it draws a line in the sand for when exposure to Guaranteed Pension Rates stop being a liability. And the greater exposure to real assets in the fund means that there is an asset mix with increased potential for future returns to them too.

Ultimately, improving the recovery prospects on one part of the with-profits fund should inevitably have positive effects on other policyholders in the fund too. It won’t rid with-profits of the cancerous effects of over generous guarantees overnight, but it just might be the first dose of the right medicine.

Fanning the Flames for Phoenix

Today is a good news day for with-profits pension policyholders. Phoenix Life Group, the owners of a book of pensions sold by Sun Alliance, are writing to policyholders with a retirement date beyond 1st January 2020 to give them an option to amend the terms of their contract. Policyholders can give up their Guaranteed Pension Rate in return for an uplift in their current fund value.

I think it's a great initiative.

With-profits plans with Guaranteed Pension Rates are extremely valuable but they are awkward. To maximise the value policyholders might have to accept a single life income that ceases on their death rather than include a pension for a spouse on death, they might opt to not take the Pension Commencement Lump Sum, and they might put up with low growth prospects and poor death benefits in the meantime.

Offering to enhance the current fund value in exchange for the Guaranteed Pension Rate introduces much improved flexibility for policyholders.

Up until now, affected pension plan holders and their advisers have had to leave these plans in the filing cabinet and plan around their inflexibility. Now, for those policyholders who are comfortable with the investment and longevity risk and who vote yes to the scheme, there exists the option to plan a retirement that suits them rather than just accept what's given.

Affected policyholders might like to know that we've set up a website dedicated to helping you work through the main points to consider before you vote - http://www.phoenix-scheme.com/

What's the time Mr Wolf?

Speaking with an Aviva policyholder this afternoon, she had realised that the length of time you intend to stay in the Aviva with-profits fund was critical to whether to accept the reattribution offer, but she was frustrated that noone could say what length of time one needed to wait. Unfortunately that's because noone knows.

If this is the sticking point for you, there are two time periods that you need to consider:

1. Time to wait until the next Special Distribution might be worth more than your reattribution offer, and
2. Time to wait until Aviva might actually make their next Special Distribution (after the one due in January 2010).

On the first issue, both Aviva and the Policyholder Advocate have issued guidelines. Personally I find the figures provided by the Policyholder Advocate to be more plausible. Her calculations are based on the type of policy held and you can read about those in the purple book sent with your offer. Alternatively we have links on our website http://www.reattribution.com/. Broadly her conclusions are if your policy matures before 2016 you're likely to be better off accepting the offer and if you can wait beyond 2022 any future special distribution is likely to be better than your reattribution offer. Please refer to the Policyholder Advocate's guide for full details.

On the second point, it's worth noting that special distributions out of the inherited estate are fairly rare occurrences. This may change in the future of course, particularly as one might imagine that Aviva's shareholders will be keen to get a retun on the investment made in buying out policyholders' rights with the reattribution offer. However, I'm more inclined to see this as a long-term plan for Aviva. Despite some fairly resilient With Profits Bond sales figures announced this week, regular savings with-profits endowments and pensions appear to have all but died a decade ago. The point where the inherited estate can be safely distributed is when the large liabilities connected with these endowment and pensions have left the books. These policies were the main investment choice up to the mid to late 90s and a 25 year endowment sold in 1999 would mature in 2024. So my crystal ball says you may be looking at being a policyholder for another 15 years, possibly longer before the next special distribution.

In addition to a long term on your policy, you also need to be sure that you are willing to stay in the fund that long. Again, http://www.reattribution.com/ should help you work through reasons why you might choose not to keep it that long.

Avast Ye Aviva Yes Voters

I was fascinated at the Aviva Adviser Reattribution roadshow to hear the With Profits Actuary explain how the inherited estate is like a treasure chest that the shareholders own, and that the current generation of policyholders is the holder of the key that unlocks the treasure chest. I don't know about you, but when I hear about treasure chests I think of pirates and ill-gotten gains. So the analogy seems appropriate and somewhat brazen.

So how did the pirates Aviva get to build up such a treasure chest? The short and somewhat simplified answer is that they invested 100% of policyholders' money but gave back less than 100%. In Claire Spottiswoode's excellent executive summary she states "KPMG...concludes that the estates are likely to have mostly resulted from payouts to past policyholders having been less than past contributions."

One of the many important questions With Profits policyholders have to ask is what is the chance of getting back less than you ought to? And in the case of Aviva policyholders who hand the key over to Aviva by accepting the reattribution offer, what are the chances that Aviva will play fair by giving you back what's yours rather than keep a bit more for the treasure chest?

Well, there are some fairly decent and robust processes put in place that have been independently assessed. But history shows us that a bountiful treasure chest can be built up through "prudent management".

An important point to consider is that Aviva manage the funds to give you back 100% of your smoothed share of the fund. Smoothing is where they hold back more in the good times to give policyholders who have plans maturing in the bad times some protection against the falls. One might think that the good and bad times even out but actually investments have more good years than they have bad; a consequence of inflation. So arguably it is more often the case that 100% of your smoothed share is less than 100% of your unsmoothed fair share of the fund. Those are the times when a little bit extra stays in the treasure chest.

Wise to this fact, KPMG suggested that Aviva publish unsmoothed asset shares alongside smoothed asset shares so that smoothing can be assessed. They also proposed the smoothing account should be subject to annual independent external review. It's unclear whether these suggestions have been adopted. I hope they have but I suspect they haven't.

Policyholders who accept the reattribution offer need to think very hard about their long term commitment after they have received the payment and the last special bonus due in January. On our website www.reattribution.com we have a free reminder service where we'll remind you in January to get a with profits health check for your policy.

Aviva Reattribution - Be Sure to Vote!

Policyholders in Aviva's CGNU With Profits fund will have now received details of the offer that Aviva shareholders are willing to make to current policyholders in return for giving up the right to any future Special Distributions.

And what a bumper pack of information it is too! As an Independent Financial Adviser I've had a pack consisting of letter, summary sales aid, sample policyholder letter, sample voting form, a summary explaining all the supporting information available to advisers, the "It's your Choice" guide (48 pages), the Adviser Guide to Fund Transfer and Reattribution (32 pages) and the Policyholder Advocate's "Making your Choice" guide (32 pages).

I have to ask whether all that information is really necessary? The level of repetition in the first 10 pages of "It's your Choice" alone makes the prospect of reading any further one of dread for most policyholders I'm sure.

Interested in With Profits as I am, I persevered through the paperwork, read some of Claire Spottiswoode's revealing insights on her website www.policyholderadvocate.org and attended an Aviva Adviser roadshow. All of which was genuinely fascinating, but I'm left wondering just how many eligible policyholders will have opened their envelope, looked at the sheer volume of literature and put it in the "things to get round to soon" pile (like the one sprawling on the left of my home study desk!).

That's a real worry. Many people will have had experience of demutualisations where everyone gets a windfall whether they act or not, but that's not what happens here. For most policyholders it is in their interests to accept the reattribution offer but if they don't vote "yes" in time they will lose out. How many thousands of people will lose out because of information overload?

We've set up a new website at www.reattribution.com which takes policyholders through the key financial planning considerations step by step. We believe that most policyholders will be able to work their way through fairly quickly and make an informed decision whether to vote Yes or No. Depending on answers given, a few policyholders may need independent financial advice to make a truly informed decision but for most it's a fairly simple choice; take the money and then review whether to stay or go.

Cash-in and Rise like the Phoenix

Lifting its head limply amidst the ashes of burnt notes is the Phoenix With Profits Bond. Originally sold by Royal & SunAlliance, the policies have moved to Resolution and now lie with the Pearl Group.

Investors who took out a With Profits Bond in 1999 need to pay very close attention to their 10th anniversary and act.

Phoenix allow policyholders three months to take their money back on the 10th anniversary and get a gift far in excess of their fair share of the fund. So someone who invested on 30th December 1998 had until 30th March to surrender and get the full face value of their investment back. If that investment said on paper it was worth £20,000 they could pocket the full £20,000.

But if they waited until April to cash-in they would only get back an amount that the actuary considered to be their fair share of the fund and NOT the value stated on paper. In this case it would result in £15,560 being paid back.

Put another way, by taking advantage of this guarantee date, such a client would enjoy a bonus of £4,440 just for cashing-in. Amidst the cinders of this failed investment, such a policyholder walk away unharmed, rising again, revitalised like the Phoenix.

The way that Phoenix gradually reduces the MVR for policies as they approach the 10th anniversary is a good way of managing policyholders’ reasonable expectations. However an unfortunate bi-product of this is that you only know exactly what Phoenix thinks your fair share of the fund really is after the three months have passed. By then it’s too late and in the case of a December 1998 investor you’re saddled with a 22.2% shortfall.

In an industry fond of using the term loyalty bonus, this is a massive penalty for staying loyal.

And although Phoenix writes to policyholders about the date, I’ve realised with the client I met this morning they don’t copy in your Independent Financial Adviser. So unless you have an organised adviser or are willing and able to make sense of Phoenix’s two page letter you could end up making an extremely costly error.

If you invested in a Royal & SunAlliance With Profits Bond ten years ago, be sure to seize the day!

Pink Elephants and With Profits Penalties

Bill McFarlane's "Drop the Pink Elephant" is a great resource for anyone who wants to get their message across clearly. The analogy in the title of the book refers to the fact that people hear the words you say and appending a negative to a word simply plants the opposite of what you want to say in the listener or reader's mind. For example, if I asked you not to think about a Pink Elephant your mind will visualise one. It's how the brain works and to get our message across we need to take care to say what we mean and not what we don't mean.

I was reminded of this when reading a newspaper article this morning about how some savers can access their With Profits Bonds on the 10th anniversary free of any penalty. It's the use of the word "penalty" that troubles me because it implies a punishment for breaking the rules.

If you were told that for one day a year you could drive at any speed on any road without risk of a penalty, most of us would still drive like we do on the other days of the year. We know and understand why the rule is there and a penalty-free driving day would be irrelevant.

My concern is that an investor might look at a penalty-free date on their With Profits Bond and conclude that as they weren't thinking of cashing-in they weren't planning to "break the rules" anyway and let the date pass them by. If that's the case then the terminology could cost the investor thousands of pounds.

With Profits Bonds are a masterpiece in how to make a relatively straight forward concept complicated by dressing it up as something apparently simple. To understand the investment you must firstly take away all the language and jargon and look at what it actually does. You invest your money in a With Profits fund. This fund invests in company shares, property, bonds and cash, and like any other managed fund, the value goes down as well as up.

No matter what it says on your statement, the only value that really matters* is how well the fund has grown since you invested. If your £10,000 investment is now only really worth £12,000 then it matters not a jot* that it says it's worth £14,000 on paper. The insurance company will always target to give you back what your fair share fund is actually worth.

*The exception to this, using our example above, is that most will guarantee to pay the £14,000 if you die and some will allow you take the £14,000 on a specified date.

If the language was reversed and the insurance company spin stripped away and replaced with words to help the policyholder understand, savers would be left with an entirely more positive approach to this 10th anniversary. We might, for example, say that the 10th anniversary was a reward for cashing-in.

With every day that passes there are hundreds of savers missing out on a potential cash-in reward. This is a real challenge for the consumer press and the financial advice industry to really get the message across clearly, effectively and quickly. We need to drop the pink the elephants and help explain this golden opportunity.

Act Now to Reduce Surrender Tax Charge

If you have surrendered a With Profits Bond during the current tax year and there's higher rate tax to pay on the gain, you only have a few days left to mitigate your tax bill.

Surrendering an Investment Bond creates a Chargeable Event and probably a Chargeable Gain. To see if higher rate tax is due you divide the gain by the number of years you held the policy and add that "top slice" to your taxable income. If you are a higher rate tax payer, or if this top slice makes you a higher rate tax payer, you will have an additional 20% tax to pay on that gain.

However, making a pension contribution in the same tax year means that effectively you get the usual tax relief of a pension PLUS you might be able to avoid paying the extra tax on the gain.

For example, imagine you have taken advantage of a 10th Anniversary No MVR Guarantee on a With Profits Bond where you invested £20,000 in 1999 and received back £30,000; a gain of £10,000. The £10,000 gain divided by 10 years means that the top slice to add to income to see if higher rate tax is payable is £1,000.

We'll assume your taxable income is at the cusp of paying higher rate tax (£40,835 in the 2008/9 tax year) so the £1,000 top slice is all assessable to higher rate tax, making a tax bill of £2,000 (£10,000 gain X 20% extra tax).

Rather than write a cheque for £2,000 to HMRC, you might be able to write a cheque to your own pension fund of just £800. This is grossed up by 20% basic rate tax to make a £1,000 gross pension contribution.

By making a £1,000 gross pension contribution you reduce your taxable income by £1,000. So when that £1,000 top slice of income is added to your taxable income you stay within basic rate tax band and there's no tax bill to pay on the gain.

In this case it's either £800 in your pension savings plan grossed up to £1,000, or pay £2,200 in tax. I know which I'd rather do!

Realistically your pension company will need your application and cheque by Friday 3rd April. If you've surrendered a bond this year and there's higher rate tax to pay, there's no time to waste!

Smooth as Ice

My Moneyfacts March 2009 magazine arrived this morning with fresh quarterly data on the performance of With Profits Bonds. To my knowledge Moneyfacts is the only magazine to provide performance data on With Profits Bonds that includes the Market Value Reduction (MVR) and actual surrender values. The surrender value after applying the MVR represents the policyholder's fair share of the fund, and allows you to assess how companies are smoothing returns.

I provided a fairly detailed analysis on my website last month explaining how a comparison between Distribution Bond performance and With Profits Bonds performance can give you a good insight into how returns are being smoothed. You can read more about that analysis here: http://www.withprofitshealthcheck.com/news

I've updated my figures for the same five insurance companies (Axa, Legal & General, Norwich Union, Prudential and Standard Life) and the results show that as at 1st February 2009 With Profits Bonds appear to still be smoothing returns. This is intimated by the fact that despite similar asset mixes in the funds, the With Profits Bonds are paying back more to clients who surrender today than for policyholders in the Distribution Bonds.



The point about smoothing is that it protects investors who are surrendering their investments after a sharp fall in the value of investments. It works by holding back some of the returns when times are good. So investors who surrender today could benefit.

Please note that past performance is not a reliable indicator of future returns and that this blog is for information only. Before taking any action you should consult an Independent Financial Adviser; if you don't have an IFA please get in touch and I'll be pleased to help.

The Compensation Game

The Financial Services Authority has announced its intention to stop insurance companies using the slush funds ("the inherited estate") of With Profits funds to compensate policyholders, but only from the summer onwards. The slush fund consists of money earned on policyholders' investments that have not yet been added to their policies, and works as a buffer to protect the money already added when asset values fall. This means that where it is found that a policyholder was missold a policy in the past, the company can say "sorry about that" and pay-out compensation by raiding the slush fund.

Honestly, in what other world could this happen? If an IFA has been found to have missold a policy there's an expensive insurance policy with a large excess to call upon, but ultimately it impacts on the IFA's profitability. What insurance companies are doing here is effectively taking money from those policyholders who weren't missold to give to those who were. Where's the fairness in that, and where's the incentive for companies to ensure they abide by good practice?

It's simply staggering that this practice has been allowed to carry on for so long and reflects poorly on the industry and the regulator. In the case of the regulator this is a case of better late than never, but how disheartening to read the whimpering complaints and straw-clutching of insurance companies who submitted responses to the last Consultation Paper.

The FSA's announcement that this practice "may not lead to the fair treatment of policyholders" is Great British understating at its finest. Where the slush fund is raided it invariably leads to the fund having to invest in safer investments with lower expected returns. Ultimately, where it leads to the whole slush fund running dry, the fund effectively becomes a gilt fund with a risk and reward profile vastly different to the one that the policyholder thought he was buying at outset.


Two interesting points were raised in the Consultation Paper:

"Conflicts of Interest and Risk of Unfair Treatment of Policyholders"

"With-profits business differs from other types of long-term business, in that the interests of different parties in a with-profits fund and the wide discretions exercised by firms in the management of with-profits funds, can give rise to conflicts of interest and risks of unfair treatment of policyholders that do not arise in the same way or to the same extent elsewhere."

This sentence should see alarm bells going off in the heads of policyholders. Why invest your money in a fund where conflicts of interest could lead to you being unfairly treated?


Hard for Policyholders and Advisers to Understand

"The complexity inherent in with-profits makes it hard for policyholders (the principals), and in some instances their advisers, to understand elements of their funds' performance."

As an IFA with a background of educating advisers in With Profits over many years, I know this statement to be true. It's good to see the regulator recognising this fact. I hope policyholders start to realise that their With Profits policies need to be reviewed by a knowledgeable IFA.

Norwich Union With Profits Bond 10th Anniversary Guarantee Explained

Like many providers, Norwich Union guaranteed to not apply a Market Value Reduction on the 10th anniversary of investing in their With Profits Bond. This guarantee could be worth thousands of pounds to savers who invested in 1999, but I suspect that many are failing to take advantage simply because they don't appreciate its value.

If you have a 10th anniversary guarantee date coming up, the seven minutes spent watching this video explanation could prove seven minutes well spent.

A Tale of Two Opacities

Two into One Won’t Go

In April 2004, the management of Aviva puzzled over what to do with their two large With Profits funds.

One of the funds, the fund which contained business written as the old Commercial Union and General Accident (the CGNU fund), was healthy and robust. The slush fund (called the inherited estate) it had built up through keeping guarantees and bonuses low was larger than the management felt was necessary. Shareholder value could surely be enhanced if they could only find a way of accessing this excess, as it could if they could merge the fund with its sister fund and enjoy economies of scale.

Unfortunately the other With Profits fund, made up of business written as the old Norwich Union, was coughing and wheezing. Back in 2004 the markets were some way off their 1999 peak and all the promises the Norwich Union fund had made to policyholders were in jeopardy of not being met unless the company took some action. This weakness was a barrier to their desire to merge the two funds because policyholders in the strong CGNU fund would never agree to merge with such a weak fund and jeopardise future returns.

They were not the only insurance company with a threadbare slush fund. Most With Profits companies in the same position decided that the best way to be sure that they could honour their guarantees was to get out of risky investments and invest in assets, such as government gilts, that they could have confidence would deliver the required returns.

But Aviva knew that a retrenchment to safe investments would rule out the possibility of the two funds merging in the future. It would be better if they could find a way to get the slush fund big again and the best way to do this was to generate strong investment returns.

The Gamble

A unilateral decision to increase the charges with effect from 1^st May 2004 was made with a view to the extra charge boosting the slush fund. An extra 0.75% per year would be deducted from every policyholder’s investment which would give the fund the extra security it needed to stay invested in shares and commercial property.

This 2004 charge implementation was in stark contrast to the much heralded ‘choice’ for clients in their 2008 reattribution offer. The charge effectively resulted in a change to the contract terms and passed the onus for meeting the guarantees away from the shareholders and back firmly on policyholders.

By November 2006, the “gamble” that policyholders in the Norwich Union fund had underwritten was coming good. Two and a half strong years for stock markets and commercial property meant that the 0.75% per year charge had been worth paying for those with policies maturing at that time.

The Norwich Union fund policyholders weren’t the only winners. If the CGNU fund was healthy and robust in 2004, just imagine its strength at the end of 2006! It was ripe and bursting at the seams.

It was time to make progress with a fund merger. To get the CGNU slush fund in the same proportion as the Norwich Union fund they needed to skim off the excess. £2.1bn of the slush fund was distributed to CGNU policyholders as Special Distributions in 2008, 2009 and 2010, with 10% of the Special Distribution going to shareholders.

The plan to merge the two funds came as part of a reattribution offer, where CGNU fund policyholders would be allowed to deny themselves any potential future Special Distributions if they accept an offer from the shareholders to buy them out of any potential windfall. In the summer of 2008, shareholders were willing to pay £1bn for the right to future windfalls from policyholders.

Well, everything was going to plan until October 2008 when the management heard a little sniffle from the CGNU fund and it started complaining about a sore throat. Those Special Distributions had a double whammy effect of £2.1bn less slush fund for tough times like these, and £2.1bn more liabilities. Oh dear. Too many liabilities and not enough slush fund was the problem the Norwich Union fund had!

At the end of 2007 the CGNU fund had 71.5% in shares and commercial property but by the end of 2008 this had dropped to 55.7%. In my opinion the reduction of risky assets was a direct result of falling asset values relative to the size of liabilities, combined with a much reduced slush fund.

So it looks like the CGNU fund can now match the Norwich Union fund for the size of its inherited estate. How long before they join policyholders in the Norwich Union fund by paying an extra 0.75% per year? After all, they continued to charge 0.75% to Norwich Union policyholders even before the severe market correction.

It’s hardly surprising that the 2008 reattribution offering was taken off the table last week. £1bn is a lot to pay for the now remote prospect of future Special Distributions and for increasing the risk to shareholders in the process.

Right Here, Right Now

And right here, right now, how pleased and rewarded do the Norwich Union With Profits fund policyholders feel about the extra 3.75% they’ve paid over the past five years in charges they hadn’t bargained on when they took out their plans?

If the fund had matched its guarantees and invested fully in UK Gilts like some of its competitors instead of applying the extra charge and taking investment risks, investors might have enjoyed a return similar to the Norwich Union Gilt (S4) Life Fund which has grown by 25.1% over the past 5 years. Instead the fund they are in, after the extra 0.75% charge, has grown by 19.5% over the past five years. In others words, for policyholders with plans maturing today, the strategy has backfired.

Five years on and gilts would have seen a better return that that achieved due to the extra 0.75% charge:

NU Gilt Life (S4) data taken from Trustnet on 5^th Feb 2009. With Profits data taken from Norwich Union Information Sheet to Accompany PPFM January 2009 with 0.75% per year deducted from returns.

While I’m sure these policyholders don’t blame Aviva for the global financial crisis, they have every right to feel aggrieved about the risk and reward strategy adopted for them. Was the extra charge a method to increase returns for those policyholders or was it part of a strategy for improving efficiencies and therefore profits to shareholders through fund merger while also attempting to release some of the surplus in the CGNU fund for the benefit of shareholders?

Maybe the CGNU policyholders should be thanking the Norwich Union policyholders for creating the position where they can enjoy ‘Special Distributions’? Or maybe they should be cursing the outcome of reducing their slush fund as it seems that their fund is now not the healthy and robust fund it once was.

Whatever your opinion on the motives and actions taken, the whole process raises important questions about the attractiveness of With Profits as an investment. The extra charges that can be applied at will, the lack of control over how your fund is invested, the fact that shareholders can take 10% of the profit on your investment without seemingly ever bearing the brunt of financial risk because they simply increase charges, all adds up to With Profits being a deeply questionable investment vehicle for many savers.

For some, the guarantees make up for the disadvantages but if the guarantees on your own plan are negligible, is it really worth the shenanigans?

Be a Smooth Operator

Investors in With Profits Bonds should consider becoming ‘Smooth Operators’ and take advantage of the generous values being paid out to investors who ask for their money back.

“Our analysis shows that when markets are strong With Profits Bonds hold back returns so that when times are bad they can pay out more than they are actually worth” explained Miles Hendy, a Chartered Financial Planner at withprofitshealthcheck.com.

“This ‘smoothing’ primarily benefits those investors who cash-in their investment and the windfall they receive ultimately means less profits to share amongst those investors who stay invested and who have effectively subsidised the extra payout. It may feel counter-intuitive, but in the world of With Profits Bonds, a strong market downturn is a good time to take profits”

Fraser Heath Financial Management, the Bristol based Independent Financial Adviser that operates the withprofitshealthcheck.com website, analysed the past performance of five of the UK’s leading providers of With Profits Bonds and Distribution Bonds. When they averaged the overall mix of shares, property, bonds and cash held in the companies’ funds it was clear that there was little difference between the two types of investment product. With the same mix of assets and the same fund managers, this seemed to be a fair way to see exactly how well the With Profits Bonds were smoothing returns.

On 1^st November 2007, despite the onset of the credit crunch, investments had been enjoying strong returns for over four years. The average return of the Distribution Bonds was higher than the With Profits Bonds over 1 year (by 5%), 3 years (by 7%), 5 years (by 11%) and 10 years (by 19.5%).

However, by 1^st November 2008 investments had taken an almighty hammering and this turned the results upside down. This time the average return of the With Profits Bonds was higher than the Distribution Bonds over 1 year (by 6%), 3 years (by 9%), 5 years (by 16%) and 10 years (by 4%).

While the design of With Profits Bonds means that they should continue to hold back some returns in periods of strong growth and subsidise returns after a market correction, please note that the figures above refer to the past and that past performance is not a reliable indicator of future results.

“A ‘Smooth Operator’ could get the benefit of the extra payout available for surrendering their With Profits Bond when markets are low, re-invest in an alternative investment with a similar asset mix, and might consider buying another With Profits Bond when investment markets have recovered.” Miles explained.

Fraser Heath advise investors who are considering asking for their money back to consult an Independent Financial Adviser before doing so and would like to stress that this press release should in no way be considered a recommendation to sell.

Our withprofitshealthcheck.com website has a 32 page on-line guide to help investors make a decision about how to take full advantage of their With Profits Bond. We would be pleased to offer Independent Financial Advice to clients who contact us.

Markets were strong in November 2007 and Distribution Bonds pay back more to investors than those in With Profits Bonds:

But times are bad in November 2008 when the value of With Profits Bonds fall but protect investors more than those in Distribution Bonds:

For more details please visit www.withprofitshealthcheck.com

With Profits Prophets

Personal finance commentators seem to have the same problem analysing With Profits as football pundits have understanding Rafa Benitez's decisions. While football commentators struggle to understand why Rafa attacked Sir Alex, why he paid so much for Robbie Keane or why he substituted Gerrard mid-week, it seems some Independent Financial Advisers seem to equally stumble over the thoughts behind 0% bonus rates and Market Value Reductions.

There were two comments I read in the press over the past week from IFAs that left me questioning whether they had grasped some of the fundamentals of With Profits. Perhaps in providing soundbites to journalists some of the details were lost? The two comments were;


1/ A 0% bonus rate is even lower than cash

Well, yes, if you compare a With Profits bonus rate to a cash savings account then clearly 0% is lower, but the two can't be compared. That's because a With Profits policy usually has a guaranteed investment return already built in and the bonus rate is the icing on top.

For example, a With Profits endowment promises at outset to pay a Guaranteed Basic Sum plus all bonuses added at a future date. Back in the 80s when interest rates were double digit the insurance company might have set the Guaranteed Basic Sum with effectively a guaranteed rate of return of 6% per year. The extra bonuses then added on have might increased this guaranteed rate to around 9% per year. However, the performance of the With Profits fund, the shares, property, bonds and cash the fund owns, may have generated a return of only 7% per year for the time you've been saving in the fund. In order for the company to give you back a return that reflects your fair share of the growth it would be wrong to add more bonuses.

If you have a With Profits policy with a 0% bonus rate it may well be because you have some really good guarantees that you will benefit from when your saving plan ends. On the other hand, it may be that the rate is 0% because other policyholders have amazing guarantees and your low return is helping to pay these guarantees for others. You really need to check the guarantees if you have a bonus rate below 2%, and a good IFA can help you here.


2/ The current economic conditions have caused many insurers to place market value reductions (MVRs) on their funds, meaning it is not in the best interests of most clients to take action at present.

Just because there's a Market Value Reduction applying, it doesn't mean that you shouldn't ask for your money back. Even with a Market Value Reduction it could be that your savings plan is getting the benefit of smoothing that With Profits companies apply to protect savers who need their cash back after a severe market downturn. The Market Value Reduction is just the mechanism the company uses to make sure you get back your fair share of the fund rather than the conditional value that appears on your statement.

The conditions that may apply for you to get the higher conditional value usually include maturity, retirement, death, or in the case of a bond, a specified anniversary date. If you're close to being able to claim on any of those conditions then that's a good reason to hold firm. Otherwise, a Market Value Reduction is a valid reason to give your With Profits plan a health check.

For more details about checking the health of your policy, please visit www.withprofitshealthcheck.com.

"Gamble that leaves us without profits"

Comment on FT Personal Finance Article 23/01/09

In fairness to the writer, this article is more balanced than most articles I've read over the last week in connection with With Profits policies. For example it includes statistics that show that a decent With Profits fund has more than doubled the return of a UK Index Tracker over 20 years. As the title implies, however, the article focuses on the negatives and the returns of the worst performer.

In answering its own question about why there was so much variety in returns of With Profits compared to the variety of returns in UK Index Trackers, the article blames actuaries for how they set bonus levels when in fact the cause of the variety is down to a more straight forward explanation and is more honest than implied if it were simply down to the whim of actuaries.

Studies have shown that as much as 90% of the returns of an investment are determined by the mix of assets held. All the UK Index Trackers are in one type of asset only (shares of UK companies) and by their nature of aiming to track the FTSE index there really ought to be very litle variety of returns. By contrast a With Profits fund is typically invested in a wide-spread of assets (such as cash, commercial property, gilts, shares in companies in the UK and those of companies abroad). It follows that funds with multi-assets will show greater variety of returns in the peer group than funds all invested in the same asset.

With regards to the wide extremes of returns referred to in the article, it is important to note that the type of assets held in a With Profits fund can be influenced by factors other than those aimed at maximising returns. In particular, it is often the case that where a With Profits fund has in the past offered generous guarantees it needs to invest in more cautious assets in order to make sure it can deliver on those promises. This may be fine if your policy has those guarantees; not so fine if it doesn't because your potential returns will be restricted as a result.

I'd add that I can certainly relate to the experience described by one of the writer's colleagues of the apparent use of With Profits Bonds as an investment panacea for all clients. In my time working for two insurance companies as an Account Manager for regional and national IFA practices, I know that With Profits Bonds were sold as a core holding to many, many investors.

However, to explain away the reason for this high sales volume on commission is an over-simplification and only in part reflects my experience. It doesn't for example, explain why many IFAs who charge clients a fee and transact investments with all commission put back into the plan were recommending With Profits Bonds in the late nineties and early noughties, and why quite possibly some still continue to.

One of the perils facing all financial advisers is that we know time will be the judge of the quality of our advice. When choosing an adviser you can undertake all the due dilligence possible, get references, recommendations, check qualifications, have a fact-finding meeting and so on, but no matter how hard you look you won't find one with a working crystal ball. A good adviser will be highly qualified, invest a large proportion of time continuing to develop his or her knowledge of markets, trends and changes, undertake a detailed analysis of your financial position and your aspirations, explain recommendations simply and point out the risks, consequences and disadvantages of the recommendation. But the advice can only ever be based on what is known at the time. If advisers, fund managers, journalists and investors knew a year and a half ago (let alone 10 or 20 years ago) what we know today we'd have all done a few things differently...

Of course as time moves on, it's essential for advisers and investors to check that any recommended investment remains valid in the light of what we know now. That's why we set up www.withprofitshealthcheck.com

Norwich Union With Profits Announcement

I spent a little time this morning reviewing the news stories that appeared on Friday 16th January in connection with the Norwich Union annual With Profits announcement. Two things struck me.

The first was that journalist and adviser commentary seemed to reflect a sense of shock and disappointment that terminal bonus rates had been cut and annual bonus rates were coming down. I'm not so sure we should be up in arms about falling returns in With Profits funds. The funds invest in company shares, commercial property and corporate bonds, all of which took the biggest pounding for a generation in 2008. A With Profits fund cannot defy gravity.

The second point was that they all concentrated on the bad news story of lower returns rather than focus on the good news story tucked away in the middle of Norwich Union's press release. The good news is that With Profits funds have guarantees in certain situations, regardless of the value of the underlying invcestments in the fund, and that 33,000 With Profits Bond policyholders have a golden opportunity to take advantage of a 10 year guarantee during 2009. The guarantee in January is effectively a 16% one-off bonus, but only for those inestors who act on their 10th anniversary date. There's more information on this in the News section of our website www.withprofitshealthcheck.com.

If we assume that the average bond holder invested £10,000 10 years ago, each of these investors can claim an extra £2,171 if they act in time. 33,000 policies with a £2,171 windfall is a £71 million pound giveaway. But how many of these 33,000 bond holders will know about this feature or understand the implications when Norwich Union write to them about it? I think that's newsworthy.

One final point is that I raise my hat to Norwich Union for including this information in their press release. I'm sure they are relieved that so far the opportunity has not been spotted. It's a mark of the company's honesty and of their commitment to treat their customers fairly that they mentioned it.