Darth Vadar - The Real Face of With-Profits

When you are assessing your with-profits policy, keep in mind that if you take off its mask, you may be surprised with what appears underneath.

The unmasked with-profits, the real value of your investment, is what matters. The shiny, black and sleek exterior is just for show, except in certain circumstances. The secret to understanding your investment lies in realising that it's what's underneath that determines your investment return. Only then will you realise your plan's growth potential and learn to evaluate whether the guarantees are valuable. Only then will the force be with you.

Owners of Aviva With Profits Bonds can unmask their with-profits plan by reading our free Aviva Aluminium Report on the value of the 10th anniversary guarantee.

How many millions will be lost before the message gets through?

It should have been a fine day today. I woke up and was delighted to discover that my expose of Aviva's questionable stance on communicating their 10th anniversary guarantee on With Profits Bonds had made the front page of Professional Adviser. I had finished my Aviva Aluminium Report the night before and was pleased with the way it explained why policyholders only gain from their 10th anniversary guarantee if they switch out or cash-in. And I was enthused at the prospect of spreading Professional Adviser's discovery to personal finance journalists - a message that could finally wake everyone up to potentially the biggest missed opportunity by policyholders, the media and financial advisers ever.

But on leaving the office after 7pm, I felt dejected that not one personal finance journalist had even acknowledged receipt. I have an image of my geography teacher a few months prior to my O Levels telling the class he felt like someone shouting at passing cars that the bridge they were heading for had collapsed. Every day there are thousands of policyholders driving past those people capable of shouting loudly to the point of no return at full speed oblivious of the thousands of pounds they are losing as a result. There's nothing we can do for the tens of thousands who have gone over the edge already but there are hundreds of thousands more that we can still save over the next year or so. But with thousands falling daily I lament every day that passes with my screaming hoarse voice unheard.

And it's not just my geography teacher haunting me tonight. I recall with great clarity a conversation ten years ago with the chief actuary of the company I worked for, explaining that the with-profits fund had to reserve for the guarantees that they had committed to even though over half of those guarantees are never taken up. I suspect that nowadays most advisers and policyholders fully appreciate the value of Guaranteed Annuity Rates, but I suspect that many still don't evaluate guaranteed sums at maturity, guaranteed bonus rates, and particularly 10th anniversary With Profits Bond guarantees and that over half are wasted.

His words haunt me because I know they were pivotal to my career change and decision to set up With Profits Health Check. Knowing that I can explain the value of policies to with-profits policyholders I felt sure I could help them avoid wasting their money. And while I've achieved that with clients who have approached me through with profits health check, I know I'm still just scratching at the surface.

What was Professional Adviser's discovery, you ask? The message that might finally get more people waving at the edge of the road and catching the eye of policyholders otherwise destined for the point of no return?

Well, like a great movie, they were the quiet words said against the backdrop of white noise and mayhem. Not the words in the headlines or the posturing, but the words tucked away near the end of the article. Spoken by Aviva's Richard Kelsall, they simply said

"...we should fully expect customers to switch out of with-profits..."

You may have grasped it but I suspect you may still be wondering why I think those words should be the catalyst for getting the media to start waving vociferously at cars heading for the edge. And it's this. When the man who is writing the cheques says he should be writing you a cheque, you probably ought to think he has a point.

Until now, all we have heard is the white noise. We hear IFAs looking like spivs with watches in the inside of their coats telling people how bad with-profits is and the 10th anniversary is a chance "to get out of jail free." If I'm reading these words as a policyholder worn down by a complete mistrust of the financial services system I would be sceptical of the story, particularly if I didn't understand what my With Profits Bond was really worth.

But finally, Professional Adviser cornered Aviva and got them to admit that even they were advising policyholders to switch out and capitalise on this 10th anniversary guarantee. Let's not underestimate that admission. If these policyholders bank their guarantees we calculate that Aviva shareholders will end up paying out over £500 million!

And Aviva CGNU was just one of 16 insurance companies offering these guarantees. The sheer size of these guarantees is difficult to comprehend. I think we're talking about about billions of pounds that are up for grabs but only if eligible policyholders ask for their money back while the guarantee still applies.

Someone surely has to help get this message over before too many more fall over the edge...

With Profits Bonds in Plain English

This week Aviva stated that they expect future With Profits Bond sales to come from direct marketing and affinity groups rather than through Independent Financial Advisers. As many IFAs have pointed out in various discussion on this news, its popularity amongst IFAs has waned for many reasons including its complexity and lack of transparency. In an effort to try and make it more transparent for someone thinking about investing in a With Profits Bond, I think that a truthful description of a With Profits Bond might read as follows;

* Your money is invested in a managed fund and what you get back depends on the performance of that managed fund.

* If you ask for a valuation when the value of your managed fund has fallen, we'll pretend it's actually risen in value so you feel better about it.

* If you actually want your money back, however, that's when we'll tell you what it's really worth.

* The pretend value assumes that you've had a nice steady return on the whole sum you invested. But when you think about it, that would be nonsense. How can we pay 7% to your salesman and your money still be worth the same you put in? It's laughable when you think about it, ha! ha! No, if you actually want your money back then obviously for you to get the pretend value not only does the managed fund have to have performed well but it's got to cover all those charges too.

* The assets in the managed fund will not be optimised to generate the best investment returns. Instead, we'll manage the fund so that when stock market values fall and we get nervous about the guarantees we've made to previous policyholders, we'll sell lots of shares because they may fall further. Only when values of shares have picked back up will we have the confidence to increase the allocation to shares at which point you'll not have fully participated in the rally like a normal managed fund would have.

* We should point out that if markets fall for a sustained period and the guarantees we've made to other policyholders are significant then the managed fund may turn into a fixed interest fund. The long term growth prospects and efficiency of this investment will be compromised for you and bare no resemblance to the investment you thought you were making, but at least all the other policyholders will be ok, that's the main thing.

* Oh, and about those guarantees. They're great if you die at a time when your managed fund is worth less than we pretended it was. Your relatives can then get the pretend value. Other than death, well, we've been stung for offering guarantees to other policyholders in the past so we're a bit stingy in that regard nowadays.

* Please also note that when we say "with profits" we also mean "with losses". The losses include things like paying fines for misselling previous policies. We know what you're thinking: if the shareholders benefitted from the misselling, why don't they pay the fines, right? Ha! Ha! Well, we can see what you're saying and the Finnacial Services Authority looked at that last year but we successfully lobbied them that this would be retrospective so we can still pay future fines for past misselling out of the fund and your return will suffer if we do.

Why don't they make a sales aid with these points on I wonder?

With Profits' Malaise: The Cause and Effect

Although with-profits has been around for 200 years it's only since the 1960s that the funds started investing in equities. At that time they could look back on high inflation and high stock market returns in the fifties and see the gain to be had. This served policyholders well right up to the mid to late 80s as inflation and investment returns stayed high. And that's ultimately the cause of its downfall.

Against this backdrop of double digit stock market returns, how were actuaries supposed to know the full extent of what was going to happen over the next twenty years? I read one high profile IFA call with-profits a rip-off last week but that implies some form of deception which I don't believe was there. (If it was a rip-off, the company he works for were not only complicit but were the major beneficiary of the con.) Insurance companies thought it was prudent to offer guaranteed annuity rates at levels that are now worth twice the open market rate. They thought it was cautious to offer a guaranteed basic sum on maturity that required an annualised return of 6% per year. They thought a guaranteed bonus rate of 4% was playing it safe.

It's these guarantees set in a time when no one dreamt of the prospects of almost 0% interest rates that have caused the problem, and not, in my opinion, reckless marketing. For sure, over-payment of terminal bonuses as a competitive tool in the 80s and 90s, using the Inherited Estate to buy group stakeholder pension business and acts like paying special bonuses to ease through a reattribution to shareholders have exacerbated its problems, but ultimately they simply promised too much at a time when they thought they were doing anything but being generous.

It's these guarantees that have led to financial strength problems and the reduction of risk assets in even the strongest with-profits funds (Prudential's with-profits fund's last stated equity exposure is just 39%). A reduction of risk assets means a reduction in reward prospects.

The critical issue that the media and financial advisers must address urgently with policyholders in with-profits funds is not the opacity, the misselling fines, or the inherent conflict of interest in the funds. It's simply to work out the value of their guarantee.

In other words, if we know that by cashing the plan in that the policyholder would need to generate an 8% per year return net of charges and tax in an alternative plan to match the guarantee promised if he stays, then it simply doesn't matter what the asset mix is or the financial strength or anything else. They are the lucky ones who bought policies that led to the problem.

But for policyholders who don't have valuable guarantees then all of these factors matter.

My fear is that the cause of with-profits' malaise, these wonderful guarantees, will unwittingly be discarded by people who hear the bad news about with-profits and assume the problem applies to all policyholders.

Notes:
I posted a version of my article above originally on www.ifalife.com.
The source for the data that I used in my graph was www.finfacts.com and www.statistics.gov.uk.