Don’t bury with-profit funds yet, investors warned

Thousands of investors north of the Border hold with-profits endowments, pensions and savings worth millions, including policies in so-called “zombie” funds no longer open to new investments.

More than 20 million with-profits plans worth some £330 billion remain in force despite dwindling sales and poor performance that has prompted countless investors to cash in their investments before maturity

Yet those policies often contain pension income guarantees that are becoming more attractive as annuity rates plunge to new lows. And with millions of policies approaching maturity, advisers say those caving in to the temptation to ditch the investments could pay a handsome price over the long-term.

With-profits plans are used as the basis of pensions, savings and mortgage endowments. The model is based on what’s called “smoothing” – holding back investment growth in benign conditions markets to bolster returns in more volatile times.

The boom period for with-profits was in the late 1980s and early 1990s – which means a huge number of 20 and 25-year policies are either at or approaching maturity.

The diminished popularity of with-profits means millions of people have their money tied up in funds that are now closed to new money – with mixed results for those whose investments are now run by firms with no  incentive to attract new business.

Unhindered by the need to post eye-catching returns, many of these closed vehicles – often called “zombie funds” – invest primarily in low-risk, low-growth assets. The biggest closed fund operator is Glasgow-based Phoenix, with six million policyholders who originally took out their plans with insurers including Scottish Mutual, Alba Life, Britannic, Pearl, Royal & Sun Alliance and NPI.

Performance varies between different funds and legacy brands. But some Phoenix endowment holders have seen growth averaging less than 3 per cent a year over 25 years, its figures show.

A 65-year-old man investing £20 a month for 20 years with National Provident (now part of Phoenix) has seen his policy plunge in value by almost half since 2006, according to 2011 research by Money Management magazine.

Tom Munro, director of Tom Munro Financial Solutions, said: “There’s little incentive for fund managers of closed funds to seek out higher returns favouring to protect assets by investing in lower-risk assets suiting those close to maturity, but leaving longer-term investors locked in to a fund that’s producing mediocre returns.”

Phoenix is hamstrung by the performance of the funds prior to its ownership of them, according to a spokeswoman for the group.

“They closed for a reason, because the performance was poor. This means that our funds are unlikely to be table toppers now and in the future. However, what policyholders get from us is security and a promise that their guarantees will be paid out,“ she said.

Closed funds aren’t alone in focusing on low risk assets at the expense of long-term growth, leaving investors with shortfalls. That spells shortfalls for huge numbers of investors, including those with endowments who had intended to use their plan proceeds to repay their mortgages.

Mark Thornton-Smith, financial planner at Edinburgh-based Cornerstone Asset Management, said: “A decade of market volatility has led to disappointing with-profits bonus rates and now many people are finding that their mortgage repayment vehicle will fall short of its target.”

If you’re among those facing a shortfall you’ve doubtless wondered if it’s worth cashing in your policy and finding a more suitable investment. Surrendering isn’t always the answer, however, for various reasons.

One is the penalty charged for transferring out prematurely, in the shape of the market value reduction (MVR). The number of firms applying these, and the scale of the charges, has fallen over the past two years, while some policies will have a date after which they are MVR-free. Where there is an MVR, however, it may be hefty enough to make it worth hanging on to maturity, according to Thornton-Smith.

“The penalty for surrendering early could be up to 20 per cent and it’s very unlikely to be applicable at maturity, so if the plan is not far from maturity this adds to the argument for keeping hold of it.”

Then there are the generous annuity guarantees to be found in some older-profits policies. The rates paid by annuities have plunged to new record lows this year, thanks partly to the effect on gilts of quantitative easing. The drop has cost millions of people valuable income in retirement, but some older with-profits policies have guaranteed rates far above the current level, while some offer annual increases of up to 4 per cent.

Around a fifth of the policyholders with Phoenix have annuity guarantees. Some Pearl customers hold pension contracts with guaranteed annuity rates of up to 31 per cent higher than the current average, for example, while there are instances of rates 50 per cent above those available on the open market.

Alternatively, scrutiny of your policy paperwork may reveal that it promises a guaranteed minimum growth rate or a guaranteed minimum fund value. Again, such guarantees are usually on older, traditional with-profits plans, Thornton-Smith noted.

“Even if there is no guaranteed growth rate many modern ‘unit-linked’ endowment plans will at least guarantee that the unit price will not fall, which again offers some peace of mind, even if the upside potential of the investment is limited,” he said.

But while such benefits could settle the argument in favour of sticking with your investment, they may well be buried deep in the policy documents.

If you’re considering your options, it could pay to do your homework.

First dust off any old policy documents and check the terms and conditions for possible benefits and guarantees.

Also, read your most recent statements, which will tell you the current surrender value of the policy. This includes the current value of all the annual bonuses added to date, plus the current value of the terminal (or final) bonus, although it’s often, unhelpfully, given as a projection of their value at maturity.

Independent financial advice is highly recommended when working out what to do with your with-profits plan. If you do decide to surrender, an adviser is also best placed to put together an alternative investment.

CHECK THE SMALL PRINT

What to do when you get your annual with-profits statement: Read it thoroughly and check you understand every section. Many statements include a glossary of terms to explain the wording used. Remember why you took the policy out:

• If your policy is an endowment, was the maturity payment to cover a specific purpose such as repayment of a mortgage?

• If it’s a pension policy, look at the projected pension payment on retirement and see if it covers your retirement needs.

• If the policy no longer meets your needs, have you made additional provisions such as changing your mortgage into a repayment one or increasing your pension contributions/made other financial arrangements for your retirement?

If you are thinking of surrendering your endowment policy or moving your pension:

• Contact your provider for a projection to see what your policy might be worth at retirement or maturity.

• Check you don’t have valuable guarantees in place such as maturity guarantees, guaranteed annuity rates and market value reduction (MVR) free dates, which only pay out once the policy matures or when it is converted into an annuity.

• You may also have the opportunity for a good final/ terminal bonus. For many policies, the bonus at the end could be considerable and could be worth hanging on for this.

Check if the policy includes life cover. The policy could include a valuable life insurance benefit which would be lost if the policy is cancelled. This is particularly important for consumers in poor health who may struggle to get a new life insurance policy elsewhere.

Does the policy have an MVR-free date? Some policies have these built into the terms and conditions which means they can be cashed in without having to pay an MVR.

Are there any tax implications which will reduce the amount you receive on surrender? As an alternative, find out if you can leave the policy paid up where you don’t pay any more premiums but it remains invested in the fund and some life insurance benefits are received. Or consider selling it to a “second-hand” market maker.

Make sure your personal details such as name and address are up to date so the insurance firm can let you know when the policy matures and provide essential information about the policy. Don’t forget to inform your insurance firm when you move home.

If you haven’t received a statement for some time, contact your provider – it may be that they don’t have your most recent details.

If you have any questions about your statement, speak to the provider and preferably seek independent financial advice.

Source: Phoenix Group