Jeff Salway: Will your investment pay peanuts?

The UK’s insurers are unveiling details of the annual and final bonuses to be paid on their with-profits policies, showing what the performance of their with-profits fund over the past 12 months means for pensions, endowments and investments.

Edinburgh-based Standard Life was one of the first big providers to publish its results, offering something of a mixed bag for policyholders. It revealed that it was cutting bonus rates and reducing payouts for thousands of investors even after its with-profits fund grew almost 8 per cent in 2012.

And that picture is indicative of things to come, experts believe, leaving investors asking whether they’d be better off just cashing in their policies.

Many people have already done so in recent years as the appeal of with-profits has diminished along with the returns. Yet more than £330 billion remains invested in some 20 million with-profits policies. Standard Life alone still has 1.4 millions with-profits customers. They include 800,000 people with pensions policies, 550,000 with endowments and almost 60,000 holding with-profits bonds.

While some have seen an improvement in payouts, around 600,000 have seen their bonuses slashed.

Someone with a pension policy maturing after 20 years would now get a payout of £77,703, down sharply from the £92,735 had it matured five years ago, the latest figures show. Similarly, a £50 a month endowment maturing after 25 years would be worth almost £10,000 less than the equivalent policy maturing in 2008.

The insurer admitted that 98 per cent of customers holding with-profits endowments are likely to suffer shortfalls.

So why are investors getting less back even when the underlying fund has benefited from more buoyant markets? The problem is that with-profits products are based on smoothing. This refers to the practice of holding back some of the gains in good years to offset losses incurred during more turbulent periods.

But it no longer works effectively, according to Carl Melvin, director and chartered financial planner at Affluent Financial Planning in Paisley.

As with-profits providers now hold more low-risk assets (such as bonds) than equities, – due partly to regulatory demands – the flaws in the product have become all too apparent.

“With-profits funds have low equity and high gilt and bond content and those ‘low-risk’ assets pay lower returns in the long term,” said Melvin. “The strong performance of UK gilts has helped but gilt values cannot defy gravity and when the gilt correction comes, what then for with-profits funds?”

Patrick Connolly, certified financial planner at AWD Chase de Vere, expects other providers to follow Standard Life’s lead.

“In 2012, all of the major investment asset classes rose in value and so as a result all with-profits funds should have made a positive return over the course of the year. But it is unlikely that strong underlying performance will be directly translated into bigger bonuses and higher payouts,” he said.

Before you decide to offload your with-profits policy, however, check there’s not a very good reason to keep hold of it.

One is that, even now, there’s a marked difference between the performance of the best and worst providers. Prudential, LV= (formerly Liverpool Victoria) and Aviva tend to be the strongest providers. The worst are usually, but far from exclusively, drawn from the growing pool of closed funds, which don’t need to attract new business.

For example, someone holding a £200 a month, 20-year pensions policy with Prudential last year received a payout of £87,978 on maturity. The equivalent investment with Scottish Widows paid out just £70,086.

It’s a similar story when we turn to endowments. Prudential last year paid out £33,679 on the typical £50 a month, 25-year endowment policy, compared with the £28,439 paid out by Standard Life and £28,071 by Scottish Widows.

The latter two have cut their endowment payouts this year to £27,791 and £25,432 respectively. Prudential is to publish its latest figures at the end of February.

But closed funds are likely to account for the bulk of the worst returns, said Melvin. They are the books run by consolidators including Glasgow-based Phoenix Life, which has six million customers with policies that had been bought with providers such as Pearl, Alba Life, Scottish Mutual and National Provident.

Some endowment holders now under the wing of Phoenix have suffered average annualised over 25 years of less than 3 per cent. With poor returns resulting to some extent from the historic performance of the funds, the blame can be laid partly at the door of the legacy providers. Not entirely though, Melvin claimed. “Closed funds are absolutely the worst place to be. If you are closed to new business you are, by definition, not available for new investment so your performance is not going to be scrutinised by an investor or IFA as it otherwise would,” he said.

Even then, however, investors should do their homework before ditching their policies. There could well be penalties for cashing in prematurely, while the policy may have valuable guarantees, such as guaranteed annuity rates.

It is important that with-profits investors don’t make any rash decisions,” said Connolly. “While bonus rates and payouts might still be falling there could still be a number of reasons why people should retain their existing policies.

“If they are in doubt, policyholders should speak with an independent financial adviser.”

PENALTIES

Most with-profits funds levy early exit penalties, called market value reductions. They are generally lower now than a decade ago and some insurers no longer impose them, while most with-profits bonds are MVR-free after the first 10 years. Some policies have a date at which they can be cashed in without penalty.But they can still eat significantly into the investment where they do exist, and the difference may make it worth hanging on until maturity. This is where independent financial advice is a smart investment.

WHAT’S IT WORTH?

It won’t be clear until maturity how much you’ve ultimately got to show for your investment. The current value of your policy, before maturity, is expressed in the surrender value. This includes the annual bonuses to date and the current value of the terminal bonus. Insurers often make matters more complicated by expressing bonuses as a projection of their value at maturity and not as a current value.

DOES IT HAVE GUARANTEES?

Some with-profits policies provide guaranteed maturity values, minimum bonus rates and guaranteed annuity rates. With annuity rates falling and life expectancy rising, the last is increasingly valuable. Some people with old Pearl policies – now run by Phoenix – have guaranteed annuity rates more than a third higher than the current average. Many policies will also include valuable life insurance, so make sure you know exactly what you’re sacrificing before surrendering your investment.

WILL MY INVESTMENT IMPROVE? As explained in the main article on this page, some providers are far better than others. The top performers are generally those with the greatest financial strength, as they have sufficient capital to support being invested in higher growth assets such as equities. The proportion of the average with-profits fund that was invested in equities halved to just 33 per cent over the seven years to 2010. Find out about your provider’s financial strength and the fund’s equity ratio.