Penalties complicate the picture on with-profits

The Edinburgh-based group is freezing regular bonuses despite last year's market recovery, although it said most customers would see some increase in their plan values, owing to final bonus payments.

With-profits policies hold back investment growth in benign markets to bolster returns when they are more volatile, and are used as the basis of pensions, savings and mortgage endowments. However some Standard Life investors will receive lower payouts than they would have a year ago. A 200 a month with-profits pension plan taken out in 1990, for example, would have a maturity value now of 82,301, over 10,000 down on the level at maturity two years ago.

Of its 1.2 million with-profits customers, half hold endowments. Around 75,000 are set to mature this year, including 46,000 mortgage endowments, but most are expected to fall short of the amount required to pay off the home loans. Yet Standard Life is one of the more consistent with-profits providers and was also able to announce a drop in the penalties levied on customers leaving the fund.

Other investors will not be so fortunate, and the gulf between the best and worst funds continues to widen. While the likes of Prudential and Wesleyan have continued to reward investors with generally decent performance, providers including Scottish Widows and Friends Provident have not. Then there are the "closed" with-profits funds run by the likes of Pearl and Axa Sunlife, producing dismal returns.

Iain Wishart, owner of Wishart Wealth Management in Edinburgh, said that while many with-profits investors are pessimistic about the outcome, some have unrealistic expectations.

"Many remain in blissful ignorance of the reality as insurance companies often quote maturity projections of 4, 6 and 8 per cent on life funds and 5, 7 and 9 per cent on pensions, hiding the reality of low or no bonus rates from the consumer."

As the performance of with-profits has declined, their popularity has nosedived and millions have cashed in their policies. Yet more than ten million investors still have a with-profits policy. If you're one of them, what do you do when faced with sinking policy values or a potential shortfall?

SHOULD I STAY OR SHOULD I GO?

The temptation for those disappointed by returns or concerned about the prospect of a potential shortfall is to cut their losses. But there are important factors to take into consideration first, such as the penalty charge for early surrender, how long you have left on the policy and any guarantees it carries.

The first port of call is to find out exactly how much your policy is worth and to get an estimated value at maturity. This would include any regular and final bonuses due and, crucially, any penalties charged for getting out early. Getting an idea of the eventual value is particularly relevant for policyholders with targets to meet, such as those with endowment mortgages.

But getting out is far from straightforward, thanks mainly to the penalties for surrendering policies before maturity, known as market value reductions (MVRs).

Patrick Connolly, head of communications at Chase de Vere, said: "If you are close to the maturity date then it is probably sensible to retain the policy if there are exit penalties for surrendering. Many with-profits policies still have an MVR in force, and in some instances these can be as high as 20 per cent."

Some policies include a date at which you can surrender without an exit penalty, such as on the tenth anniversary of taking out the policy. Ian Morrison, financial planning consultant at Lift-Financial, cautioned: "My experience has been that the providers who offer this service do not generally advertise this option readily, so check your policy."

Some policies are worth retaining for the guarantees they include. For example, certain contracts carry guaranteed annuity rates far more generous than any available on the open market. Others will have benefits including guaranteed growth rates.

If you're considering staying put in the hope of getting decent returns it's worth looking at the financial strength of your provider and how their fund is invested. The most consistent providers are typically those with sufficient financial strength to remain sufficiently invested in higher risk assets including equities.

For example, Wesleyan holds around 64 per cent of its assets in equities, according to Money Management. The next biggest equity proportions are 38.3 per cent, at Scottish Widows, and 38.2 per cent at Prudential. The part of Standard Life's with-profits fund on which mortgage endowment and non-unitised pension bonuses are based holds just under a third in equities, but some providers have reduced their equity exposure to single figures.

But the lack of transparency in with-profits makes it virtually impossible to judge potential returns, Morrison noted: "Unless there exists a guarantee, the annual return, the terminal bonus, and the option of MVRs being applied lie solely at the discretion of the provider."

RETURNS

Average return over five years in with-profits life sector – 14 per cent

Best returns five years – NFU Mutual Avon Bonus – 33.1 per cent

Best Returns one year – Winterthur Life UWP (Shadow) – 17.1 per cent

Worst Returns five years – Phoenix Life Alba, Scottish Widows Assurance, Winterthur Life – 0 per cent

Source: Trustnet