Fears for unit-linked funds as watchdog launches review

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INVESTORS and pension savers have more than £800 billion sitting in unit-linked funds that are being investigated amid growing fears of potential consumer detriment.

Millions of people have money in the funds, which are used as the basis of pensions, savings, endowments and insurance policies. Around £815bn is invested in the funds, a figure set to soar even higher over the coming years as more workers are shifted into pension schemes under the automatic enrolment reforms that came into force in October.

The failure of unit-linked funds would pose a “high risk” to consumers, the 
Financial Services Authority (FSA) warned. The City watchdog last year expressed concerns that some insurers were falling short of expected standards in their governance of unit-linked funds. The issues could lead to people having savings in funds that are too risky for them, it said, raising the prospect of serious consumer detriment.

Now it has launched a review of the sector that will investigate whether insurers are managing unit-linked funds fairly and in line with consumer expectations.

“Due to the size and importance of this sector, any failures pose a high risk to our statutory objectives, particularly the protection of consumers,” said the regulator’s latest insurance newsletter.

Its study, to be published in the autumn, will check that insurers are calculating policyholder benefits accurately and fairly. It’ll also look at whether the underlying assets in unit-linked funds are suitable for policyholders, reflecting its concerns over consumer understanding of what they’re actually investing in.

Iain Wishart, owner of Wishart Wealth Management in Edinburgh, said transparency is a real problem in the unit-linked sector. “Some insurers have created what are known as ‘mirror funds’ – the investor thinks they are buying a specific fund and manager, yet in reality their life fund as part of, say, a capital investment bond performance may well trail far behind the actual unit trust they thought they were buying.”

The other risk to consumers is that many unit-linked products are managed funds in which money is left invested regardless of performance, according to Barry O’Neill, investment director at Carbon Financial Partners in Aberdeen.

“As the life assurance companies don’t have to try too hard to attract or retain this money due to investor apathy, the performance can be very poor. The other issue with managed funds in general is that most investors don’t properly understand the nature of the risks they are taking.”

Such funds can have up to 85 per cent of their money invested in shares, O’Neill pointed out.

“There’s nothing inherently wrong with that, provided you understand and accept the potential downside risks involved, but many investors don’t and get a nasty surprise when stock markets fall,” he said.

Wishart called on the FSA also to look at the charges levied by unit-linked funds, which, unlike unit trusts and open-ended investment companies, don’t have to disclose their total expense ratio.

The FSA’s probe was launched a day after it kicked off an investigation into the £11bn-a-year pension annuity market. It will seek evidence that people are losing out by not shopping around for an annuity at retirement and look at whether savers are being short-changed by particular pension providers.