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A greater understanding

Over the last couple of years, with-profits has come in for a great deal of criticism. Initially, much of the criticism focused on discretion, transparency and governance issues.

The FSA, Sandler and the industry generally have been busy dealing with these issues and today, as I write, the FSA has released consultation paper 167 which deals with a lot of them.

More recently, though, a new wave of criticism has emerged. This time, targets have included falling bonus rates and the application of MVRs.

Such has been the level of criticism that many policyholders may be losing sight of the positive returns that with-profits have brought them (and will continue to bring them) over the medium to long term. After all, this is what counts for a medium to long-term investment such as with-profits.

MVRs

There remains a lack of consumer understanding of MVRs. They are not welcomed by providers, policyholders nor IFAs but they are a necessary evil in the interest of fairness to all policyholders.

MVRs are applied to avoid paying claim values to surrendering policyholders that are significantly in excess of the value of their share of the und-erlying assets. Failure to do so would undoubtedly impact on the investment return to continuing policyholders.

MVRs are applied to ensure that all policyholders get a fair share of the with-profits fund. They ensure other investors cashing in their bonds do not adversely affect the values of individual policyholders continuing to invest in the fund.

From the provider&#39s point of view, it is worth remembering that providers do not relish applying MVRs. Applying MVRs results in negative publicity for the provider and the with-profits industry generally. At the end of the day, however, providers have a duty to act in the interests of all their policyholders.

Bonus rates

A second criticism, which is likely to gather pace as we enter the traditional bonus rate season, is falling (annual) bonus rates. Many providers have been criticised on these grounds in the last year or so.

Annual bonus rates have been reduced gradually over the last few years in line with declining inflation and the associated reduction in expected future investment returns. Final bonuses continue to be set to give smoothed claim values that reflect the achieved investment returns.

The amounts of bonuses allocated to policyholders depend mainly on the investment returns achieved on the assets in the with-profits fund. Investment returns were very favourable during the 1980s and, to a lesser extent, during the 1990s and these good investment returns have been reflected in the claim values of maturing policies.

However, these high investment returns were, in part, a reflection of the high inflation rates seen in the past, which are now much lower.

Many criteria are considered when setting the annual bonus level. They include financial security, underlying assets, competitiveness, affordability, reasonable value for money, fair and equal treatment of all policyholders and smoothing.

Quite understandably, given the prominence of annual bonus rates, policyholders might be losing sight of the fact that the annual bonus is only part of the return they get. Final bonuses are then to be added to (the majority of) policies. The focus on annual bonus rates (which are after all, short term) could cause policyholders to forget the very positive returns earned from their with-profits policy over the duration (medium to long term) of their policy.

The opinion of many policyholders will undoubtedly be influenced by what they read in the press, see on the TV and hear from family and friends. Unfortunately, MVR and bonus cuts make headline financial news unlike many falls in other investment vehicles, for example, individual unit-linked funds and unit trusts.

This is understandable given the size of the funds and the significant number of people invested in any one withprofits fund but it is potentially misleading for investors who hear a disproportionate amount of negative press about with-profits.

Summary

No one should be allowed to forget that there is a lot to commend with-profits. The with-profits proposition is unch-anged – investment in a managed fund containing a diversified mix of assets, with smoothing of returns. The industry, however, has a very real challenge ahead to reassure investors and remind them of the potential benefits of with-profits.

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