Amid everything else being thrown at us at the moment – the retail distribution review, Mifid, platform justification and so on – it is easy to forget that we are actually here to do business.
Current commentary would have it that we are not supposed to be product orientated but we must nevertheless consider products, including those legacies from the past. Some of these legacies are poisoned chalices, not least with-profits.
There is something approaching £400bn still invested in this particular asset class, including significant amounts in closed life funds. It is hardly surprising that the FSA is taking an avid interest but, as usual, mixed messages are coming through.
IFAs are quite rightly being urged to help their clients by advising on existing with-profits investments but we are also warned that this is an extraordinarily complicated topic and those who advise on it had better be up to speed or incur the wrath of the regulator, let alone compensation claims from the client.
Those of us who are not actuaries are hugely indebted to people like life industry analyst Ned Cazalet who have helped us see through the fog from time to time. Unfortunately, it seems that life offices are only too happy to stir the broth of confusion and, dare I say it, it has been in their interests to make things look so complicated that only the bravest or foolhardiest of IFAs will tackle the subject.
I know I am not alone in finding this state of affairs extremely irritating but, being one who has often gone where angels fear to tread, I will risk the regulatory flying squad and offer my own insights on the topic. I confess that I am not one of the IFA gurus and there are those much better qualified than I to navigate these murky waters. However, I like to think that I am able to apply a measure of common sense.
To misquote a phrase from philosopher George Santayana: “Those who do not learn from history are forced to relive it.”
In the middle of the Equitable Life crisis, I recall the regulator issuing dark threats lest IFAs dare to take clients out of its with-profits fund. At the time, either bravely or foolishly, I ignored these strictures and repatriated funds as quickly as possible. The outcome was that I saved my clients an absolute fortune, not to mention years of heartache, as we got out while the going was good.
Another well known life office has always included terminal bonuses in annual valuations for with-profits pension funds. When the going got tough, these terminal bonuses were diminished to make current bonuses look halfway decent.
One particular client with big with-profits funds saw as much as £90,000 wiped off the value of his pension between December 2003 and July 2005. In 2006, after much pleading, we persuaded this client to bite the bullet and transfer out into cash. Incredibly, he then received letters from this insurance company trying to override the advice provided.
In the end, the client did transfer and saved about £12,000 into the bargain, as this was the amount of money he would have lost in bonuses if he had remained in the fund during 2006. Heaven knows what would have happened since.
With any with-profits investment, there are some fundamental questions that IFAs should be asking on behalf of their clients:
Will the client lose any life cover?
If you are in good health, you can probably get term insurance cheaper and better.
Are there any MVAs or surrender penalties?
In the view of many IFAs, some life offices which still apply market value adjustments are a long way short of treating their customers fairly. Other big life offices have done away with MVAs years ago.
Why is the client in with-profits?
The probable answer is because they are a low-risk or even reluctant investor. So what other investments should you compare with-profits against in this case? Today it is a no-brainer – you compare with-profits against cash.
You can currently get a return of 6 per cent gross from a cash fund. I will let you do the arithmetic for higher and lower-rate tax. Which with-profits funds offer bonus rates better than this? Not many. Even when interest rates were lower, few with-profits bonuses were better.
What is the bonus rate?
Some life offices are actually paying zero bonuses.
If there is a penalty, how big is it?
How long does your client have to be getting 6 per cent gross from cash to make up the MVA and is that acceptable to them?
How much can your client withdraw each year before a penalty is imposed?
Say your client withdraws the maximum amount and puts it in a high-interest account. You can then calculate the diminishing with-profits fund, increasing cash account, plus the interest and bonuses accrued until the with-profits fund is depleted. What are the results? It’s arithmetic, not rocket science.
Obviously, if your client suddenly becomes more risk tolerant and is prepared to accept the risks implicit in equity investments, then the whole ball game changes.
In conclusion, it is understandable that the regulator wants clients to be advised on with-profits. It is understandable that it is concerned in case clients are ripped off or churned. However, I think clients are being held hostage by the life companies which are harping on about complexity when this may not be entirely relevant.
If you can show that you have addressed the basic points and that the conclusion will impact positively on the client’s pocket, rather than dwelling on the arcane and opaque workings of with-profits, then I cannot see you being hauled off to the Tower in chains, particularly if the proceeds from with-profits fund find themselves in a good cash account.