As you climb aboard the world's most luxurious liner for that trip of a lifetime, you turn round for one last wave before departing for the sunshine. Suddenly, something catches your eye. There are no lifeboats on this magnificent vessel.
Do you stay on board and spend the whole journey praying that the ship will not hit an iceberg or do you disembark? Of course, you would take the latter option so why do so many clients build pension funds that have no lifeboats?
Small self-administered schemes and self-invested personal pensions allow considerable investment flexibility, so clients can even invest part of their pension fund in their own business. As this obviously increases risk levels, it must be balanced to some extent by investments which offer total security.
IFAs are now in a dilemma. They need to offer real guarantees to underpin riskier investments while not losing all the benefits of performance. So IFAs are turning increasingly to a traditional source of investment guarantees. Traded endowment policies are one of the few remaining ways to invest in traditional with-profits funds, which carry such high guarantees that many life offices have removed them from sale for new business. Traditional with-profits has been replaced with alternatives such as unitised or synthetic with-profits, where the guarantees pale in comparison.
On the face of it, the fall in bonus rates over the last few years would rule out with-profits from many investment recommendations. You certainly might be sceptical if your policy is trying to repay a mortgage on a fixed date or if you have suffered an unexpected market value adjuster on a with-profits bond.
The Tep is a strange animal, though. Falling bonus rates have had a number of benefits for buyers of Teps. Falling bonus rates mean falling purchase prices. A typical Standard Life policy will cost about a third less today than it would have done a year ago. While prices have been falling, the value of the guarantees within policies has continued to rise. These are real guarantees from annual bonuses that, once added, cannot be removed or reduced.
This combination of falling prices and rising guaranteed values means that many Teps offer full capital protection to the investor. With policy guarantees (sum assured and accrued bonuses) exceeding the cost of buying the policy (purchase price and all future premiums), the risk of investment downside is removed.
The guarantees are as strong as cash deposits but the investor also enjoys the prospect of investment growth above cash returns.
Recent bonus rate cuts mean the strongest with-profits funds are close to or at equilibrium and paying out close to what they are earning. Life offices will use the first phase of investment recovery to rebuild depleted reserves. Medium to long-term investors – the typical pension scheme client – can then expect rising bonus rates in the second phase of recovery.
This scenario assumes that investment recovery will continue in the long term. Those with-profits funds that have been strong enough to maintain a high equity content will be best placed to deliver future increases in bonus rates.
What happens to the value of a Tep if the recovery never arrives and bonus rates continue to fall? Even in this scenario, a Tep will deliver returns above cash through what would probably have been a volatile investment period. Unlike many pseudo-guaranteed products, Teps offer visible and real guarantees. On the day a policy is purchased, the investor knows how much they are guaranteed to receive at maturity and with each future declaration they see the value of their guarantees increase.
This contrasts with a unitised with-profits investment, such as a trustee investment plan, where the only guarantee is the current reversionary bonus rate and the bonuses added in previous years. Unlike a Tep, there is no guarantee for the lifetime of the policy in the form of a guaranteed sum assured.
Teps offer investment in a wide range of financially robust life offices, many of which offer no other public access into any form of with-profits. This allows investors to select a balanced portfolio of life offices while risk can be diversified even further by selecting policies that mature in a range of future years.
Anyone using their SSAS or Sipp to invest in their own business needs to provide some form of underpin. Many modern attempts to replicate with-profits do not offer meaningful guarantees but Teps can remove downside risk and provide this underpin with confidence.
This approach should allow clients to afford that dream cruise at retirement, as long as the liner has sufficient lifeboats.