Some months ago, Hargreaves Lansdown decided not to offer with-profits bonds and Prudential UK chief executive Mark Wood is reported to have described this as a “dereliction of duty” in Money Marketing's recent round table on with-profits.
I found it an astonishing attack. It is the adviser's job to advise on suitable products. Many IFAs and investors have been let down badly by with-profits over the last few years and consider it to be no longer viable. IFAs have no duty to sell life offices' old-fashioned products. Their duty is to clients.
One of the most discussed issues among IFAs today is how to get clients out of these products in the face of punitive market value adjusters.
It is not that with-profits has not performed historically but most IFAs have no confidence that it will do so in future. This is not based on sentiment, it is based on economics. Reserves built up often over 100 or 200 years have been consistently run down in the scramble for new business and the final nail in the coffin was probably the introduction of the with-profits bond contract in the late 1980s.
The problem is that with-profits is opaque and there is often a substantial conflict of interest between the actuaries and management, who represent the shareholders, and the policyholders who are the main beneficiaries. This point was picked up by Sandler, who recommended eradicating this conflict of interest in any replacement product design.
Smoothing may have worked for investors when reserves were huge and markets riding high but those reserves are largely gone and the only certainty is that providers stricken by fallen equity markets, orphan asset stripping, over-ambitious payouts and the pressure of realistic accounting will use smoothing to rebuild those reserves and they can only do that by not paying out.
Smoothing can only work against today's investors and that alone must make IFAs think twice about with-profits. But there is a deeper problem. Increasingly, regulators are concerned that clients should understand the risks they take with any investment decision.
Endowment misselling claims have been all about this. Investors bought low-cost endowments to get cheaper mortgages. At that time, no one in the retail market thought of investment risk in association with endowments. Today, IFAs and their clients are more sophisticated. In an increasingly litigious world, IFAs simply cannot afford not to understand an investor's attitude to risk.
But it is impossible to assess with-profits risk due to the opacity and discretionary nature of these investments. Even more concerning is that investment risk is driven not by the needs of policyholders but the needs of life offices exercised at the discretion of actuaries.
We have recently seen many with-profits funds move away from equities into fixed interest at or near the bottom of the equity market and at a time when the fixed-interest market is high. Many investors will be unaware that the investment risk they are taking has changed dramatically. I do not think anyone would claim this was a smart move on behalf of investors – it was driven only by the needs of providers as reserves were depleted. Realistic accounting will encourage this trait.
I know what I would call a “dereliction of duty”. It is life offices encouraging clients to invest in something which is opaque, where there is a massive potential conflict of interest between the decision makers and investors and where asset allocation has been driven by the needs of the decision makers. Try explaining that to the thousands of investors who have lost out on terminal bonuses or who want to move out of with-profits but face penal MVAs set by the actuaries.
You cannot take the risk out of investing but you can provide simple, transparent products allowing IFAs to create appropriate portfolios based on investors' attitude to risk.
Brett Williams is managing director of Selestia