I am a 60-year-old director of a company. My executive pension plan has just matured. I noticed a performance comparison in the financial press where my insurance company shows what returns it would have given on a policy similar to mine. The returns it quotes are much more than I got. In fact, I paid in more and got less. What is going on?
Any example is idealised and does not quite follow the real world. There are some important differences between the example and what happened with you.
Only half your premiums went into an annual-premium contract. The other half went into a series of single-premium policies.
The annual-premium contract was half the size of the one in the example and so the fixed charges would have reduced the return. You also missed the last premium. However, the return was consistent with the one quoted.
The big difference is between the series of single premiums and the equivalent annual-premium contract. The returns on the single premiums are much lower than from an annual-premium policy.
The survey also covers single-premium policies but only those for five, 10, 15 and 20 years. Comparing like with like, the returns are consistent but as your premiums were a 10th of those in the survey, fixed charges had an even bigger effect. For intermediate terms, the yields were also consistent.
The yields on single-premium contracts were much lower than for annual-premium contracts. In general, you would expect a series of single premiums to give a lower return than an annual premium because of the extra cost of administering a new contract each year.
The interaction of the reversionary bonus system with what actually happened to investment returns over the last 30 years has boosted the returns on some annual-premium policies. This is what happened here and made the comparison even worse.
Between the mid-1970s and the mid-1980s, investment returns were exceptionally high because inflation was high and the stockmarket was recovering from the crash in 1973/74.
With-profits policies smooth investment returns and there is some delay in underlying investment returns being fed through into bonus rates. This is more significant with annual- premium policies where the bonus is declared as a percentage of a sum assured based on the total premiums an insurer expects to receive in the future.
In the early years, bonuses on annual-premium contracts represent a credit for expected future returns. A 20-year policy with a premium of £1,000 a year might have a sum assured of £20,000 and get a reversionary bonus in the first year of £600.
This is artificial. There is no way the insurer could have made a £600 profit on an investment which might be only about £100 after expenses. On the other hand, just before the policy matures, an underlying investment of £70,000 might produce a reversionary bonus of only £2,000.
A lot of smoothing is going on. This has the benefit that overall returns are kept high and, as maturity approaches, the policyholder can be fairly confident about how much he will get, whatever happens to the stockmarket.
Each year's bonus rate does not just reflect investment returns in that particular year, it reflects investment returns over a number of years. In the late 1980s, when investment returns fell, bonus rates held up as the high investment returns in the early 1980s continued to feed through into bonus rates.
There was some reluctance to cut bonus rates at all. Most insurance companies could look back on a history of rising bonus rates going back to the beginning of the century. Cutting bonuses was a big decision. This favoured newer annual-premium contracts where a significant part of the total investment return is in the form of reversionary bonuses declared in the first few years.
With a single-premium contract, a £1,000 premium might produce a sum assured of only £1,300. Investment returns, therefore, more closely reflect the returns actually achieved over the life of the contract.
The initial advice you received was good. The single-premium contracts gave you flexibility to cut contributions in bad years without penalty.
The real problem is that, because of the way the bonus system works, the return on the annual-premium contract was actually higher than it ought to be. This is what makes the returns on the single-premium policies look poor.
The second problem is that the insurer has not explained itself and typing errors in the letters even include the figures quoted. It is not surprising you are unhappy with it.
It is a sad comment on our industry that, even when we get the big things right and the system actually works in the client's favour, we can make such a mess of explaining ourselves that policyholders can still feel unhappy.