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Expose the WP myths

Over the last couple of years, a lot has been written and said about with-profits products. Much of it has been negative and while some criticisms have a ring of truth, many are sensationalist and have no foundation.

Together with Sandler and the FSA, the industry is soon to re-invent the with-profits concept. We should be careful that in creating the new with-profits we should not throw out what is good about the old. In particular, we should squarely bust those myths that are plainly wrong.

Recent research shows that even after all the press coverage of 2002, consumers have little understanding of the workings of the product, especially when it comes to the concept of smoothing or of what an MVR is.

If as an industry we had been clearer in describing the product, consumers would surely have had better understanding. The poor understanding can lead to various myths. For example, accusations of unfairness fall in many areas and in nearly all cases are unjust.

Here we begin to see the importance of customers understanding what they are buying. The concept of some members giving up money after especially good returns to aid those leaving the fund in poor years is central to with-profits and it is not unfair.

Another suggested area of unfairness is in exposure to losses. Complaints often focus on the use of inherited estates to pay misselling fines. Critics may suggest that shareholders take all the profits and policyholders take all the losses by the fines being levied to the estate but there is an implicit assumption here that ownership of the estate is solely by the policyholders.

To a certain extent, the point is academic. Sandler&#39s proposals for a “charges minus expenses” operation remove any exposure to profits or losses from other businesses although mutual companies will have some thinking to do about policyholder rights.

No matter how well customers understand with-profits, the need for discretion means the main work of the actuary is hidden from the man in the street. The consumer just sees the insurance company and not the actuary working on their behalf (and their behalf alone).

Critics point to a conflict of interest between responsibilities to shareholders and policyholders when actuaries also hold executive positions in proprietary companies. But where is the evidence showing action has been taken that favours shareholders over policyholders? Should we really allow people to say discretion is unfair?

Actuaries also determine the application and level of MVRs using their judgement and experience. Yes, MVRs are unpleasant for policyholders but that does not necessarily make them unfair.

Policies of keeping payment values within a certain percentage of unsmoothed asset value mean that while MVRs could be large, the result is broadly the same for all policyholders – and thus fair.

Another criticism is that early surrenders unfairly pay for bigger maturities.

It is undoubtedly unfair when it happens. It is not, however, endemic. Companies that do not follow this practice should not tolerate the myth that this is an industrywide problem and would do well to advertise their approaches.

It is also a myth that smoothing is of little value. In 2002, equities are seriously depressed. The asset shares of with-profits funds are consequently also deflated, yet smoothing means policy values have been much less affected than the stockmarket.

Adverse selection means smoothing is unsustainable. In theory, whenever we have the situation that smoothed values are above fully exposed values, consumers would all cash in their policies. Providers would be forced to apply MVRs right up to the asset share level and with-profits funds would bec-ome nothing more than managed unit-linked funds.

Thankfully for with-profits, theory and practice are not the same, partly because investors are in for the medium to long term, not the short term.

My experience on with-profits bonds over a decade is that there is no obvious link to the ups and downs of the stockmarket. Indeed, peaks in Nov-ember, March and May seem more connected to a need for money for Christmas, Easter and Summer holidays than anything else. So adverse selection has not been a problem for 10 years at least – how sustainable do critics want the smoothing concept to be?

In summary, I have to conclude that there is a lot to commend with-profits and many of the criticisms are myths.


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