With-profits funds have taken a bit of a hammering recently. The review of low-cost endowment sales has left many people with the feeling that a withprofits fund perhaps carries more risk and fewer guarantees than they first thought.
The debacle at Equitable Life has compounded these concerns. Low reserves, poor free-asset ratios and a naive belief by the management team that they could avoid standing by contractual guarantees by robbing Peter to pay Paul has finished the company as a trustworthy entity.
More recently, Standard Life has taken some flak in the press because they have decided to remove the 4 per cent growth guarantee on its unitised with-profits pension policies. It must be a slow time for the press, they seem to have missed the point.
Not only has this guarantee of 4 per cent never been called on but Standard Life, probably as a result of its undoubted financial strength, was actually the last provider to remove such a guarantee. It has been able to maintain its bonus rates on unitised with-profits funds and declared 5.5 per cent for 2000.
All the others removed theirs years ago – and I do not remember the press attacking them for doing so. Still, perhaps they were focused on some other topic at that time.
I do however, find it fascinating that a centuries' old mathematical error seems,on the whole, to have stood the test of time.
Remember, the bonus system of with-profits came about originally because the mutual insurance companies – non-profit-making firms – overcharged their customers for pure life insurance.
In today's price-sensitive, explicit-charge world you can see why so many are lining up to attack with-profits funds. However, I still believe they have a role to play, although perhaps we should be seeking some ways to explain them more clearly to the consumer. The difficulty is managing what the actuaries call reasonable expectation – a difficult item to define.
Intriguingly, if you ask most advisers to design a low-correlation growth fund without too much risk or too great a degree of volatility, most of them will probably design a with-profits fund.
A typical collective investment portfolio will probably contain about 75 per cent equities (UK and international), 15 per cent commercial property and 10 per cent fixed interest and cash. Now have a look at a decent with-profits fund – Standard Life, Scottish Widows, Norwich Union, etc. Notice any similarities?
The difference is, of course, that a non-with-profits collective will ride the rollercoaster of stockmarket fluctuation.The with-profits fund will, as they say, have the peaks and troughs smoothed out. Sure, it is a bit of a mystery but there must be tens of thousands of with-profits planholders who can put up with that mystery for the relative security of being able to sleep at night.
Remember, no one has lost any money at Equitable Life – and probably will not in the future. No one lost a guarantee at Standard Life because it had never been called upon. Take a look at the compound annual return achieved by long-term with-profits funds. Yes, future bonus rates are likely to be lower but that is true of the returns on other collective investments.
I know we are now projecting forward the returns on investment funds at a much lower level than we have done historically but put that in perspective. Lower returns do not necessarily mean poor value for money. Real returns are what matters, the relationship between annual return on investments and rate of inflation.
Low returns with low inflation are just as beneficial as high returns and high inflation. Of course, if you want high returns during low inflation you might have to invest in a more volatile fashion.
So what role does the with-profits fund have to play? It should not be exclusive. It should be used for what it's best at – as a building block. If a client has a sizeable with-profits personal pension fund and a decent time before they want to take benefits, perhaps we should be encouraging them to top up with other types of investment fund and avail themselves of a bit of diversity.
But perhaps as advisers we should be a little careful of too much criticism of the with-profits fund.