The last few weeks have seen the media spotlight turn once again on
with-profits. Among the various discussion points, including orphan assets,
free-asset ratios and transparency, much attention has focused on the
market value adjuster.
Here is another area where there is significant potential for the concept
of with-profits to be misunderstood by investors and commentators alike.
It is clear the industry needs to increase its efforts to ensure the
underlying principles of with-profits are communicated effectively to
consumers and the reputation of with-profits as a useful investment option
is not allowed to become tarnished by reactionary responses.
At the end of the day, a with-profits fund is essentially just a managed
fund with a smoothing mechanism although it also offers guarantees at
certain points in time, for example, at a selected retirement date under a
pension policy or on regular withdrawals under a with-profits bond.
Put simply, the smoothing mechanism allows investors to reap a return
which is commensurate with the length of time they have been invested in
the fund. It is the essence of mutual investment philosophy.
Just as a terminal bonus may be added on withdrawal if the smoothed value
of the underlying assets exceeds the value of the units, an MVA may be
applied on withdrawal when the smoothed value of the underlying assets is
less than the value of the units.
The purpose is to ensure all investors in the fund get a fair deal and
benefit to a similar extent. The smoothing mechanism ensures they are not
as exposed to the vagaries of stockmarket fluctuation as they would be in a
The MVA has been referred to as an exit penalty. This implies incorrectly
that it is a charge levied irrespective of other criteria. An MVA is levied
to protect the remaining policyholders from the potential impact of
investors withdrawing their money at a specific time and also ensures that
those investors withdrawing receive a fair share.
The reason why several companies have moved to introduce MVAs in the last
few months is due to stockmarket volatility and the resulting need to
protect policyholders both now and in the future. The application of an MVA
in conjunction with annual and terminal bonuses merely helps to ensure that
each policyholder receives a fair share of the fund growth. There is
nothing more sinister afoot than that.
With-profits should be seen as a mediumto long-term investment and MVAs
are less likely to apply to policyholders who have been invested for a
longer period. Before a selection is made, it is important to scrutinise
the provider's financial reserves and outlook, as well as the structure of
the underlying investments backing its with-profits fund.
In previous months, I have touched on the concept of investment risk and
the importance of communicating risk effectively to investors. We must also
be clear that investors understand the basic premise of their investment.
This includes explaining how a with-profits fund works and how the
smoothing mechanism can work to their advantage.
Here is another area where the ABI's Raising Standards initiative is
likely to make a difference. This requires a provider to include within its
literature a with-profits summary which explains the operation of its fund
in plain English. There are actually two summaries – a simplified version
issued whenever the customer has the option to invest in a with-profits
fund and a more detailed version available on request.
Given that a survey in the Mail on Sunday suggested at 91 per cent of
investors would welcome more information about with-profits, it would seem
that companies signed up to Raising Standards are likely to steal a march
on their rivals.
Peter Dornan is director of group businesses at Aegon UK.