Is there a future for with-profits? It might have seemed unthinkable only a few years ago to ask such a question. How could a product with over£480bn invested in it and providing long-term returns of up to 11 per cent after tax become the subject of such negativity?
Well, volatile investment conditions, falling bonus rates, market value reductions and concerns about the black box of with-profits have all focused attention on this stalwart of the investment market.
Some forthright opinions are emerging. We have seen commentators suggesting that the death knell is sounding for with-profits and that a new breed of replacement products is the way forward. However, let us just recap for a moment on the recommendations that came out of the Sandler review. A with-profits “stakeholder” savings plan was seen as a key part of a well functioning market, based on a 100/0 structure with explicit charges and a clear ringfencing of business risk from investment risk.
While there may be difficulties for 90/10 or mutual providers in moving to this structure, the Sandler recommendations underline that with-profits will have a valuable role to play in closing the savings gap.
As the new breed of alternatives develop, we may not see with-profits attracting business volumes at the same level as in the past but the role for it in the market will remain. Both smoothing and elements of guarantees will remain as strong a pull for investors as they have in the past, particularly where they can be provided within a tested wrapper.
Consider the market conditions that we are currently operating in. We have seen an almost unprecedented period of volatility and sustained falls over the past three years. Until market sentiment becomes more robust, it is likely that the retail investor will be faced with volatile conditions. The smoothing effect in the with-profits concept is clearly well suited to such conditions.
It is no surprise that the cost of providing guarantees is becoming much more expensive for with-profits and more widely. Managing investor expectations on the impact of this on future returns will be important but an aggressive move from explicit guarantees would be to miss the point of the with-profits concept. As with smoothing, they represent a fundamental customer need and the challenge for the industry going forward will be to find ways of making them tenable.
There are no easy answers at this stage other than to say that further innovation will be absolutely key.
What of the new breed of replacements for with-profits? Recent examples we have seen include smoothed managed funds, structured products with soft guarantees and funds overlaid with derivatives to provide protection against market falls.
Innovation is to be welcomed but there must be a question mark over the extent to which the current offerings provide a robust alternative to with-profits. And how much of an advance are derivative-backed products over with-profits on the high-profile issues of transparency and investor understanding? Highly questionable.
I am sceptical about just how actively these alternatives are being sold to IFA clients. Anecdotal evidence seems to indicate they are being sold in limited volumes, perhaps sugges- ting that each one addresses some investor needs but that few, if any, provide all the answers.
So, will with-profits survive? In its 100/0 form, with-profits has undoubtedly moved forward and the answer is likely to be yes. However, expectations will be for with-profits to attract a lower share of the market than we have seen in recent times. Meanwhile, there are opportunities for the new breed of alternatives but more time is needed for them to evolve into something that still matches the full set of investor needs.
Ben Gunn is head of retail operations at Friends Provident