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Life offices face the critics over bonus rate cuts

Scottish Widows&#39 decision to slash its bonus rates by more than a third has raised the question of whether other life offices will have to reduce bonuses as drastically as they prepare to announce their decisions over the coming weeks.

Widows claims the cuts merely highlight the extent to which the global slowdown has hit investment returns and it claims that others will follow.

Norwich Union, which is due to make its bonus announcement this week, is the next office to be widely tipped to make substantial reductions.

Some IFAs agree with Widows&#39 view. Roberts Clark director Jo Roberts says: “Widows is just the first of many life offices likely to make this move. They are all going to make serious cuts, if not as extensive. But I think it is realistic to assume that NU will reduce rates by up to 30 per cent or so.”

Roberts claims NU has problems with its pension assured fund and is likely to take strong measures as a consequence. NU says adverse stockmarket conditions make bonus cuts inevitable in the life insurance sector.

In justifying his company&#39s decision last week, Widows chief executive Mike Ross also placed the blame firmly at the door of the global slowdown.

But while IFAs acknowledge that the FTSE 100 index fell by around 16 per cent last year, there are some who doubt the validity of the argument in the case of Widows.

PolicyPlus International, which buys and sells with-profits policies, bel-ieves Widows&#39 policyholders may be paying for its imprudent tactics last year.

Sales and marketing director David Carrington says: “I suspect that Widows has made such a savage reduction because it was dipping into its reserves for too long when other life offices were cutting bonuses. I think the downward trend in surrender values for its policies also points to this. But when it comes to other life companies, I hope that we have already had most of the pain.”

With the exception of NU, Roberts agrees with Carrington but believes that most life offices are likely to make more modest cuts, if only to boost their own image at the expense of Widows. She says: “By being the first major life office to cut bonuses, Widows has set the benchmark. It may mean that other life offices try to ensure their bonuses are not cut as far as Widows to paint them in a less than favourable light.”

It is a view supported by other IFAs, who claim life offices would rather ensure they have a good public image than give policyholders a coherent explanation as to how they calculate bonus decisions.

Dennehy Weller managing director Brian Dennehy says: “The life offices that come out best when all the announcements have been made will not be the ones with the biggest bonuses, it will be those which have best marketed the way they structure their bonus rates. A lot of people&#39s perception of with-profits policies would improve if life offices were more open about the way they calculate these.”

Dennehy says the fact that Widows has not implemented uniform cuts across the board – “unfairly” reserving the biggest reductions for older, less popular savings scheme policies – is indicative of the approach that life com-panies take to determining bonus rates.

However, Skandia claims this smoke and mirrors approach masks a more fundamental problem which could result in policyholders seeing bonus rates plummet by more than 60 per cent over the next 20 years.

Senior group marketing manager Peter Jordan says life offices routinely use terminal bonuses to top up bonus rates and that more than half of payouts are now financed in this way.

This claim is disputed by CIS, which announced a reduction in its terminal bonuses last month. Chief actuary Tim Bunch says: “If I knew what was going to happen over the next 20 years I would be a very rich man. We can expect the industry to continue to reduce bonuses over the next few months, it is going to take a considerable recovery for this downward trend to reverse.”

As much as CIS may look to the stockmarket to jus-tify the raft of reductions likely to be implemented in the near future, there are other life offices more willing to concede that there is an issue with the way the funds are run. Scottish Equitable, which makes its bonus rate announcement in March, is one.

Head of public affairs Scott White says: “The problem is most extreme for life offices which fail to use prudence in managing their funds. Any organisation delivering bonus rates which do not reflect the underlying investment will be caught out in the end.”

In a demonstration of how seriously the problem is perceived, the FSA has warned life offices that they should use prudence in determining bonuses and be able justify their investment decisions.

None of the providers so far making reductions – CIS, Eagle Star and Widows – say this had any impact on their decisions. Those providers yet to announce cuts are equally as dismissive of the warning.

This is no surprise, says Cazalet Financial Consult-ing principal Ned Cazalet, as providers have far more fundamental reasons for slashing rates. He says: “I expect a number of life offices to make cuts of 10 per cent or more. They have to. They have simply been shelling out bonuses when they have no money.”

I expect a number of life offices to make cuts of 10 per cent or more. They have simply been shelling out bonuses when they have no money

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