If you believe all you read in the financial press, it would appear the die has already been cast – some commentators are suggesting that with-profits are on the way out and so is mutuality.
This is absolutely not the case and we see no reason why IFAs should not continue considering with-profits policies for clients in the same way they have sold hundreds of thousands of them in the past.
The life savings of millions of policyholders are tied up in with-profits policies through pensions, endowments and with-profits bonds. Withprofits has long been perceived as the answer to many people's prayers – a more stable home for long-term savings which can help avoid the direct effects of stockmarket falls through smoothing.
Despite what has been said about the supposed demise of with-profits, they are still delivering the goods. Over 10 and 25 years, their performance has exceeded most other forms of comparable investment, outpacing deposit accounts, balanced managed funds and many unit trusts. Even the worst-performing with-profits policy outperformed the best balance managed unit-linked policy in the 25 years to the end of November 2003.
The best return this year came from Liverpool Victoria, paying £222,627 on a 20-year with-profits personal pension taking premiums of £200 a month. Compare that with the best unit-linked equity fund taking £200 a month over 20 years, which is paying out £104,178 (Axa Sun Life). The lowest is £84,390 from Scottish Widows and the managed fund from Allied Dunbar is paying out £101,776 this year.
It would be churlish to suggest that with-profits are faultless products. The Equitable Life saga, pension misselling and the growing problem with endowment shortfalls have all played their part in tarnishing the image although some of these issues also applied to other types of products.
When it comes to endowments, it does appear that, in many cases, the advisers or providers did not do enough early enough to inform customers of potential shortfalls. The upshot of all these negative issues in financial services has led to a growing band of people – from IFAs to consumer groups – sounding the death knell for with-profits.
This criticism has coincided with, and no doubt has been fuelled by, one of the worst bear markets in history and few areas of the financial sector escaped a battering. Look no further than the split-capital investment trust and precipice bond scandals – and remember that, in many cases here, investors have lost almost their entire investment.
Every industry has its good players and those who are less successful. It is no different for the with-profits industry.
The key to a decent-performing with-profits fund is financial strength. Strong companies and insurers can afford to keep a higher proportion of equities within their fund. If you believe equities will outperform other asset classes over the long term – then clearly you have to have a decent exposure to shares to benefit.
Despite the recent bear market, we, along with most analysts, continue to believe equities will outperform bonds and property over time. A with-profits fund with a low equity weighting will probably struggle to satisfy the investors over the long term.
We believe a with-profits fund should normally have more than half of the fund in equities. Our current weighting (as at March 31, 2004) is 63 per cent equities, 14 per cent in property and the remainder in fixed interest.
The question of financial strength has given rise to new realistic reporting rules from the FSA. The new rules force insurers to become more transparent and take more account of guarantees made to policyholders.
The rules introduce a key test known as a risk-capital margin under which insurers must show the financial impact of a worst-case scenario of falling equity markets and changing economic conditions. But the changes to reporting should not cause a problem to a wellmanaged, financially strong insurer.
Those against the new rules believe the new framework forces insurers to ditch equities in favour of bonds because it is easier to meet the new requirements if the fund is invested in less risky investments.
Liverpool Victoria does not have such an issue because of our financial strength and our prudent approach to reserving and we will not be forced to cut our equity weighting. We are not alone and several insurers have also said they have no qualms with the new requirements.
One of the fiercest criticisms of with-profits has been the lack of transparency. Some of it is justified, particularly when it comes down to communication and education, which needs to improve. The criticism of opaqueness has led a number of providers to develop so-called alternatives to with-profits.
The latest muse is constant proportion portfolio insurance. But is CPPI, linked to structured, derivative-backed products, full of complex mathematical formulae any clearer than traditional with-profits? I'm not so sure. I wonder whether words such as gearing and multiplier will simply bamboozle the British public and some IFAs too. CPPI products will not share in the profits of the business in the way that with-profits funds offered by mutuals do and they could also still be forced sellers of equities. It is debatable whether CPPI-related products can be deemed a with-profits alternative at all.
Other new-style with-profits are moving towards the Sandler-proposed smoothed investment product. But again one has to question whether these new products are with-profits substitutes. These new funds are ringfenced from other assets and do not participate in the business's other profits.
They have separate smoothing accounts and many do not offer annual bonuses or guarantees – which are key features of traditional withprofits funds. Some, with their use of derivatives, look like nothing more than protected unit trusts while there is often a restriction on equity allocation which again defeats one of the main objects of the with-profits philosophy.
It is telling that one or two insurers have even hinted that they may ditch the term “with-profits” from the product's name should they launch a new-style fund.
The latest twist to the with-profits debate came last month when Standard Life announced its intention to demutualise. We firmly believe mutuality is very much alive and well in Liverpool Victoria's case and that policyholders are better off for it.
Returns from a prudently managed mutual should always beat those from a quoted company because all profits are distributed to policyholders. Quoted companies, on the other hand, set aside 10 per cent of profits to pay shareholders dividends. Indeed, with-profits from mutuals have outperformed plcs by 10.5 per cent during the past decade, returning £7,614 compared with £6,888, according to Money Management for a plan investing £50pm to February 1, 2004. Take a look over 25 years and the difference is more marked – mutuals returned an average of £67,907 while plcs returned only £56,004.
With-profits policies may not be whiter than white in terms of transparency and communication but talk of their demise has been greatly exaggerated. There are some consumer concerns that need to be addressed and undoubtedly the long-term solution should also include better education of customers.
But much of the criticism is misguided. What's more, the proposed changes in CP207 will potentially damage the future performance of with-profits funds and we have raised our concerns in our consultation response.
As with all financial products, with-profits will ultimately be judged on performance. Many providers have delivered the goods in the past without the need for explicit rules and guidance.
Financially strong insurers will continue to have the freedom and flexibility to juggle the asset mix to the benefit of policyholders. This, crucially, will allow such providers to hold more equities and property in the fund and less fixed interest.
Over the longer term, a with-profits fund with the correct asset allocation strategy will produce decent rates of return. They deserve their place in an investment portfolio.