Some time ago, I spoke at a providers' roadshow where the core topic was income drawdown. My slot was on the necessity of setting up a balanced portfolio when activating drawdown. This entailed me trying to convince the audience that with-profits on its own does not provide that balance.
To put matters in perspective, I used some PIA statistics which showed that over 50 per cent of clients were wholly invested in with-profits. In a sideswipe against the opaqueness of with-profits, I declared that “with-profits, I have never liked it since I first fully understood it”.
When the penny dropped, many delegates told me in private that they to had come to recognise that they did not fully understand with-profits.
In my opinion, the introduction of market value adjusters was the start of the inevitable decline of with-profits as the most popular investment medium for individual plans.
The MVA totally negates any arguments about smoothing bringing a lower level of volatility. The MVA allows the actuary to claw back from reserves without that clawback benefiting the policyholder.
An actuary from Equitable Life explained to me that the MVA simply put the individual in the same position, had he invested in an equity fund. When I suggested that this placed with-profits in the same risk category as the equity fund, he was unable to reply.
So, why has with-profits lost so much of it sparkle? After all, in many cases, cash funds are producing better returns at present. I believe that the improvement in persistency is the main culprit, with more and more with-profits plans reaching maturity than was true in the past.
The growth of secondhand policy sales has taken away from the actuary responsible for the with-profits fund those “windfalls” which fell to the fund as plans were surrendered. I can still recall asking a mutual office in the mid-1980s just how many policies benefited from their latest terminal bonus, only to be told the grand total was 23.
It was interesting to note that in the FSA's press release said “the annual costs can be high, certainly by comparison with, say, a index-tracking fund”. I suspect many investors are equally disillusioned with tracker funds, given the current market, and perhaps both with-profits and trackers need to be in a higher risk grouping.
So, is there a future for with-profits? Well, given the love affair that some banks and bigger IFAs have with the ubiquitous with-profits bond, it will probably last for some time yet.
Having said that, with the downward pressure on charges plus the calls and possibly stringent requirements (yet to be fully detailed) from the FSA, change may come quicker than many expect.
The concept of with-profits is okay in itself. It is the detail and how it has operated in practice that has brought it into deserved disrepute, a new and fresh model is long overdue.
The principle of smoothing is fine, provided that the generation of policyholders who created the reserves benefit from them whether they pay to the bitter end or leave early. By creating tranches of policyholders, they could all still benefit from smoothing but in regard to the performance of their tranche.
An MVA is unacceptable if we are to deliver a fund which provides stability and at the same time good value .
So, should the name with-profits be banned and replaced with a more representative name? Suggestions on a postcard please and I will publish the best three in a later column.
I leave you with the following thought – with-profits but for whom?
Robert Reid is principal of Syndaxi Financial Services