Once upon a time, life insurance companies made clear promises. Then, as now, making promises was risky, so they calculated the premiums on a pretty conservative basis. So, when the time came to fulfil the promises, there was lots left over.
They put the customer first and thought that some of this “lots left over” should be shared with the people who had coughed it up in the first place. So, with-profits was born, in the context of guaranteed sums assured and unambiguous promises.
Until a couple of years ago, it didn't really matter that what passed for with-profits bore little resemblance to the products of old. There had been innovation and improvement in insurance policies, just as there had been in motor cars. The modern motor car and the modern with-profits policy were fiendishly complicated but, as long as they worked properly, there was no need for the average consumer to be worried.
Then came Equitable Life, which had always made a virtue of having nothing left over. If it happens again, the FSA will be on the wrong side of the revolving air-conditioning system. Hence, the five issue papers.
Who is paying for pension misselling? Who owns the inherited estate? What went wrong with endowments, many of which are invested in with-profits? Why is with-profits so expensive? Why do early leavers get such poor treatment? Why has no one ever defined policyholders' reasonable expectations, at the heart of the law on the subject? Is the appointed actuary being torn apart by conflicts of interest?
The with-profits promise boils down to “Trust me, I'm an actuary” or, more properly, “Trust us, we are the directors of a life company, advised in the matter of managing the fund by a clever chap who is an actuary.”
Amazingly, we do trust them. They have got about £340bn of our money. The ABI tells the world that with-profits is just another kind of fund, like a unit trust, only safer and less volatile. Piffle. A with-profits policy is a lot closer to an equity investment in the life company concerned. The customer owns the policy. The life company owns the assets. The principal benefit of with-profits is that, on the day of maturity, the value of the policy does not depend on the level of the stockmarket. This is scant comfort if there is no fixed maturity date and the provider is applying a market value adjuster (actuary-speak for cut) to protect the other people in the fund. In any event, there are cheaper ways to protect against the level of the stockmarket on one fateful day 25 years hence.
Why is this relic of a bygone age – this pig in the mother of all pokes – so popular?
Life companies want to sell with-profits because they can hide the (high) charges. Intermediaries want to sell with-profits, especially bonds, because the commission (paid for by the high charges) is healthy and it does not look as though the consumer is picking up the bill.
Consumers want to buy the product because they are deluded into thinking that it is just as safe as the building society but will perform better.
It is in the interests of all three players – makers, sellers and buyers – to sustain the delusion. The FSA should insist that life companies give the product its proper name – “with-profits, or losses, depending on how it turns out”.
I wonder if with-profits bonds would go on selling at the rate of 10,000 a week?
Graeme Laws is the former deputy managing director at National Mutual