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Small wonder

It has been evident for quite some time that life companies have been getting serious about investments.

The days of with-profits bonds being the mainstay of a life insurer&#39s investment sales have well and truly gone and their investment products are now more comparable with those available from traditional retail investment professionals such as Invesco Perpetual and Jupiter.

This change effectively means that life companies now have to be incredibly focused on the investment engine while still maintaining competitive wrapper/ charging structures.

Clearly, it is an IFA&#39s job to determine the financial planning needs of a client which will then in turn determine whether the most appropriate wrapper for an investment is a life company bond or a straight investment into a unit trust/Oeic.

I am not going to debate the pros and cons of each wrapper from an IFA and consumer perspective as this is generally well covered. However, I think it is also interesting to consider the two different routes from the perspective of an insurer or bank which owns both a life company and a retail investment house. In other words, which business would the group chief executive like to see money channelled through? Let us take Mr Garvey. He is the chief executive of a leading UK insurance group which owns both a life company headed by Mr Smithers and an investment house headed by Mr Bones.

Garvey has just been given the choice of whether £100m of investment business hits the group books via the life company or via the investment house. This is where it gets complicated.

Garvey needs to look at what will serve the best int-erests of the group as a whole so consideration will be given to the profitability of business via the two different channels.

Typically, a competitively charged life company bond using an internal fund will have a 10-year reduction in yield of 1 per cent a year but it will pay initial commission of 4.5 per cent and 0.5 per cent annual commission.

In contrast, a similarly managed Oeic from the same group would have a 10-year reduction in yield of 2 per cent a year and will pay 3 per cent initial commission and 0.5 per cent annual commission.

Using the above figures, you would think the answer was obvious – a life bond charges the consumer less and the life company pays out more to the IFA, hence the Oeic must be significantly more profitable.

Well, in the real world it is but in the bizarre world of life company accounting, the bond wrapper still appears to be king – the magic accounting treatment for bond wrappers is different to that of unit trusts/Oeics but I will not pretend to understand the intricacies.

The bottom line is that the sheer amount of shareholder capital required to fund bond pricing structures and commission is incredible and this leaves the shareholder looking at a very long payback period. Collective investment sales require little shareholder capital and will, in cash accounting terms, see almost immediate paybacks.

The conclusion of my simplistic overview seems to be one of the factors that is driving Friends Provident to become a leading asset manager.

I think it is fair to say that Friends Provident is a life company minnow (in UK market share terms at least) with a position outside the top five but it is now an asset management powerhouse, with F&C ranked number four in the UK in terms of assets under management.

Interestingly, Friends&#39 move has seen Aviva&#39s UK asset manager Morley relegated to fifth place and Standard Life to ninth spot.

Friends has been aiming to be a top five asset manager since its flotation and, as capital invested into asset management businesses generates cash more quickly than capital inves-ted into life operations, its move to buy F&C was an eff-icient use of capital.

Currently, Friends Provident&#39s operating profits from life and pension earnings are about 90 per cent but this figure is expec-ted to fall to around 69 per cent in 2006 – a clear strategy to diversify earnings.

So a life company minnow creates an asset management giant – a smart move, Mr Satchell. The ind-ustry question now is, are some of the current life company giants happy to play second fiddle to Friends on the retail asset management scene? Not if they think the days of magic accounting are numbered.

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