The with-profits bonus declaration season is in full swing and there have been some big cuts in bonus rates.
The cuts will be disappointing to policyholders and may lessen the attraction for new investors.
What has been happening and what is the impact for new investors in with-profits?
Putting investment conditions into context, last year saw another fall in the UK stockmarket making a string of three down years – the worst bear market for more than a quarter of a century.
Last year alone, the UK stockmarket fell by 24 per cent, the biggest one-year fall the FTSE 100 has seen since 1974. The impact of the index falling to 3,940 at the end of 2002 from 6,930 at the start of 2000 was bound to be significant.
With-profits funds invest in a mixture of assets and some funds should have seen lower falls in value than full equity investment.
Fixed interest and property performed well. However, equity backing ratios (the proportion of the fund invested in real assets, shares and property) have fallen and may remain lower for some time.
The mix of investments may lead to lower long-term returns but for now it will mean that performance volatility and risk will be reduced.
In determining bonus rates and payouts at Norwich Union, we believe we have to ensure the right balance is maintained between what is paid out now to customers with maturing policies and the guaranteed values added to policies through annual bonus additions now and in the future.
We have to take prudent action in this difficult climate to protect the interests of all policyholders and ensure continued financial stability of the with-profits fund.
We need to see a sustained improvement in the investment climate to enable current bonus levels and payouts to be maintained. As a result of the continuing stockmarket volatility, we expect to review bonus rates at least twice yearly.
This will enable us to respond to changing market conditions and ensure continued fairness and transparency in the payments we make to policyholders.
Where does this leave new investors in with-profits? It is important at the outset that new investors are clear on how with-profits work and the company's bonus philosophy.
NU's philosophy is to be open and transparent with the information we give customers. We explain our smoothing policy and how it affects the relationship between earnings (asset share) and payouts. We explain what we have done and why and what it means.
It can be a challenge to explain these issues simply and clearly to be transparent. It has risks but we have found that the rewards are greater.
We also have to remember that smoothing can and does work both ways.
In a year where we have experienced poor returns we over-add value to policyholders and in a good year we may under-add value. However, this is within controlled and published limits. It is these clear guidelines that give customers protection and ensure transparency.
Overall, our aim is to provide a return to investors that reflects a fair share of the investment returns on the with-profits fund. We do this by targeting our payouts at 100 per cent of asset shares on average, which are determined by accumulating the premiums paid with the returns earned on the with-profits fund less our charges.
The key point to this app-roach is that there is no systematic targeting of payouts at less than 100 per cent of asset share.
It is important that where a consumer invests at the current time, the effect of smoothing on the total payout will depend on the investment returns in the future and for a medium to long-term investment, it will not be affected by the negative investment returns of previous years.
It is true that being in withprofits can mean less of a potential upside than 100 per cent investment in equities. However, very high equity content also increases risk in the longer term. We are all great at getting investment decisions right with the benefit of hindsight.
For many, the balance between risk and reward will continue to steer them to looking at a with-profits investment. For others, the choice of a product that allows equity investment with an option to switch to with-profits later may seem to be the best of both worlds if, of course, you get your timing right.
We firmly believe that with-profits is still a key part of the investment mix for many customers. The fundamentals are unaltered, namely equitybacked investment with smoothing of returns.
The fundamentals of with-profits investment remain the same and still continue to deliver the benefits of equitybacked investment with smoothing of returns.