With-profits bonds have withstood recent pressure and are still popular with investor.
The with-profits bond market has come under fire recently. There are two main reasons for this. The first is the impact of new regulations on the market, the second is the concern expressed by the Institute of Actuaries over the marketing of some bonds.
The revised valuation regulations were issued in May this year by the insurance directorate of the FSA. The new regulations require increased solvency reserves for with-profits bonds.
For Prudential, this has led to an increase in liabilities of about 15 per cent for the Prudence bond. We believe the changes will affect all life offices that write unitised with-profits business such as with-profits bonds but clearly the greatest effect will be on those offices with low free-asset ratios.
In some cases, however, it may force the weaker offices to cut bonus rates or reduce the equity content of their fund. For our own part, we have already said our financial strength means we are not changing our investment strategy nor our bonus philosophy as a result of the “new regs”.
The second key issue for IFAs is the letter dated June 30, 2000 to life offices' appointed actuaries from the life board of the Faculty and Institute of Actuaries.
The letter expressed concern over with-profits bonds being sold through potentially misleading headline bonus rates, (which on occasion include one-year guaranteed extras, which are effectively enhanced allocation) and questioned how providers intended to meet the costs of guaranteeing these rates.
In particular, the use of high annual bonus rates could put pressure on the financial strength of a with-profits fund, which in turn would restrict the freedom of the company's with-profits fund to invest in those asset classes more likely to achieve better long-term returns.
Ultimately, a high reversionary bonus may result in lower total returns or a higher risk to clients, something that no IFA wants to see.
For this reason, we share the concern of IFAs, particularly in light of the new regulations, which is demon- strated by the fact that we do not use a high reversionary bonus rate as a sales tool for Prudence bond, and do not add together allocations and “real” bonus.
Some commentators have brought into question the future of the with-profits bond. However, the with-profits bond can answer a number of different client needs and is often a strong foundation on which to base a portfolio.
Although it seems as if it has been around for longer, the with-profits bond was only created as recently as 1990 and has enjoyed steady growth. In 1999, the ABI says with-profits bonds accounted for 37.8 per cent of the lump sum investment market that includes Isas, Peps, unit trusts and other life bonds. This proves that however unpopular they might be with some IFAs or with the press, they remain popular with investors.
Why are they so popular? Our research indicates many investors do not want the hassle of actively managing their investments and they have been put off buying unit trusts either by stories about “fat cat” star fund managers or by poor performance figures.
They also think life companies are perhaps more dependable in terms of managing their money. Investors are also attracted by the unique smoothing process that with-profits investment brings.
While we all know that past performance is no guide to the future, track records do count for a lot with investors. With-profits bonds have an excellent track record of providing much higher returns over the medium to longer term than deposit accounts but with less risk than direct stockmarket investment.
In addition to a good level of capital growth, many people are also attracted to with-profits bonds by the option to take an “income” from their bond. The majority offer the flexibility to take income as a sterling amount or a percentage of the fund and to start and stop “income” as desired.
Some also offer the option of taking out the growth in the bond, preserving the original capital. Unfortunately, there are still some with-profits bonds in the market which do not have full income flexibility, and do not give clients the full benefit of the vehicle.
One further attraction is the option of adding further investments by topping-up the original bond, which can have considerable tax advantages for the client. All in all, with-profits bonds can offer significant attractions for investors, and the reasons for their popularity are clear.
The with-profits bond has proved to be a key weaponin an investor's financial armoury and we believe its attractions should ensure that it remains so in the future. It is important to remember, however, that in the final analysis it is the investment performance by which success is judged and that financial size and strength, not a high headline one-year rate, is the key driver of value to the customer.
