If the FSA goes ahead with its proposals for disclosure to consumers, part of its wide-ranging with-profits review, changes will be required to the way that with-profits products are sold.
The effect will be on two levels – first, changes to the information to be provided at point of sale; second, changes in the way that IFAs go about selecting a product provider.
Information provision at point of sale
The FSA is proposing that two tiers of information be made available for consumers – core and supporting.
Core information must be provided to all consumers at the point of sale and would include details of the product's features, investment mix, risk profile, a description of smoothing and the consequences of early surrender (for example, MVA position).
Supporting information is available on request and would include more detail on the management of the fund, for example, on the smoothing policy, factors that are considered when deciding on an MVA, and bonus policy.
All this material must be presented in clear English, possibly incorporating a range of prescribed terms.
Despite the increased information requirements, the FSA is intending to streamline delivery by requiring details to be carried in key features documents and with-profits summaries only.
Product providers will need to review and rewrite their product literature. This includes a review of key features and with-profits summaries (or producing them for the first time) and ensuring that other material uses clear English and consistent terminology.
IFAs will need to ensure that the resulting material is clear and accessible and that the appropriate information is provided to their clients.
Selecting a provider
Historically, with-profits has been seen as pretty much a generic investment vehicle – one fund being much like another.
As a result, selection has tended to focus on financial strength, past performance and product features and, in the case of bonds, allocation rates have often been a key determinant.
With the FSA proposals, much more information will become available to IFAs and consumers and, as a result, IFAs will need to look more closely at the fund they recommend.
The way that Oeics and Isas are sold provides a good indicator of the way that the selling of with-profits could change. Typically, they are selected by looking at past performance, the asset mix of a fund, its risk profile, the pedigree of the manager and the quality of the information available. Charges are a factor but not an overriding one. In essence, the process is about the fundamental quality of the fund and its prospects.
So how would the selection process for with-profits look in the future? Essentially, it will require a deeper understanding of a fund's characteristics and should involve getting answers to the following questions.
What type of withprofits fund is it?
The FSA points out that the level of risk exposure varies between fund structures. It defines these risks as falling into two categories – investment and business.
Investment risk refers to exposure to the performance of the fund's assets and all funds will be exposed to this type of risk.
Business risk refers to exposure to such things as expenses of management, mortality and profits (or losses) from other, non-with-profits, business activities.
Exposure to these risks will vary between funds.
There are basically three types of with-profits fund in the market, each with different risk characteristics which are as follows:
90/10 proprietary company
Here, some of the business risks of the fund are borne by the shareholder(s). In return for bearing these risks, the shareholder receives a cut of typically 10 per cent of the cost of bonuses Mutual company
This type of fund will be exposed to all the business risks listed by the FSA, because the company is owned by the policyholders and, as a result, there is no one else (that is, shareholders) to bear them.
These risks could include pension misselling, mortgage shortfall guarantees and set-up costs of non with-profits business activities.
Again, some risks are borne by the shareholders but their remuneration comes not from 10 per cent of bonuses but from profits made on product charges, which includes an explicit annual management charge on the fund.
Clearly, there is a need to establish the nature of a provider's fund as this will have a bearing on the risk profile of the product recommended.
What are the charges?
Charges will have a fundamental impact on investment returns.
They fall into two categories – product and fund.
Product charges are usually clear, as in the amount of initial charge.
Fund charges are usually less obvious. It should be necessary to establish what the exact annual fund charge is and, more important, whether this could change in the future and under what circumstances Where is the fund invested?
This should cover the asset mix of the fund – how much is invested in shares, property, fixed interest, etc? – as well as information on exposure to other business activities.
How are investment returns achieved?
This requires information on the underlying fund returns as well as details on how this relates to net returns in the hands of investor – for example, after charges, tax and smoothing. Customers need to be reassured that there is a defined process for calculating their returns, it is not just up to the discretion of the company.
Can I understand this fund?
A simple but important question. The fact remains that with-profits is more complicated than other investment vehicles and consumers will have questions. How does smoothing work? When will MVRs apply? Explain the charges, etc. So advisers will need to be comfortable that they have picked a provider whose fund is explainable and who provides accessible information on it.
While the FSA is propo-sing additional documents,as noted above, the clarity of the material is up to each product provider.
The ability of providers to offer clear explanations of their fund will be driven by the underlying structure. For example, it is possible that the inherent complexity of a mutual fund will make a simple explanation of its operation harder toproduce.
The FSA proposals will bring about a change in the way that with-profits products are selected. Essentially, the adviser will need to pay much closer attention both to the type of fund and the extent to which product providers give clear, understandable and specific information.