Head of with-profits marketing, Standard Life
I was glad to see the words “remains a good option” in the motion because it seems all too easy to forget just what a good choice with-profits has been for many investors.
It is over 200 years since with-profits policies were introduced as a way of dealing with uncertain mortality risk costs. Since that point, the concept has developed in various ways, particularly with regard to investment strategy.
Thanks to the equity exposure that with-profits funds have held for a number of decades, with-profits payouts represent excellent long-term real returns despite the latest round of payout changes.
Of course, one cannot ignore the criticisms which seem so prevalent these days. But it should be realised that many of the matters raised are not actually with-profits issues.
At best, these matters relate to more general aspects of, for example, historical product design and experiences of particular providers. At worst, they involve inaccurate or half-truth “soundbites” generalised into universal problems.
This historical legacy should not be allowed to obscure significant developments we continue to see both from providers and the regulator which go a long way to address the valid concerns which exist.
To new investors, with-profits is often presented as a smoothed managed fund with or without participation in other business results and represents an efficient approach to the risk/return trade-off implicit in any investment decision.
As with any managed fund, an element of investment diversification comes through the spread of investments in the fund. But what sets with-profits apart is the addition of smoothing which reduces the timing risk that investors face when withdrawing their money. Investment allocation alone cannot diversify this disinvestment risk. But if you do not want to carry the risk yourself, you either pool it with other investors through with-profits smoothing or you buy the protection.
But some may ask – is this still with-profits if it does not include reversionary and terminal bonuses? This seems ironic as the reversionary/terminal bonus system is one of the most highly criticised aspects of with profits, often due to a lack of understanding.
Reversionary bonuses can certainly provide valuable guarantees at future dates for those who hang on to their policies. But due to lower levels of nominal investment returns expected because of low inflation, the high rates of reversionary bonus seen in the past are just too expensive to offer on new policies.
Terminal bonus rates were introduced many years ago as a mechanism for delivering smoothed investment returns to policyholders. So why criticise a move to emphasise the underlying smoothed policy value, a step towards greater clarity?
Guarantees are not necessarily a thing of the past for with profits though. Many with-profits policies still guarantee no MVRs on death. MVR-free income withdrawals from bonds are another example. There seems to be an increasing acceptance that guarantees must be met from somewhere – either through a specific charge or by adjusting the asset mix of the fund. Some people will still want guarantees to feature in their financial planning, but then all investment decisions involve a risk versus return trade-off.
Another argument put forward is that every investor needs to be treated as an individual, with their own bespoke investment strategy subject to regular review. This is sometimes then used to suggest managed funds have had their day. Apart from the cost of such arrangements, it has to be asked whether this approach would result in, say, millions of recognisably different investment strategies. Perhaps the place of balanced funds, be they managed funds or with-profits funds, has not gone yet.
I do not try to argue that the alternatives to with profits are not worth considering for some investors – even though they have their limitations. Back-biting within the industry will not do much to help close the savings gap. My point is that a smoothed managed fund – ideally with participation in a well-run mutual – is a good option for investors to consider. I am not the only one who thinks this, judging from recent product launches and the proposals in a report to HM Treasury earlier this year.
Debating whether with-profits has a future is difficult because the proposition is changing. I knew the scope of my challenge when I read an advertisement in this paper for a brand new with-profits fund without either reversionary or terminal bonuses – a little like selling pencils without lead.
We have to analyse the constituents of with-profits – my definition will be a smoothed managed fund with guarantees subject to tax and charges
A deceptively simple word, smoothing has a myriad of faces. The core issue is smoothing returns across generations of customers.
Over the lifetime of most policyholders, the rough and ready approach adopted in my youth has been replaced by something called asset share, which, in effect, pretends that the customer's money has been invested in a unit-linked fund mirroring the with-profits fund. Smoothing, in effect, means paying a different amount to that notional value.
Smoothing down is easy but, for the first time in my career, smoothing upward is being tested. The problem is that this secret process is occurring in a transparent world and that inevitably leaves our audience questioning and suspicious.
When markets increased, we saw the phenomenon of orphan surplus, again a myriad of complexity, but, at its simplest, this always seemed a marketing contradiction – smoothing worked in the past such as to short-change your parents, but trust us, we will treat you fairly. I wonder if we will now see the idea of orphan deficits with shareholders giving money to the fund – dream on.
The difficulty is that, at least in the life fund, with-profits has become a capital investment -with-profits bonds predominate. If surrender values are to be smoothed (the very existence of market value adjusters suggests not), then surely every IFA has a duty to advise clients to select against the fund.
If there is subsidy at any point, surely the customer has to be advised to exploit it. Similarly, we have seen a few IFAs arguing that it is unprofessional to invest client money into funds which will have to rebuild their capital base after this subsidy. In short, transparent smoothing conflicts with the requirement of an IFA to put customers first.
Guarantees have always been the Holy Grail of financial marketing. The issue for our customers is in the mechanism. The reality is that both the regulations and practical management dictate that there is a level of equity markets at which a forced switch out of equities and into bonds or cash will occur. The more secure the guarantee the greater this risk.
Tax and charges
I have long found it unacceptable that life funds are subject to CGT while perhaps 90 per cent of its customers are not. Quite how the reality that 90 per cent of with-profits bondholders are being forced into the CGT net unnecessarily has escaped the provisions of good advice escapes me.
There has been much written on the subject of governance of these funds, but they are surely structurally flawed in that management has no motivation to reduce costs. At least 90 per cent of the costs are borne by the policyholders. Those policyholders in effect get almost no say in how that money is spent and that is just wrong in principle and certainly unacceptable in the modern world.
A with-profits fund is a mixed managed fund of equities, bonds, property and cash. The 90s saw great pressure to increase the equity content, in effect resisted only by the requirement to match guarantees. It is not so long ago that these pages saw comparative tables lauding a high equity content.
The competition in the form of Isas, notoriously driven by fashion (remember all those technology funds), similarly drove for a 100 per cent equity content.
The reality is that all customers need a balanced approach to risk assets. Whether they need that balance to be decided by a faceless institution or by their IFA on an individual basis is perhaps the great marketing question of our times. I have no doubt as a customer that asset allocation is something that I expect from my IFA, customised to my requirements.
All the research shows there is great demand for an investment evening out stockmarket fluctuations and I do not doubt that. Equally, it surely depends on the question asked. Let us contrast:
“Are you a middle-of-the-road investor who wants the benefits of stock market investment without all the ups and downs?”
“Would you like to invest in a fund where you have no control over the investment, where there are scenarios where that investment will be forced to sell equities cheap and buy bonds dear, where capital gains tax will be paid (and you may even be subject to higher rate tax on those gains), where all expenses are borne by you with no accountability from the board and where the end proceeds will be determined by that board entirely at their discretion?”
Not quite such a high take-up I imagine.
With-profits has served this country well for two centuries. It worked as a proposition in a society where the population wanted to place blind trust in institutions over the very long term. The world changed into a much harsher environment where trust is replaced by transparency, aggressive regulators and consumers and with a short-term focus
The brand has been tarnished, unfairly in many instances, by Equitable, pension misselling and endowments
It is time to move on, the IFA can no longer take the lazy approach to wealth management, he or she has to fill the void with proper understanding of the dynamics of asset allocation and proper customer risk management. Customers want to trust their advisers, not faceless institutions.