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Too much to bear for reserves

It is interesting to read of the apparent dilemmas surrounding advice to clients on whether they should remain invested in with-profits or go into something else.

First, I think perhaps that the FSA may be quoting somewhat conveniently out of context the IFA who is reported to have asked whether he was expected to understand the with-profits policies on which he had been advising for the past 10 years.

The benefits distributed to investors in with-profits funds have always been subject to a high degree of actuarial discretion and few people outside that profession could reasonably be expected to understand the workings of the actuarial mind. But, in a nutshell, an actuary is employed to strike a carefully chosen balance between what policyholders will accept as a satisfactory return on their investment and what his employing company can get away with creaming off for itself. That is about the measure of it, isn’t it? How many life office actuaries ever invested their own money in with-profits? Reportedly, hardly any.

Three or four years ago, it seemed to most advisers unconscionably vindictive of the FSA to start sticking the boot into with-profits funds at the very time when they were most vulnerable to attack. But, nearly three years after the UK stock-market finally bottomed out and started what has been a strong recovery, we are still seeing feeble levels of reversionary bonuses (if any), little if anything in the way of terminal bonuses and savage MVRs only now starting to become an unpleasant memory.

What really caused with-profits to come so badly unstuck was a longer bear market than they had ever had to cope with before, revealing that their traditional reserves against bad times were in fact of very finite capacity. As Ned Cazalet has pointed out, a bear market any longer than two years was simply more than with-profits funds had ever been equipped to deal with.

So, when I write to clients about their with-profits investments (mainly single-premium bonds), I point out:

l The average annualised return on their investment achieved over the past however many years (usually less than 5 per cent).

l The current levels of reversionary bonus.

l The amount by which investors have missed out on what world stockmarkets have achieved since mid-2003 and, in the light of the reforms imposed by the FSA as to the way in which with-profits funds are run (which, in themselves, are not entirely unreasonable, I have to admit).

l The future outlook for the with-profits investment medium.

Most clients need little persuading that with-profits is a dinosaur investment medium that has basically had its day. Of what value are smoothed returns mechanisms that manifestly fail when the going gets tougher than an 18-month or two-year stockmarket downturn?

Nearly all our clients just want out from their with-profits bonds as soon as this can be achieved without an MVR. Churning? Not a problem. All you need to do is take reduced commission on the reinvestment and there is no reason for the client not to feel quite satisfied that they are being treated fairly. All that is needed is an under-standing of the issues and an ability to communicate them properly.

Julian Stevens

WDS IFAs

Bristol

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