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What now for with-profits?

With-profits is proving as difficult as Rasputin to kill off. The expected bombshell from Ron Sandler, which many had feared would kill off with-profits, failed to materialise and life companies are breathing a collective sigh of relief.

While his report has plenty to say about with-profits – indeed they formed one of the original reasons for the review – smoothed investment vehicles will have a continued place, even if in an altered form and perhaps name.

Speaking in the House of Commons debate following publication of the Sandler report, Treasury financial secretary Ruth Kelly gave the with-profits an unexpected – if qualified – endorsement. She said: “With-profits policies are a huge feature of the British savings landscape. Many people have valued, and will continue to value, the ability to smooth out investment returns, so change in the market cannot come overnight, but with-profits policies do need to change.”

Sandler is understood to have transferred out of Equitable Life while drawing up his report but his review team reportedly all have with-profits policies and, as has so often been pointed out, it is estimated that there is just under £400bn in with-profits, so any change would not just impact on the savings industry but the capital markets as well.

So, rather than abolish with-profits, Sandler has given them a starring role in his new threepiece suite of safe-haven “stakeholder” products.

Relieved life companies have – officially at least – welcomed Sandler&#39s report. Even the widely anticipated requirement for with-profits funds to be ringfenced transpired in the report to have survived only in a much-diluted form. For the “safe” stakeholder version, with-profits would have to conform to the ringfenced 100/0 structure and adhere to new transparent regime with explicit charges.

However, the report recommends that its “new model” of with-profits should apply to all with-profits policies in time, except for the ringfenced structure. But it criticises the 90/10 structure for allowing a conflict of interest and predicts that the companies would move over to the 100/0 structure of their own accord.

Policyholders of companies which chose to close existing funds rather than convert would have their existing rights protected. Nevertheless, analyst Ned Cazalet believes the Sandler proposals have the potential to heap all the risk on to existing customers.

Standard Life marketing director Michael Leahy predicts the company could offer three different kinds of with-profits, even though Sandler proposes that mutuals are exempted from the ringfencing proposals, even for “stakeholder” with-profits.

Norwich Union chief actuary Mike Urmston says any regime that differentiates bet-ween mutual and proprietary companies is unfair and that his company will push hard to stop any such rules from being introduced. The FSA is set to consult on the proposals this autumn.

However, Norwich Union is considering the ringfencing of its fund and the reattribution of its orphan assets – valued at £5bn at the end of last year. But it says it will continue to write 90/10 business for the foreseeable future.

The Sandler report&#39s trenchant criticisms of active management are extended to with-profits. The reports says: “The probability of the same prov-ider outperforming the index through active management over the normal horizon of a policyholder is close to zero.”

Again, providers say this is already being done to some extent – Urmston says he can see Norwich Union offering both actively and passively managed with-profits.

However, the writing is on the wall for the with-profits moniker. The report recommends the term “with-profits” should be looked at. It says it is an historical term which conveys no useful meaning and might better be replaced by “smoothed investment funds or similar”.

Companies have been lining up in a beauty parade to claim their specific with-profits is the one that Sandler is proposing. Indeed, there has been an array of reinterpretations of with-profits over recent years by various companies. Most recently, Scottish Widows has launched two ring-fenced with-profits products in growth and income flavours.

Scottish Widows brand and network development director David Graham says: “We are feeling quite pleased that our with-profits meets most of the new requirements. It is not often that Scottish Widows finds itself in the forefront.”

Other providers claiming their products anticipated Sandler&#39s recommendations in some way or other include Skandia, CIS, Norwich Union, Britannic Assurance and Standard Life.

Some commentators bel-ieve that a wholesale restructuring of with-profits could initiate another bonanza of carpetbagging as shareholders are forced to buy out policyholders. Money could speculatively be placed in the funds most likely to receive cash distributions from orphan assets and Norwich Union is acutely aware that regulatory changes should avoid creating any such massive instabilities in the market.

Similarly, Sandler&#39s recommendation that a level playing field between fund management firms and life companies be created has similar potential, according to Hargreaves Lansdown head of research Mark Dampier, who predicts a firestorm sale of investment bonds ahead of the introduction of any new rules.

Hargreaves Lansdown created a stir recently by announcing that they had put a with-profits on hold and are not swayed by Sandler&#39s newcomers. Dampier says there is nothing in Sandler&#39s report that would make it reverse that decision. Although the firm continues to sell stakeholder ringfenced with-profits and it says it would look carefully at new vanilla products if and when they surfaced.

Dampier says the recommended removal of one of investment bonds&#39 biggest attractions – the 5 per cent withdrawal rule – is a fatal blow for with-profits.

He says: “It is like saying you can carry on fox hunting but without horses. It is potentially the death knell of with-profits as we know it. But that is not to say that some clever marketing person will not come up with a new role.”

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