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With-profits freeze for investors while funds soar

Laith Khalaf
Laith Khalaf: ’What is the point of a fund that smooths the ups and downs of the stockmarket when it is hardly invested in it?’

Investors in with-profits funds are facing disappointment this year as providers freeze or even cut annual bonus rates despite delivering strong returns.

Friends Provident, Standard Life and Aviva have revealed their annual bonus rates following reviews. Standard has reduced 500,000 customers’ rates as it looks to increase its exposure to equities and property despite all the company’s funds achieving double-digit returns.

Friends decided to freeze the bonus rates for most investors in the Friends Provident with-profits fund despite returning 13 per cent in 2010. All annual bonus rates in the Axa Sun Life and Sun Life funds are also unchanged.

Aviva has held bonus rates for all its two million customers, although the terminal bonus has risen by 6 per cent.

Prudential and Legal & General are expected to announce annual bonus rates in the coming weeks. With-profits funds offer investors a guaranteed level of return – the sum assured – at the end of the policy. Providers then seek strong investment performance with the aim of returning more than the guarantee. If investments outperform the sum assured and the annual bonus, a finalb bonus will be paid out. If investments dip below the sum assured, the policyholder should still receive a payout equal to the sum assured.

The key problem with the annual bonus, according to Hargreaves Lansdown pensions analyst Laith Khalaf, is it increases the guaranteed value of with-profits policies at maturity. He says: “Insurers are naturally cautious about increasing regular bonuses and would rather bide their time and pay a terminal bonus on maturity if things have not gone belly up.”

Phoenix Group, which manages closed with-profits funds, says annual bonus rates have been low in recent years because the benefits guaranteed under most policies are high in comparison with investment.

Phoenix deputy with-profits actuary Andrew Burke says insurers are involved in a balancing act between annual and final bonus payment rates.

He says: “In managing a with-profits fund, you want to retain sufficient flexi- bility in the fund to have the opportunity to maintain a reasonable exposure to gro- wth assets.

“If your guaranteed benefits get too high you might start to find yourself constrained in the investment policy you can run.”

With-profits funds do not guarantee that the annual bonus will rise in line with strong investment performance and tend to adopt a cautious investment policy to ensure they are able to meet their liabilities. As a result of this caution, insurers tend to avoid regular increases in annual bonus payments in favour of a bigger terminal bonus if the fund has performed well on maturity.

Khalaf says the fact with-profits funds have to base their investment strategy on liabilities is a fundamental structural flaw. He says: “Insurers target a percentage payout, typically in the region of 80 per cent to 120 per cent of your fair share of returns. So you might get lucky but you might get unlucky. I think investors would rather know where they stand.

“With so many with-profits funds with such low equity exposure, you have to ask the question – what is the point of a fund that smooths the ups and downs of the stockmarket when it is hardly invested in it?”


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