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With-profits in a fight for survival

A lot has been written about with-profits recently – most of it negative. Let&#39s face it, it can be an easy story to write.

Start with falling bonus rates and then bring in the difficulties of one particular insurer whose approach to with-profits was not at all representative.

For good measure, you can then criticise the terminology – a reference to “reversionary” bonuses is always good for a laugh. You can then have a go at actuaries and the obscure rituals they indulge in when setting bonus rates.

This would be all very well were it not for the fact that these articles refer to a version of with-profits which is rapidly becoming outdated and, in some cases, is virtually extinct. If you are interested in with-profits and especially if you are advising on the purchase of withprofits, you will be more interested in where it is going rather than where it has been.

With-profits has never stood still. It has evolved over the years to meet the different demands of consumers. Usually, these evolutionary chan-ges are gradual but sometimes (as with the introduction of unitised with-profits in the 1980s) a major evolutionary leap takes place. It is quite possible that with-profits may be on the brink of another one of those leaps.

Insurers and the actuarial profession have been coming up with a number of proposals on how with-profits could change. These proposals cover all aspects of the with-profits concept from the way in which the benefits emerge to the information that the with-profits investor receives.

These are not newly formed initiatives set up as a knee-jerk reaction to the current wave of criticism. They arise out of work which was started over three years ago. Those who seek to criticise with-profits are thus reinforcing the objectives of these initiatives.

Before looking at the direction these initiatives are taking, it is worth examining the basic principle of with-profits to see if it will still be relevant in tomorrow&#39s world. If it is not, no amount of change will save it from extinction.

With-profits can only continue to be called with-profits if it retains some basic identifying characteristic which sets it apart from other forms of investment. Legislation seeks to define with-profits in different ways but, from a customer perspective, it involves investment with a high-equity content and returns which avoid the volatility of direct-equity investment.

The with-profits investor is looking for both of these features and, if equities continue to be the best long-term investment but with some short-terms shocks to the system, it seems likely there will still be a dem-and for with-profits from Mr and Mrs Cautious who want returns which are better than deposit returns without the need to watch the prices every day.

There are other forms of investment which are sometimes put forward as better than with-profits (for example, life-styling options in pension plans) and they may well produce better returns but if you want Mr and Mrs Cautious to invest this way, they should really change their name to Mr and Mrs Don&#39t-Care-About-Short-Term-Volatility. So, if the with-profits concept remains valid, what changes might investors expect to see in future?

The way in which the inv-estment return emerges may alter. With-profits has contained some form of guaranteed underpin. In unitised with-profits, it is the daily price which never decreases in value. Even if investment goes pear-shaped over a prolonged period, the amount available on the benefit dates will be based on, at worst, constant with-profits prices.

These guarantees must be backed by assets which will have a predictable capital value to match the benefit promise (for example, gilts) and this can restrict the amount of equity investment which, in turn, acts as a drag on long-term investment performance. In short, as we all know, all guarantees come at a cost.

The alternative is to have a form of with-profits which does not carry these guarantees and under which investment ret-urns remain smoothed but could rise as well as fall. Bec-ause there are no guarantees to pay for, this form of with-profits should produce better longterm returns on average. The development of with-profits under stakeholder pensions, although it started with a different agenda from the one being followed here, has ended up in a way which best supports this guarantee-free form of with-profits. Perhaps in the future the investor may have a choice between with-profits as we currently know it – still suitable for Mr and Mrs Cautious – and a newer form which might appeal to Mr and Mrs Little-Bit-Risky.

The way in which with-profits announcements are made may also change. Those who have to advise on the relative merits of with-profits offices often have very little information to go on. Bonus levels themselves are not an adequate measure. Earlier this year, the actuarial profession issued a paper with proposals for greater disclosure behind the with-profits fund so that analysts could better understand what was going and the implications for future bonus declarations.

The actuarial profession is also examining a number of options which, in the interests of greater public disclosure, will make the company actuary more accountable. This might take the form of a review of the actuary&#39s recommendations by an external independent actuary followed by some form of public domain reporting on the conclusions. These two previous points might be of more interest to advisers than individual investors but consumer needs have not been overlooked either.

Under ABI proposals, the with-profits investor will be provided, at the point of sale, with a description of how with-profits works. It will be concise, written in plain English and will explain what they can expect to see over the lifetime of their policy. To back this up, they will be given a new form of annual statement which will show clearly how their policy is progressing.

With-profits has reached the point where it has to develop to survive. The way it looks may change and so may its habitat. It can no longer survive in the dark corners of the insurance jungle and must come out into the open where it can compete on equal terms with the rest of the investment species.

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