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With-profits rule means another plus for GPPs

For those playing spot the difference between the draft and final

stakeholder regulations, the biggest surprise was the change to the

conditions for offering stakeholder members a with-profits fund option.

From the draft regulations, we knew that such with-profits funds were to

be ring-fenced to avoid any obscure cross-subsidies and that no more than 1

per cent of the overall fund could be removed each year to cover costs.

What we did not expect was regulation 15(2) which states: “A stakeholder

pension scheme shall not invest any assets in a with-profits fund that

includes non-stakeholder pension scheme assets.”

In other words, anyone wanting to offer with-profits to stakeholder

members will have to set up a brand new with-profits fund.

Providers will not be allowed to channel stakeholder members into existing

funds even if, as is the case with my own company, they meet the other


With-profits is a very popular investment choice for many individuals. It

offers those who are relatively risk-averse the chance to gain exposure to

equity investment but with some protection.

Returns are smoothed each year to reduce the effect of market volatility

and the unit price is guaranteed never to fall. Many individuals are happy

to sacrifice the potential for higher returns (perhaps from full equity

investment) in return for these safeguards, and why shouldn&#39t they?

But it is these very safeguards, or guarantees, which may mean regulation

15(2) rules out with-profits from stakeholder.

The FSA rightly requires any provider offering guarantees to demonstrate

capital adequacy. A with-profits fund must have substantial capital

backing to fall back on to cover risks such as drastic falls in equity


Any brand new with-profits fund will need a major injection of capital on

day one but where will that come from? Might this explain the absence of

any brand new with-profits funds for the last 20 years?

Some may conclude that it will be only the most financially strong offices

which will be able to offer with-profits. But this misses the key issue.

However financially strong the provider, they will expect to get a fair

return on their capital.

Under stakeholder, where the charge is capped at 1 per cent, it is

extremely difficult to see how a fair return can be achieved. It may be

that somewhere out there is a very persuasive product development manager

who produces statistics showing just how much the provider&#39s market share

of the stakeholder market will be increased if with-profits is


And there may also be a finance director out there who believes him and

agrees to stump up the minimum capital required to seed a brand new

with-profits fund.

Should IFAs rush to recommend this provider for stakeholder? There is a

far from clear-cut answer to this question. To give the potential for good

returns, with-pro-fits funds must have high equity exposure. But in view of

the inherent guarantees, the higher the desired equity exposure, the

higher is the capital requirement.

So the minimum capital injection means minimal equity exposure and poor

potential returns.

Some providers may try to mirror the with-profits concept by using

derivatives. Ironically, it looks like this will be allowed despite being

more costly and unlikely to produce ret-urns commensurate with high equity

with-profits funds.

It could be argued that, if this is the only with-profits fund available,

then it could still represent best advice. But it will not be the only


Providers of group personal pensions will continue to offer with-profits

funds. Many of these already have substantial capital backing, allowing

significant equity investment. Thus, they are likely to deliver better


While the availability of “good” with-profits funds within GPPs will not

be the only consideration when choosing the best form of pension vehicle,

it is one more plus point on the list (to be added to wider investment

choice, self-investment options and more tax-efficient advice arrangements)

which will ensure that GPPs will have a healthy future.


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