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With-profits stands the test of time

The popularity of with-profits bonds throughout the 1990s is well documented but times have changed and the economic environment we are living in today is very different. Some IFAs and investors might question whether with-profits bonds are still a viable place to invest new money in 2003.

The downturn in markets over the last few years has taken its toll on investor confidence and IFAs will find it hard to convince some people to move their money off deposit. After all, the investor is likely to feel their money is safe.

However, with interest rates at a 45-year low and the average gross building society rate having tumbled from about 14 per cent in 1990 to around 3 per cent now, they need to understand that inflation can eat away at the value of their money.

It may surprise some IFAs to learn that investors do not generally reject with-profits bonds although they may need to be reminded why with-profits can play a key role in an investment portfolio. Even in the difficult market conditions of recent times, with-profits bonds are still offering better returns than savings accounts over the longer term but at a lower risk than investing directly in equities.

Investors can be confident that the time-tested benefits of with-profits are as true today as they have always been.

•The spread of investments, including equities, property, fixed interest and cash, gives balanced growth opportunities and enhanced security.

•Investors can relax in the knowledge that professional fund managers are working hard to maximise performance on their behalf.

•Investors are not exposed to the full peaks and troughs of investment returns. The smoothing mechanism holds back some returns in good years to help smooth the dips in years of poorer returns.

•With-profits bonds can give investors the option of taking income and growth within the same product. Unlike some other products, investors can often start and stop income at will in accordance with their personal circumstances.

•With-profits bonds can offer potential tax advantages, for example, investors can take 5 per cent withdrawals with income tax deferred and, as the bond has no fixed term, investors have control over when to cash in their policy.

•The potential investment return is not capped in any way.

With these benefits, why should anyone doubt the viability of with-profits?

Falling bonus rates, market value adjusters and the fear that new money might be used to subsidise existing policyholders and/or bolster reserves are in part responsible for undermining investor confidence in with-profits. Under closer inspection, however, these become less of an issue.

First, let&#39s consider falling bonus rates. It is true that bonus rates have been falling over time but this is merely a reflection of the economic environment we are living in. Viewed in context, with-profits bonds are still delivering competitive real returns. For example, Prudential&#39s with-profits bond returned 11 per cent growth over the five years to May 1 whereas the FTSE All Share index returned -22 per cent over the same period.

Market value adjusters have also undermined investors&#39 confidence in with-profits and are understandably unpopular with investors cashing in their policies. However, these play a key role in maintaining fairness between those policy-holders leaving a fund and those remaining. If an MVA isn&#39t applied when necessary and a policyholder is allowed to take more than their fair share of the return of the fund, it would be to the detriment of remaining policyholders and/ or the fund&#39s financial strength.

Finally, those concerned that new money will help cross-subsidise existing policies in some way and/or be used to rebuild reserves should seek clarity from providers. A number of providers, including Prudential and Legal & General, have tried to put investors&#39 minds at rest by publicly clarifying their position. Financially strong companies, particularly, have no need to bolster reserves in this way.

It is clear that IFAs have several hurdles to overcome before they can sell with-profits bonds in today&#39s environment. Getting investors to move their money off deposit is the first hurdle. The second is to explain the time-tested benefits of with-profits. Finally, investors may need to be reassured that with-profits continues to be a viable place for the future.

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