This article challenges eight commonly held assumptions about with-profits policies. It first appeared in Skandia's Informer Magazine in May 2010.

The Great Wall of China cannot be seen from the moon. Apparently it’s the equivalent to looking at a hair from two miles away. But the urban legend that it can be seen is so widely repeated that many readers may well be surprised to read that it’s not true.

Similarly there are assumptions relating to with-profits policies that are repeatedly stated as facts by journalists and media-connected IFAs that are either misleading or just plain wrong.

With-profits has a veneer of complexity that has lead to this widespread misunderstanding. I think the confusion relates to people mistakenly believing that the policy is worth what it states on paper. However every policy has two values, the most important being the true value of the savings plan known as the policy’s 'asset share'. This figure represents the actual investment return experienced on the money invested in the fund. The other value, the one that appears on the annual statement, is only worth this amount on a guarantee date if the asset share is equal to or less than the guaranteed value. If the asset share is worth more than the policy value a terminal bonus will be paid and if asset share is less then a Market Value Reduction will reduce the pay-out to asset share (unless it’s cashed-in on a guarantee date). Understanding the role of the asset share and challenging some firmly held assumptions is the key to understanding with-profits. 

Is a Market Value Reduction an Exit Penalty?

The MVR is simply a mechanism of giving the policyholder his asset share. It works on the basis that if you want your money back at any time other than a policy guarantee date, you should not expect to get back a figure that is more than your investment has made in the fund. Policyholders should not be led to believe that getting their asset share is somehow penalising them. They instead need to be encouraged to evaluate the guaranteed value and how this might represent a significant windfall.

Should you wait for a Market Value Reduction to be removed before cashing in?

If the guaranteed value is, for example, 5% higher than the asset share but the policyholder has to wait 10 years before they can actually get the guaranteed value, what is the opportunity cost of staying in the fund for a further 10 years compared to investing the money in an alternative strategy?

A 0% bonus rate a worse return than cash, right?

It might be the case the value already guaranteed on the guarantee date through bonuses already added is worth much more than you could hope to achieve if you reinvested your asset share elsewhere. If the policy already has a guaranteed value on maturity or on an MVR free date that is greater than the policyholder’s anticipated asset share, why should the insurance company increase the guaranteed value further by adding more bonuses?

Should investors exit their with-profits fund if the life office is financially weak?

The financial weakness of the company may be tolerable if the policyholder is enjoying a guarantee on their policy, the value of which made the company weak in the first place.

Should you always keep a policy with a Guaranteed Annuity Rate?

The Guaranteed Annuity Rate has to be applied against a fund value which may be significantly lower than the policyholder might otherwise expect if they transferred. This could happen through the company adding no bonuses and investing heavily in gilts and cash over a long period. It’s important to compare the guaranteed pension payable based on the guaranteed fund against a projected return in an alternative plan using a stochastic modelling tool and reach an informed view on the value of the guarantee.

Are with-profits funds managed to maximise returns?

Where guarantees have been generous historically investment returns can be compromised by the actuary moving money into cautious assets. This risk management process can lead to insurance companies selling equities at the bottom of the market and buying them back later at a more expensive price. The lost value of this process is implied by the low return of many with-profits funds in 2009 compared to the average cautious managed unit trust. If the policyholder has guarantees of negligible value but has investment prospects restricted due to this process, even cautious policyholders should consider alternatives.

Is a With Profits Bond MVR-free date a ‘Get out of Jail Free Card’?

The with-profits bond policyholder may be in a decent fund and may not feel ‘imprisoned’ by it. I prefer the analogy of the MVR-free date being like a lottery ticket worth potentially thousands of pounds which will be lost if you don’t claim on the ticket. Regardless of the quality of the fund and the policyholder’s fondness for the investment, any investor whose asset share is less than the guaranteed value can enjoy a windfall by cashing-in on this date.

Will insurance companies adequately explain guarantees to policyholders?

In May 2007 the FSA issued an Insurance Sector Briefing telling insurance companies to improve the way they communicated to policyholders on with-profits guarantees. Some of the ‘Examples of Less Good Features’ (sic) have been seen on statements issued in 2010. The value of MVR-free dates to policyholders often runs into thousands of pounds per policy and as this value can only be claimed by cashing in its understandable that insurance companies are not making it easy for policyholders to understand. We’ve written to the FSA asking them to issue a directive to insurance companies on how to communicate these guarantees more clearly. Meanwhile it requires clients and their advisers to be proactive in checking policy conditions.

 

Communicating the Value.

The Financial Times have this week focussed in on the FSA’s findings that many insurance companies have failed to adequately inform customers of the value of Market Value Reduction (MVR) free dates and Guaranteed Annuity Rates (GAR) on their policies. As the FSA stated in their 2007 report on  with-profits, there is a conflict of interest for insurers who stand to lose out financially if policyholders fully understood and acted on their guarantees;


For many investors, the MVR Free Date on a With Profits Bond can run into thousands of pounds as the example below shows.

Did you invest in a With Profits Bond with an MVR Free Date?

As the FSA have established, insurance companies are failing to communicate valuable features such as MVR free dates to customers effectively. You need to check your policy document and be very specific in your questioning if you ring to ask if your policy has such a feature. We suggest you ring your insurer armed with the following questions:

“Does my policy have a date when I can withdraw the current fund value and a Market Value Reduction is guaranteed not to apply? What is the date and when do you need to be notified of my intention to divest?”

If the MVR free date has passed, “Do you allow for this MVR free date to be carried forward and remain effective now or is it too late?”

If they answer that the option has expired, please move on to the section below for further questions to ask. If the MVR Free date is still available to you ask:

“What is the current fund value of my policy?”

“What is the surrender value of my policy?”

“What is the value of the Market Value Reduction currently applying if I were to withdraw my money from the with-profits fund today?”

If you have passed the MVR Free Date and the insurance company is carrying forward the value of the MVR (such as Aviva [ex-CGU]), “What is the value of the carried forward MVR free amount that applied on the MVR Free date?”

“Are there any unit-linked funds that I can switch my money into without surrendering the policy?”

After asking these questions you should be able to ascertain the value of this MVR free feature for you. If the date has not yet passed you should consider your actions and be ready to act in good time. If you are at all unsure, please contact an Independent Financial Adviser with expertise in with-profits such as us at Fraser Heath Financial Management. But what if the date has passed?

What to do if your MVR Free Date has Passed

If the MVR free date has expired, you need to find out whether it had a value on the MVR free date by asking;

“What was the current fund value, surrender value and size of the Market Value Reduction on the MVR free date?”

“What is the current fund value, surrender value and size of the Market Value Reduction today?”

If you recognise from having asked these questions that you have lost out financially and you feel that you were not aware there was a financial gain to be made, ask: “I want to make a formal complaint because if I had understood that I could make this gain by divesting I would have acted. Please let me have the name, department and address for the person who deals with formal complaints.”

You then need to write in explaining that you did not understand the value to you of divesting and that you feel that the insurance company failed to adequately inform you about the feature. You should also point out that it has been the FSA’s report into insurance companies failing to communicate adequately that has brought this matter to your attention. Your letter should ask for your investment either to be switched into a unit linked fund or returned to you entirely at the value that would have applied on the MVR free date. Seek independent financial advice if you are unsure of what option (switching or cashing-in) is most suitable for you and be mindful of the Note about Surrendering below.

We anticipate that the insurance company will in the first instance reject your complaint and point to their letters that they have issued to you. In this event we believe that you should consider taking your complaint to the Financial Ombudsman’s Service citing the FSA report as being the catalyst for you understanding the feature and not the unclear letters from the insurance company.

Keep us Informed

We wish you good luck in your investigations. If you are affected by this we’d love to hear from you, whether you need our help, investment and tax planning advice or simply to share your experiences and frustrations.

A Note about Surrendering a With Profits Bond

Surrendering an investment bond can impact on income tax. If you are a higher rate tax payer (or may become a higher rate tax payer when the gain you have made on the policy divided by the number of years you have held it is added on to your taxable income), or if you enjoy the age related personal allowance for people aged over 65, you should also ask “What is the chargeable gain on the policy if I surrender the policy today”.

Alarm Bells and Little Comfort.

The FSA’s findings in their “With-Profits Regime Report” released on 30th June 2010 should ring loud alarm bells for with-profits policyholders, but their proposed actions offer little comfort for the hundreds of thousands of policyholders who stand to lose up to an estimated £1 billion from the inadequate communications of with-profits companies.

Insurers Fail to Communicate Valuable Guarantees Effectively

With an estimated 28 million policies worth £338 billion in with-profits funds at the end of 2008, savers might expect there existed a great deal of scrutiny and policing to make sure that the funds are well run. The police force for with-profits are the Financial Services Authority and in March 2010 they set out a Financial Risk Outlook 2010 with a section on with-profits that highlights just how big the problems are that they face in policing these funds.

A summary of the full list of activities that with-profits funds can carry out which might lead to poor outcomes for policyholders are at the foot of this news article.  The size of the list and the very fact that the regulator recognises that it has to try and keep a watch on all of these shenanigans should be enough to make any saver stop and ask whether their with-profits investment is really right for them.

For savers in With Profits Bonds approaching the 10th anniversary of making your investment, please pay particular attention to this concern of the FSA:


We know that many policyholders with guarantees on their policy (such as a guarantee to not apply a Market Value Reduction on the 10th anniversary) simply do not fully understand the benefit. In many cases these benefits have values worth thousands and even tens of thousands of pounds. The guarantees typically have a value on specific dates and if you don’t act on those dates you lose the value altogether.

If the FSA subsequently fines insurance companies for poor communication of these guarantees it will be scant consolation for those who missed out.

Our advice therefore is that you cannot rely on the cavalry coming. If you have a with-profits policy make sure you understand exactly what the guarantees are, what the value of the guarantees are, and when they take effect. Fraser Heath Financial Management can help you do that.



Here’s the full list of risks that concern the FSA about with-profits taken from the FSA’s Financial Risk Outlook 2010, pages 8 and 9.

• Investments that may not be appropriate to the with-profits fund, and which prevent policyholders from receiving fair value in any pay-outs or bonus distributions.
• Policyholders bearing costs that are not related to the running of the fund;
• New business being written on terms that are likely to be detrimental to existing with-profits policyholders;
• Governance that does not properly protect with-profits policyholders’ interests or take their interests into account in actions taken by the firm;
• Investments that may not be appropriate to the with-profits fund, and which prevent policyholders from receiving fair value in any pay-outs or bonus distributions. This may also be caused by low levels of excess capital resources within a wider group structure prompting utilisation of with-profit estate capital for support of strategic investments, such as intra-group or contingent loans, in a way that is detrimental to policyholders;
• Customers not receiving sufficiently comprehensive, timely and clear information to enable them to take a reasonable view of the risks and benefits of their with-profits policy;
• Firms whose new business volumes are materially diminishing, and those running closed funds, which are not fully addressing financial or operational risks and not acting early enough to formulate and implement coherent plans to distribute assets held within the fund in a way that is fair to all policyholders;
• Outsourcing administration and asset management functions (for the purpose of rationalising or controlling cost bases) which magnify conflict of interest issues, particularly where the outsourcing provider is connected to the firm; and
  
• Firms not using tools such as Market Value Reductions (MVRs) fairly and proportionately to ensure all classes of policyholders are treated fairly.
  

Some of the above risks become more acute in recessionary or volatile market conditions. For example, recent conditions could have the effect of exposing any previous pricing weaknesses where terms of business were written with heavy guarantees that are not self-supporting. This could lead to a firm seeking to offset the cost of such guarantees by reducing bonuses, increasing charges to policies and increasing MVRs in a way that is unfair to policyholders. It could also create an incentive for a firm to use inherited estates and existing policyholders’ funds to finance the guarantees for new business. Such actions could be unfair to other policyholders and lead to adverse perceptions about the firm or the sector.

Aviva last improved their MVR rates in October 2009. Although investment sentiment had improved by the time of their Annual Bonus Announcement in January 2010 they declined that opportunity to improve rates further. In view of the investment turmoil generated over Greece and the eurozone, and concerns over the strength of sterling and government gilts, we were surprised to discover yesterday that Aviva had improved their rates this month (May 2010).

Unusually Aviva have not yet commented on this action. There could be many reasons for this and we hope that we will get an announcement in the coming days. In view of the stock market correction of the first two weeks of May, this quiet improvement could signal a good time for Aviva with-profits policyholders who have been dissatisfied with their policy to get out of the fund as it implies that the surrender values and transfer values will be close to their true worth (asset share).

If you are thinking of surrendering your Aviva with-profits investment be sure to check the value of your guarantees and seek independent financial advice if you are at all unsure. We'd be pleased to hear from you. For more about this change, there's a new entry on the With Profits Health Check blog. 

The May edition of Moneyfacts magazine included a detailed review of the past performance and future prospects of With Profits Bonds. The article included a number of comments from Fraser Heath Financial Management's Head of With Profits Research Miles Hendy. Here's a few extracts from the article.



Some commentators believe that there are clear parallels between 2003 and 2009 as far as with profits funds are concerned. "In both years, falling share prices in the preceding year meant that many with-profits funds had to move in to less volatile investments to ensure they stayed solvent," elaborates Miles Hendy, a Chartered Financial Planner and Head of With Profits Analysis at Fraser Heath Financial Management. "Taking Scottish Widows, Aviva (CGNU) and Legal & General as three examples, in 2003 the average exposure to stocks and shares of these companies’ with-profits bond funds reduced by 18% from the year before and in 2009 the average equity holding of these three reduced by 11% from the year before. Selling out of shares at or near the bottom of the market means that they don’t fully enjoy investment returns when markets recover. So in 2003 the average cautious managed unit trust grew by 15.3% while the average growth of these three with-profits bond funds was 11.9% and in 2009 the average cautious managed unit trust grew 15.6% while the average of these three was 9.7%."



Given the annual bonus excesses of the past, it is perhaps understandable that most providers continue to tread carefully where these are concerned, with bonuses currently around 2.25% to 3.75%. "Bonuses increase the guaranteed returns that the insurance company have built in to their with-profits plan," comments Miles Hendy "In many cases the guaranteed returns are now far in excess of the policyholder’s asset share (the true value of their investment based on money invested and the growth experienced on that money) and it would be folly for insurance companies to increase these guarantees further by adding on generous bonuses. A low bonus rate or a 0% bonus rate is not necessarily a problem if the policyholder already has generous guarantees."



"New business sales are evidence that the fear of loss weighs heavily on investors’ minds and that there is high demand for cautious investments," concludes Miles Hendy. "With-profits can survive, but in order for it to thrive again it needs to overcome some extremely difficult challenges. If it can find a way of offering guaranteed returns combined with low costs and reassurance about investment efficiency, and combine that with a proper education programme for “new model” advisers then it could pull through. If I were a betting man, my money would be on it becoming increasingly marginalised."



For more information and advice on your With Profits policy, please email miles@fraserheath.co.uk or call him on 01454 327788.

With every day that passes a few more policyholders unwittingly lose the value of their 10th anniversary With Profits Bond guarantee as the date for them to exercise the option expires. Unlike most insurance companies, however, Aviva have allowed policyholders who pass their 10th anniversary guarantee date to carry forward the value of the guarantee.

We've been long concerned that by carrying-forward the No-MVR Guarantee policyholders might be lulled into thinking that they do not need to take any action. This would be an expensive mistake. We've argued that Aviva must do more to explain to policyholders that these no MVR Guarantees are extremely valuable but only if policyholders switch out or cash in.

After Professional Adviser joined in the campaign, Aviva have made some changes to the wording of their 10th anniversary letter and have agreed to improve the quality of their ad hoc statements.

Aviva are caught in the common position for insurance companies of managing a conflict of interest. On the one hand they know that if every policyholder understood this guarantee and cashed-in they would need to raid the Inherited Estate they acquired in last year's reattribution exercise by hundreds of millions of pounds. On the other hand, they are required by the Financial Services Authority to treat customers fairly and Aviva's head of investment marketing has stated that Aviva's "own advice is currently to switch out of with-profits (or surrender, if the money is needed) to benefit from the guarantee."

We call on the personal finance media to help policyholders urgently get to grips with their with-profits guarantees.

Readers wanting to know more about 10th anniversary guarantees can receive our free Aviva Aluminium Report.

Professional Adviser ran the following article on the front page of their February 18th 2010 edition.

The Aviva Aluminium Report is our 12 page report which explains the main issues that we believe With Profits Bond holders with Aviva (sold through CGU) should understand about their investment. While it focuses on Aviva, the concepts we explain will be of interest to any With Profits Bond holder.

The report includes;

• Why this With Profits Bond is like winning the lottery
• How you will lose if you don't claim on your winning lottery ticket
• What Aviva say about the 10th anniversary guarantee
• How the money is found to pay for these valuable guarantees
• What to consider if you don't have a guarantee

For your free copy of our Aviva Aluminium Report, please click here.

How did With Profits get into its troubled state? Was it a "rip-off" like some have suggested or was it more related to the changing economic environment? In a new blog article With-Profits' Malaise: The Cause and Effect, our with-profits expert Miles Hendy looks at the past 50 years of with-profits and warns that the cause of with-profits' malaise are valuable guarantees that are at risk of being discarded.

Like that long awaited bus, not one but two blog articles appear today. In With Profits Bonds in Plain English, Miles takes a look at what might appear in a With Profits Bond sales aid if the companies were a little more truthful.

Aviva this week stated that they considered that future sales of With Profits Bonds are likely to come from direct marketing and other affinity partners rather than through Independent Financial Advisers. The article appeared on the front page of Professional Adviser and withprofitsheathcheck's with-profits expert Miles Hendy was quoted.

There are good reasons why so many Independent Financial Advisers no longer have confidence in With Profits Bonds and Aviva's comments generated a vociferous response from IFAs in the comments section on the ifaonline website.

The Professional Adviser article appears below under the heading "IFAs to Lose out to Banks on with-profits" .