With profits policies - bonuses back from the dead?

Is rehabilitation in sight for with profits policies and with profits bonds? Do recent bonus announcements indicate that with profit policies will relinquish their swear-word status and return to the in-crowd of respected, sought-after financial products? The signs look vaguely promising but it will be a considerable time yet before the industry returns to the heady bonus payout levels of the late 1980s / early 1990s. Yes, the stock market has witnessed a storng recovery and shares have risen this past year. However, many with profits funds will have missed out on the share price rebound because they earlier reduced their exposure to equities in favour of fixed interest investments.

Friends Provident was the first to herald the with profits bonus announcement (or 'without profits' and lack of bonus announcement, depending on your viewpoint) season with the report that it will increase or maintain bonus rates on its with profits policies. The company's with profits fund benefited from a 15% return in 2005, the best performance since 1998. This marks the first time in six years the Friends Provident bonus has not been cut. Yet despite last year's return on the fund, payouts are less than previous years. An example quoted is a £50 per month 25-year endowment; the bonus means a payout rise from £37,847 to £38,843 - less than the £42,072 paid if the plan matured a year ago.

Norwich Union has also reported a year of strong performance in its with profits funds and is consequently increasing payouts on most policies. Returns on the CGNU and CULAC funds were favourable in 2005, at more than 17%, compared to around 12% for 2004 and 2003. Performance from NU's Provident Mutual fund was not so strong (10.6% return) because of the fund's high level of fixed interest bond holdings. The insurer noted that, given the strong performance of equity markets last year, it had lower expectations for the next 12 to 18 months, anticipating returns of 5% to 10% for equity and property.

Respectability a long time coming?

So when can we expect a return to the days of respectable bonuses? After all the world of investment and share confidence has seen a significant boost these past 12 months. The FTSE All Share index has climbed 20% in the period, its third positive year in succession and the largest annual gain since 1999. The traumas of the bear market of the early years of the new millennium are starting to fade from memory. According to the Investment Management Association small investors have been stumping up more than £800 million a month for the past five months. Continuing this trend would see round £10 billion invested for the whole of 2006, marking the highest level since the dot-com boom of 2000.

People are putting their savings into equities again. But with profit policyholders will need to exercise patience before banking on bonus gold. In fact, the actuarial profession maintains that with profits plans that mature in the next few years will pay out even less than the poor handouts of recent years. A 15-year policy maturing this year, for instance, will not provide such a good return as one that matured a few years ago.

The reason for continued poor returns is that policies maturing in years to come will have missed out on the investment boom of the 1980s. The bad times that closed out the last century resulted in many companies reducing the equity content of with profits funds in order to shore up reserves and meet solvency requirements. In 1999 the average proportion of funds invested in shares stood at 65%; by 2005 this percentage had fallen to 30%.

With profit policies are constructed on the pooled funds concept. Policyholder money is pooled by the insurance company and invested in a mixture of stocks, fixed income and cash. The performance of the fund is reflected in the annual bonuses, with the company storing away some of the profit from good years to underwrite the bad ones. A lack of share content means that funds are not in a position to benefit from improved market conditions; the alternative is exposure to riskier investments in the hope that they will rapidly perform.

The lack of new with profits business combined with a glut of existing policies nearing maturity puts the emphasis on a safer investment strategy in order to be certain of meeting imminent payouts. Those policyholders who want to bale out have, in past years, been penalised by severe exit charges, termed "market value reductions". It has been reported that life insurers expect to reduce such exit penalties;

Norwich Union is believed to be lifting MVRs for all it policies, excepting where funds have been paid in between 1998 and 2000. Finally, note that as a result of the bad times and company reluctance to comply with tighter solvency rules, about 50% of with profits funds are closed to new investors.

06 March 2006 © Moneyextra.com

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