From Adviser Guide: With-Profits
What are the pros of with-profits?
With-profits funds offer some unique qualities that will be very attractive for some clients and are usually sold as a safe haven product.
Although with-profits funds have been criticised for their poor returns and meagre performance - not to mention being tainted my mis-selling scandals - they offer some unique qualities that will be very attractive for some clients and are usually sold as a safe haven product.
One principal attraction for risk-averse customers is the smoothing process. This is designed to reduce the policyholder’s exposure to investment risk by providing investors with short-term downside protection in falling markets through the withholding of a proportion of the upside growth in rising markets.
The smoothing effect is designed to have a neutral effect over time, so payouts on with-profits policies do not go up and down on a daily basis as investment markets fluctuate.
There are some variations in the application of the process, notes Paul Fidell, senior investment business development manager at Prudential.
“More recently, with-profit product developments have seen some providers introduce new products which have unit prices that change daily according to an expected growth rate that is declared in advance every quarter.
“These products have the same philosophy of managing the investor’s exposure to market volatility.”
It is not a perfect process, as smoothing cannot guarantee that a policy’s value will not fall during poor market conditions and even when markets are rising it can take some time before investors see any positive influence on their returns.
But Mr Fidell points out that, as well as the attraction of a guaranteed minimum payout from some plans, with-profits do offer plenty more features to attract customers.
“When managed by a financially strong company, with-profits offers investors access within a single investment to a diversified range of asset classes – equities, bonds, property, alternative assets and fixed interest – to spread the investment risk.
“[It also offers investors] a smoothing mechanism to protect them from the volatility of investing directly in these asset classes. It’s important to remember that the final payout reflects the fair value of the policy over the time it was invested.”
Also on the upside is the possibility of receiving bonuses – although these can only be declared if there is surplus available for distribution.
Unit-linked with-profits investments offer two types of bonus – an annual bonus, declared annually or quarterly in advance with the potential for the payment of a final bonus when benefits are taken by the client.
Traditional with-profits policies award an annual bonus in arrears and can pay a terminal bonus when the policy matures or is encashed.
Each year the board of directors decides whether there will be bonus payments and if so, how much these payments will be.
The amount will depend on a number of factors, including how the assets backing the with-profits plans have performed and the overall financial position of the with profits sub fund.