From Adviser Guide:
What are with-profits investments?
With-profits funds are a life company pooled investment where customers’ premiums are invested in a mix of equity, bonds, property and cash.
With-profits funds are a life company pooled investment where customers’ premiums are invested in a mix of equity, bonds, property and cash – and can eventually pay back a lump sum in the form of an endowment or income.
With-profits offer growth, some life cover and possible cash bonuses and are assured of protection from the vagaries in the stock market by a ‘smoothing’ process in the level of returns.
“The aim is that the investor should see a steadier return year-on-year, rather than the value of their plan rising and falling directly in line with movements in the investment markets,” explains Paul Fidell, senior investment business development manager at Prudential.
“However, not all with-profits investments are the same. The style and philosophy of the fund management and bonus setting may differ between providers, as will their financial strength and the ability to declare bonuses.”
Broadly, with-profits policies can be divided into two types: traditional and unit-linked, or unitised. Traditional business set a guaranteed minimum sum at the outset – to be returned if all premiums are paid. Policies can be eligible to participate in the distribution of surplus in the fund by the addition of annual and final bonuses.
With unit-linked businesses, two types of bonus are offered – 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.
Under both types of policy the guaranteed benefits are normally only payable at certain defined times, such as on the maturity date or on death. The minimum value payable on surrender at other time is not normally guaranteed.
Premiums paid in respect of each policy flow into the fund, which is then used to pay out the policy benefits as defined in the policy conditions, notes Kevin Arnott, with-profits actuary at the Phoenix Group.
“The costs of managing the fund and tax are paid out of the fund, together with an amount each year to the shareholders, where applicable. The fund is invested in a variety of different types of investments and the return earned on these investments increases or decreases the value of the fund.”
“The board determines the level of bonuses to pay and the fair distribution of any surplus arising. The board receives independent input into their decisions, often from a with-profits committee.”
With-profits models can of course differ in the security they offer their policyholders, as Mr Arnott stresses: “[Funds are] subject to a number of inherent risks that arise from a range of factors, including product design.
“For example the provision of guarantees to policyholders, selling and marketing practices, interest rate and market fluctuations and demographic changes.
“The life company make provisions which it considers to be appropriate for the risks which it identifies in relation to the business within each fund.”
With-profits funds are multi-asset funds and are generally charged accordingly, with annual management charges varying typically between 1 and 1.5 per cent, which can be reflected in the bonus rate declared.
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