Who should invest in with-profits?

With-profits funds are by no means for everyone. Knowing your client well, these funds will be most suitable for those with a longer-term investment horizon and relatively low risk appetite and those who want the discipline of a regular savings vehicle.

The assurance of guaranteed payouts, if any are offered, may be an important factor. There is also likely to be some appeal to those who like a more balanced investment approach, with the special smoothing process with-profits funds provide.

“With-profits is an excellent diversified investment and is often considered as a ‘core investment’ component of any portfolio,” says Paul Fidell, senior investment business development manager at Prudential.

“Many investors could be considered to be cautious and they should normally have at least a medium-term investment horizon.”

There are several features to differentiate between funds, such as the guaranteed payouts offered, the level of charges, the fund’s financial strength, the equity backing ratio, the investment performance or the asset mix if you’re buying a new product.

Kevin Arnott, with-profits actuary at Phoenix Group, adds that asset allocation is more important on newer policies with lower levels of guarantees than if the customer holds an existing policy.

“It is important to consider the level of the guarantees rather than just the asset allocation. Funds that have provided high levels of guaranteed benefits often have a more cautious investment policy to make sure they are able to honour the guarantees.”

Another factor to consider might be the issue of ‘inherited estate’, where some with-profits funds have surplus assets that can be used to provide a cushion against adverse events.

By reducing the risks faced by the funds, such as by hedging some of the investment risks, the life company can reduce the amount of surplus assets that have to be held back to protect the fund against possible adverse market events.

Also, as the number of policyholders remaining in the funds runs down, some of this surplus is no longer needed and can be released. The provider can therefore use the excess surplus to increase benefits for policyholders.

Mr Fidell explains that in long-established life assurance companies, such as Prudential, the inherited estate will have been accumulated over many years from a number of different sources, including injections of capital by shareholders, premiums from previous generations of policyholders, the skill of the fund managers and investment returns on the inherited estate.

“The estate is used as working capital to support both current and future new business and is used to provide solvency support, to allow investment freedom for policyholders assets, and to provide the smoothing and guarantees associated with with-profits business.”