Fixed IncomeJan 3 2014

With-profits bonds: Closed for business

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It is hard to deny that with-profits bonds are getting less popular. However they are performing, sales numbers are not particularly inspiring and the landscape for the bonds is noticeably different to what it was a decade ago. That said, there still many bondholders out there with money sitting in existing investments and several companies are taking on new business.

This new business is operating in opposition to a culture of malaise around with-profits bonds, where companies often show little motivation to provide their figures. Firms seem to err on the side of inaction when it comes to with-profits bonds.

Part of the original appeal of with-profits bonds was that they were generally viewed as lower-risk products than many due to their ‘smoothing’ strategies. In addition, they include a mixture of assets and annual bonuses that usually cannot be taken away once they have been added.

This does not mean, however, they are completely risk-free; with-profits bonds are not appropriate for investors who may need to access some or all of their capital within the first five years as early surrender penalties apply. On top of this, a market value reduction (MVR) could apply to withdrawals at any time, although fewer and fewer companies are currently imposing it (illustrated by Table A).

One of the main advantages of with-profits bonds, and consequently one of the reasons clients might still consider them as an investment option, is the tax situation. Basic-rate taxpayers do not pay income tax when the bond is cashed in because the provider has already taken responsibility for the tax. It is possible to withdraw 5 per cent each year without any immediate tax liability, since the level of tax is calculated upon issuing the bill, rather than when the money was drawn.

A justified criticism of with-profits bonds is their lack of transparency. It is down to individual providers to determine the amount given as a bonus, or if there will be a bonus at all. Current terminal bonus rates are shown in Table B.

There is also the issue of MVR which is likewise decided and applied by providers should an investor want to withdraw their money early. Policyholders have no way of knowing what level the MVR will be in the future. Another point of criticism of with-profits bonds is that where companies are no longer taking on new business, they are less motivated to provide attractive returns through active management than those that want to attract new customers. The lack of competition is an increasing problem.

New business

Regardless of a fall in popularity from days gone by, there are still many firms open to new business and these figures, shown in Table 1, are looking healthy. A total of 12 providers responded to our survey as taking on new business, and many of those show elevated figures from last year.

An important point to note is the enormous difference between totals for 2013 and last year’s survey. This is because in 2012, Prudential’s return listed the annual premium equivalent (APE) of its new business, which is 10 per cent of the actual figure. For this year, it answered with the actual totals, which means it appears to have massively increased business when in fact it has gone up by an expected amount.

Annual management charges differ greatly between different providers, from 0.5 per cent for investments of £50,000 or above with Aviva, to Forester’s 2 per cent. Some are less explicit with charges; Royal London, for example, makes no annual charge and administrative fees are taken into account in the setting of bonuses.

Last year, Legal & General was the second-best performing company in terms of new business but this year, things have changed. In December, L&G announced it would be taking on no new with-profits bonds business. While those who already hold with-profits bonds will still be able to make transfers, no new bonds will be sold for an indefinite period. According to Mike Connolly, PR manager at L&G, “The reason is low sales volumes. Extremely low sales volumes, I would say.” For one of the best-performing providers to step out of the market shows the changing landscape for with-profits compared to a decade or two ago.

Across the companies that supplied new business information, overall sales figures are down quite considerably for July 2012 to November 2013, although the January to June period is roughly similar for the past two years.

Aviva’s sales figures slow down quite sharply over the course of 2012, and although it did not supply figures for the second half of 2013 the trend was clear. Sales dropped from £113.1m between January and June 2012 to £4.3m for the same period of time in 2013. Where 3,676 were sold in the first half of 2012, only 97 with-profits bonds were sold by Aviva during the same period a year later.

What’s available

Looking at existing bonds, performance can vary greatly as shown in Table 2. This Table shows the performance over 10 years of a £10,000 investment for a male aged 50 on encashment to 1 November 2013. Where companies are marked F59, they chose not to participate in our survey and these results were obtained from their FSA return and are correct to 1 March 2013.

The difference between figures for the first five years of the investment and the full 10 years shows the benefits of leaving with-profits bonds to mature. Even over short time periods, however, there is improvement; the average cash-in AGR over one year was -1.2 per cent last year, but this year is 1.9 per cent.

Over the first year of investment, the best-performing with-profits bond was from Wesleyan, with an AGR of 9.9 per cent as opposed to the average of 1.9 per cent. During the first few years of investment, cash-in values are typically lower because of penalties imposed for early exits.

Over 10 years, the average AGR was 4.6 per cent in 2012’s survey, but this year stands at 5.7 per cent. While not stellar, it certainly marks a change over the past year. The best-performing with-profits bond over 10 years was also from Wesleyan, giving a cash-in value of £21,785, which represents an AGR of 8.1 per cent. This displaces Royal London from the top position.

Results from some companies are far poorer, dragging down the average. Engage Mutual Assurance is right at the bottom of the league table, providing a cash-in value of £13,323 at an AGR of 2.9 per cent, which, on a 10-year investment, strikes as being extremely disappointing.

In terms of long-term trends in cash-in values, things are better than they have been in a long time, with the best and the average 10-year values at their highest in the past decade. Even Engage’s – the worst-performing bond – is higher this year than every year for the past nine years. Figures for one- and five-year investments are roughly in line with expectations, as shown in Table 3.

A look at the asset allocations of a bond that performed impressively and one that has performed poorly can be an indication as to why this is the case. A full breakdown of asset allocations can be found in Table C. Healthy Investment, for example, holds 66 per cent in fixed interest (as opposed to Wesleyan, which has just 11 per cent), which could suggest a lack of active management and attention. 63 per cent of Wesleyan’s assets are equities, which makes its bond and the Friends Life Investment Bond the products with the highest equity allocation.

It is clear that with-profits bonds have fallen out of favour, for a number of reasons, which means active marketing and competing for the best rates is no longer providers’ top priority. While there are still many millions of pounds tied up in these products, though, the onus must be on the provider to give them the kind of attention investors deserve because, as some companies show, good returns are possible.