A formally closed fund is required to operate to a formal run-off plan, designed to ensure that the fund is paid out over time to its policyholders - plus any shareholders’ share of profits - in a fair way.
The FCA has to be sent a run-off plan when a with-profit fund closes and the regulator can also ask a provider to send its current plans at any time. An open but shrinking fund will also have a plan to ensure that future payouts to different generations of policyholders remain fair.
Even a formally closed with-profits fund can continue to receive additional contributions to existing policies and even admit new members to existing pension schemes. Providers may not be able to continue to support this for all of their many different types of with-profits policy.
Unit-linked policyholders may also still be able to switch into the with-profits fund.
So a client being in a closed fund is not necessarily a cause for concern, says Mike Kipling, with-profits actuary at Friends Life. Indeed, he says being in a strong fund which is running off can have advantages, as the run-off plan may require it to distribute its ‘inherited estate’ to maturing policies.
He says key areas for advisers to look out for when reviewing their clients’ with-profits investments are the proportion of the underlying asset invested in shares and the target proportion of ‘asset share’ used when setting bonus rates.
Mr Kipling says: “A high equity backing and a target of well over 100 per cent of asset share are signs of a strong fund with an inherited estate to distribute - although a high equity backing can also lead to larger falls in expected payouts when markets deteriorate.
“If a closed fund does not have these advantages, particularly if it has a low proportion of equities, it is worth considering whether a client should surrender their policy and invest elsewhere.”
For clients whose with-profits investments have passed their original objective, for example late retirement, bonds older than 10 years, it is worth checking with the issuing provider whether any material guarantees remain or might expire shortly and whether the product continues to accrue further bonus entitlement.
If the answer is not positive, Mr Kipling says an alternative investment may well be appropriate.
He notes policies with generous guarantees and, in particular, guaranteed annuity rate options, should only be surrendered after proper consideration of their value.
Paul Turnbull, actuarial and capital director at Aviva, says when reviewing guaranteed annuities, advisers should check for key dates, such as future surrender value or inflation-protected guarantee dates.
If there are guarantees, Mr Turnbull says it is important to check the policy terms and conditions so you understand when they would apply, whether a ‘market value reduction’ could be applied at any point, and options during the client’s guarantee ‘window’.
Assessing funds
When assessing an existing closed fund, many of the risk and return factors that should be taken into consideration are similar as for any investment: what is the asset mix, how is the fund performing and how is this likely to develop, what is the impact of charges, and how is it affected by the wider economic context?
In terms of assessing the underlying portfolio, Mr Turnbull says advisers need to calculate the equity backing ratio (EBR), which is the amount the with-profits fund invests in shares and property.
Although these “real” assets carry more investment risk, they are likely to bring higher returns in the long term, so the higher the EBR the better performance you can reasonably expect. Ultimately, it is all about whether the asset mix is still appropriate for the client’s attitude to risk.
It is also only likely to be appropriate if it is performing to expectation. When assessing how the fund has fared Mr Turnball says advisers should particularly consider what the clients expectations were, whether their needs have changed, and how this fund compares against peers.
You can also look at the underlying fund’s performance, which is usually published each year, but crucially Mr Turnbull says do check policy payouts (including any final bonus or MVR), and remember that smoothing can increase or reduce what is paid out.
While with most providers regular bonuses on (unitised) with-profits bonds can be taken away, for example when MVRs are in force, Mr Turnbull points out the bonus rate still provides a reasonable gauge for the growth prospects within a fund.
Mr Turnbull adds advisers should also consider the financial strength of the provider, which is important to affirm the provider will be able to support guarantees that have been written by the fund and is more likely to withstand poor market conditions.
Good financial strength can also allow for a higher EBR and the long-term performance benefits that may bring. Check with ratings agencies such as Standard & Poor’s, Moody and Fitch, or consulting actuaries such as AKG.
Cashing out
If a client is being offered the opportunity to exit, Phil Brown, head of retirement propositions at LV, says this should very much depend on why the final offer is being made. He says your clients will need to understand the size of the offer versus the right they are giving up.
For clients considering cashing in, Mr Turnbull says you should consider whether this would trigger a chargeable event – and how this would affect the overall net return. If there was a significant chargeable gain, switching options within the same policy may be preferable.
He says: “Some providers apply MVRs in different ways, for example they could be calculated and published up-front or, instead, calculated individually based on asset share at the point of surrender... it is important to understand the policy before making any decision.”
