Your IndustryNov 13 2014

Different types of with-profits funds

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Whatever the product type, with-profits is supported by a fund that follows the same principles.

The main differences between with-profits and other investments are:

1) The value is ‘smoothed’ over the long term, typically through the application of annual ‘bonuses’ to eventual payouts which include a portion of market growth in strong years and of held back growth in weaker years;

2) There are certain dates where investment growth can be ‘guaranteed’, including selected retirement dates on some pensions; maturity dates on endowments, the death of the life(s) assured.

With-profits funds usually invest in a wide range of assets such as equities, property, gilts, corporate bonds and cash.

Paul Turnbull, actuarial and capital director at Aviva, says small portions of the fund will also probably be invested in areas such as emerging markets and foreign property, to diversify the fund and boost performance.

With-profits providers will change the mix of the fund over time according to several factors beyond simply market conditions - clearly as important a consideration as for any other fund - for example to manage the risk of previous guarantees (liabilities) built up in the fund.

There are two types of with-profits policy: conventional (sometimes known as traditional) and unitised.

All with-profits policies used to be conventional, according to Mr Turnbull. This meant a policyholder paid a premium or a series of premiums in return for the insurance company providing a benefit on an agreed date.

This might have been a payment in the event of death, or a guaranteed minimum pension on reaching a certain age.

Unitised with-profits policies became popular in the 1980s and have since become the predominant mechanism for with-profits funds. The advantage from both a policyholder and insurance company point of view is that it is easier to calculate the value of the policy.

In addition, Mr Turnbull says a benefit of the latter is that policyholders can move between unitised with-profit funds and other unitised funds, for example, unitised equity or unitised property, more easily.

Not all with-profits funds are still open to new business and as a result there can be a big difference between with-profits funds. Asset mixes and financial strength, for example, can vary considerably.

Mr Turnbull notes: “As a general rule, large funds and funds that are still open to new business often have higher exposure to equities and property, which might be expected to produce better long-term returns than smaller closed funds which tend to have lower exposure to these assets.”

Wrappers

In terms of the different ‘wrappers’ adviser can find with-profits funds presented in, these remain many and diverse.

With-profit bonds: products where you make a one-off lump sum investment, with the aim that at the end of the term the investment will have grown in overall value and bonus payments.

With-profit endowments: clients pay a monthly sum in each month for a certain period of time, for example 10 or 25 years, and then are typically guaranteed the amount paid in boosted by investment growth and annual bonuses.

With-profits pensions: client makes regular contributions or a single premium into a fund, which is invested with the aim of growing the fund through typical with-profits mechanisms.

With-profits annuity: Phil Brown, head of retirement propositions at LV, says at retirement there is the option for a policyholder to buy a with-profits annuity, which enables them to leave their money invested. The product aims to deliver a bonus each year to increase the standard guaranteed income.

Within a typical with-profits fund, Mike Kipling, with-profits actuary at Friends Life, says it is also vital for advisers to note there may be sub-funds or sub-groups of policies, which will be managed differently to others.

These differences will normally be described in the Principles and Practices of Financial Management (PPFM) that a provider must produce and make publicly available for each of its funds.

A shorter ‘customer friendly’ version of the PPFM also has to be made available and reissued to customers every time there is a major change.

Some with-profits companies have more than one with-profits fund, but Mr Kipling says policies in each fund tend to share only in the profits from their own fund.

He says: “With-profits companies can be mutual, where certain classes of policyholder have the right to share in all of the profits of the company (and may also have certain collective powers of control) or proprietary, where the profits are shared with the company’s shareholders, typically but not always 10 per cent to shareholder and 90 per cent to policyholders.

“All things being equal, a mutual ought to be able to pay larger bonuses than a fund which pays 10 per cent of profits to shareholders. All things are rarely equal, however.”