With-profits bonds: Survival of the fittest

But following mis-selling claims and poor performance among other things, the with-profits space has had difficulty regaining the reputation it once enjoyed.

Despite this, there is still a lot of money tied up in the product, although many providers manage closed books and are no longer actively selling in the market.

With-profits is simply a form of life assurance-based investment, which usually requires lump sums to be paid upfront – but the cover involved can be minimal. The investment can then buy a sum of units in the provider’s fund, which typically invests in a range of assets including equities, bonds and property.

Key attraction

It can also build annual bonuses – reversionary bonuses – that cannot be removed, one of the key attractions of the product. Also, in order to avoid major losses each year, the provider can hold back some of the profits from better performing years to boost the profits in the worse years – otherwise known as ‘smoothing’.

One other major benefit of a with-profits bond is that for clients who are basic-rate taxpayers, there is no income tax to pay when you cash in the bond. Higher-rate taxpayers may be subject to additional tax charges. Up to 5 per cent of the bond can be withdrawn each year without any immediate tax liability.

But advisers are still sceptical of recommending the product. Alan Solomons, director of London-based Alpha Investments and Financial Planning, says he used to run portfolios of bonds in the 1990s, when they would return an average 7 per cent pa. However, after a client reported a loss on one portfolio when it matured, it appeared the provider had revised its terminal bonus downwards four times in one year. “This made it plain that they were not the only ones that had over-distributed in the good years and so no longer had the reserves left to smooth out the returns in the bad years.”

“The policy involved was a 25-year policy and was bought in the last two years of its life, so it should have been a safe bet. I would never recommend with-profits as they are not transparent and can be weapons of mass wealth destruction.”

Mr Solomon adds, “The product companies cannot be trusted to do what it says on the tin.”

Robert Lockie, Investment Manager at London advisers Bloomsbury, has never recommended a with-profits bond. “I’ve struggled for years to work out the type of client for whom they are suited, which is probably why I’ve never recommended one. I’ve always thought that I could come up with a bundle of reasons why someone should buy one, but all of them could be achieved better by other solutions.”

In spite of many businesses closing to new business over the past decade, it is still an active market, with new products still available to clients.

Table 1 details the with-profits bonds open to new business as at 1 November 2015, a total of 16 bonds from eight providers. What is clear from the outset is that the last bonds launched were in 2013 (Healthy Investment’s with-profits investment bond for advisers and Kingston Unity’s investment bond RDR), and none have been released since.

During 2015, the number of new with-profits bonds set up over the past year has been steadily rising, as seen in Table 2. It cannot be directly compared with last year’s survey, which included different providers. For example, Legal & General closed to new with-profits business on 31 January 2015 and both Aviva and Prudential chose not to return the survey this year. However, looking at the data from July 2014 to December 2014 compared with July 2015 to November 2015, there has been a slight increase in new business from 215 plans to 254.

Table 3 looks into the 10-year performance of £10,000 for an investor aged 50 on encashment, to 1 November 2012. Companies labelled with F59 have figures taken from the annual results supplied to the Prudential Regulation Authority (PRA) as they declined to participate in our survey this year. It should be noted these figures are correct to 1 March 2015 rather than 1 November 2015.

There are penalties for early exits and charges for setting up the bond, so cash-in values typically tend to be lower in the first five years. From six years, the figures for cash-in values start to overtake current values. The Table also highlights the highest and lowest performing bonds – the top 25 per cent in each column are bold with the bottom 25 per cent in italics.

This year, rather than compare the performance with an average UK tracker fund, we have included the performance for the FTSE 100 and FTSE All-Share instead for a direct comparison with the market. For example, the FTSE 100 saw a return of just 0.7 per cent over the year, while the top performing with-profits bond (the Teachers Assurance Guaranteed Growth Bond) returned 15.3 per cent.

Looking over 10 years, Scottish Equitable was the highest performer, with a return of £22,133, or 8.3 per cent AGR.

Comparing one-, five- and 10-year values, the advantage of holding a bond to full maturity rather than cashing in early is clear.

Table 4 compares these time scales over the past 10 years and shows the best, average and worst investments from 2006-15.

Regardless of their popularity, this Table looks into the performance of the plans. Over the years, performance has massively fluctuated and there has been no real trend, beyond broadly following how the market has been performing.

Another way of looking into the performance of a company can be their terminal bonus – the amount varies by provider and shows how well the fund has done over the term – which can be viewed in Table A.

Market value reductions (MVRs) are a way to help providers with long periods of poor performance. If performance has not been up to scratch, the provider can choose to levy the cost to the investor as they see fit. Many providers used to offer an MVR-free date on their 10th anniversary, but these have all now passed and it is no longer available. More on provider’s details on MVRs can be seen in Table B.

Sticking point

This is another sticking point for advisers when it comes to recommending with-profits bonds. For Scott Gallacher, chartered financial planner at Leicester-based Rowley Turton, the “death” of with-profits bonds was the removal of MVR-free dates. “Previously, you could invest in a with-profits bond with the security of knowing that on the MVR-free date you could at least get your original investment back.

“With the removal of the MVR-free dates, the only guarantee of money back now is on death. Consequently for most people they would be better off with a managed fund without the additional complexity and risks of annual and terminal bonuses and MVRs being applied.”

Mr Gallacher says he will still use with-profits on occasion, but they have become a niche product. He says the main use for the plans is for older clients, who possibly want a relatively secure level of income with the added benefit of no MVR on death.

Another element advisers should look out for before recommending this product is asset allocation of the available funds. More details of each surveyed plan can be seen in Table C.

With-profits bonds can bring up plenty of concerns for advisers. But the amount of money tied up in the plans suggests that with-profits bonds are not going anywhere any time soon. And the amount still going in suggests they are still popular with some advisers and investors.

Bygone age

John Stirling, chartered financial planner and director at Essex advisers Walden Capital, believes with-profits bonds are a hangover from a bygone age. “In principle they are a wonderful idea,” he says. But there are two crucial flaws. First, smoothing can mean depriving some investors of higher returns, he says.

And second, “Regulation has pressured the concept of cross-subsidy so that even if investors are not savvy, it is not longer OK to rob Peter to pay Paul. This is fair and equitable, but does not serve the social aim of encouraging saving.”

These two reasons, Mr Stirling says, are why they are no longer promoted. And they are just two areas to consider among a range of issues that might arise. But with many legacy businesses and bonds still being sold to this day, there is definitely life in the old industry yet.