Craig Palfrey, director at online advisory firm Get Financial Advice as well as Cardiff-based Penguin Wealth, has investigated the with-profits sector and said investors face a high-risk of the fund failing to deliver as expected.
Mr Palfrey gave the example that the vast majority of funds now apply nearly all pay-outs in the form of terminal bonuses instead of annual bonuses, meaning a significant change in investor return.
Providers have quietly and by stealth moved the goalposts and created a position where the bonus entitlement is now heavily skewed to terminal bonuses.Craig PalfreyHe said: "There has been a huge shift over the past decade from annual to terminal bonus pay-out. This may seem innocuous but it is highly important.
“The shift from annual to terminal bonuses is a shift in risk. I am not sure whether we have ever encountered even one policyholder who understands this; basically we ask policyholders when we conduct a review if they understand the point that annual bonuses are guaranteed, and terminal bonuses are not.
“What has happened therefore is that providers have quietly and by stealth moved the goalposts and created a position where the bonus entitlement is now heavily skewed to terminal bonuses, which allows them to reduce or even withdraw bonuses in the future."
Once it has been added, an annual bonus can’t be taken away – even if the fund performs poorly in future – as long as you continue to meet the terms of your policy.
A final bonus may be added at the end of your policy. Whether you get one and how big it is depends on how well the fund does.
In good years, the fund manager can choose to keep some of the profits to help cover losses in bad years. This is called smoothing. This means that if there are long stretches without a profit, you may get low annual and final bonuses – or even no bonuses at all.
Mr Palfrey added the past few year’s financial markets have more or less performed well, so reductions or withdrawal of with-profits bonuses have not been triggered.
"However policyholders, generally speaking, have no idea that should asset markets start to misbehave these bonuses are at high risk of being reduced or withdrawn,” Mr Palfrey said.
He added when this is pointed out to policyholders they are surprised, and their first reaction is to ask how they can do something about this.
"If it is appropriate advice we will then help them secure the bonus through a fund switch, transfer or outright surrender,” he said.
“My warning is simple, there are millions, yes millions, of people in this position and I am suggesting that the majority are unaware of this ‘card trick’ – they are being shown the cards the providers want them to see."
Mr Palfrey said it markets perform badly, according to the providers own annual reports, principles and practice of financial management, there will be reductions in bonuses and people’s policy values will fall.
“This must be about the only investment type where what you see is patently not what you might get. I am worried this is a pending scandal and I am urging policyholders to take action now or at least become aware of the true risk they are taking.”
A spokesperson for closed life book consolidator Phoenix told FTAdviser: "Phoenix is not moving away from paying annual bonuses. In fact almost 80 per cent of our funds are now paying an annual bonus and the level of bonus has increased for over half of these policies.
"Our strategy is to pay annual bonuses where funds have sufficient excess assets available and paying one is not expected to constrain our investment flexibility.
"Even those policies where an annual bonus is not being paid may have valuable guarantees available. It is vital that policyholders speak to our customer centre before making any decisions about cashing in their policy, and preferably seek independent financial advice”.
Justin King, chartered wealth manager and chartered financial planner at Dorset-based MFP Wealth Management, said: "I would think this this is probably true, in fact I would wager most policyholders haven’t a clue how with-profits polices really work."
