With Profits  

How with-profits funds work

This article is part of
Guide to with-profits

How with-profits funds work

With-profits funds work by using guarantees, which are set at the start of the fund, and are the minimum sum assured.

Quite often, this will simply be the return of one's premiums. 

Then the actuaries will decide how to add bonuses each year, which, once allocated cannot be deducted, and will reflect how well the fund is doing, and whether the company wants to hold back returns in a good year to tide people over in a bad year.

This is the process of 'smoothing'. Then at the end of the policy the idea is to add a terminal bonus, following the final returns gained on the overall fund. 

Andrew Burke, a with-profits actuary of Phoenix, which runs 13 closed with-profits funds, says: "We get the premiums from the customer to invest and we invest them in different asset types and hopefully, over time, they will grow.

"If it looks like the assets and the premiums are going to be bigger than what we've guaranteed to pay we will look to pay a bonus."

The annual bonus is allocated to the fund, and is not taken away again once allocated. The life company will also allocate a final bonus based on how well the fund has performed compared to the guarantees made at the outset.

Kevin Arnott, also a with-profits actuary of Phoenix, says: "I think one of the things that has got to be borne in mind about closed life funds, they're obviously closed for a reason. Sometimes the reason is they're in some kind of financial difficulty.

"That comes to what sort of asset mix you have. Not all of our funds have the same asset mix; if they only have enough money to cover their guarantees, they won't invest much in volatile assets like equities, which could go down, and you won't have enough money. 

"Some funds are invested in fixed interest assets because they're not very strong.

"The funds that are financially stronger are 50 per cent in equities and growth assets, and the balance in fixed interest."

Bonuses

When it comes to working out the bonuses, Phoenix looks at the asset performance, and the expenses it has to deduct, and compares it to what it has guaranteed at the end of the term.

Mr Arnott says: "Once you've made them, you can't take them away."

The final or terminal bonuses are reviewed every six months.

Mr Burke explains: "Say someone decided 25 years ago to pay £100 monthly and we guaranteed they couldn't get less than £30,000; say these premiums with investment returns and expenses, it's grown to £40,000, you come to the end of the policy and we can see you've built a pot of £40,000, we will make a 33 per cent final bonus which will lift it to £40,000."