With-Profits failures

Over many years millions of savers and homebuyers have put money into “with-profits” funds. Unfortunately, poor performance coupled with high charges and mistakes made by actuaries mean that insurance companies who run these funds, worth up to £400bn, are failing to deliver on promises made to customers.

These kind of insurance policies, together with endowment policies and pensions and bonds invested in with-profits funds were popular in the eighties and early nineties. With-profits policies grow in value with bonuses that are added on each year and at maturity. The bonuses are meant to reflect the performance of the fund. But payouts on policies have plummeted.

Five years ago the average payment on a 25-year, £50-a-month savings endowment policy was £97.562. Now, a like-for-like plan would deliver just £55,318. At the time of sale policy buyers were told that would more than likely receive figures way in excess of what they will finally get in reality.

It doesn’t look like things will get any better either. The stock market has risen well in the last few years, but predictions from experts are that endowment pay-outs will continue to fall. A recent report suggests that pay-outs from endowment policies will fall at around 3% per year for the next 15 years. And that forecast assumes that funds themselves will manage to grow at an average of 6% per year after tax.

The poor pay-outs have their roots in the early and late nineties, at which time insurance companies who ran the funds were paying out too much on maturing policies. Abandoning the basic concept of with-profits, namely to smooth out investment returns, by keeping back some of the profits in good years so they cover the bad years, they also went after higher returns by investing more in shares, and less in property and safer fixed-interest accounts.

The stock market suffered a big fall from 2000 to 2003, and the value of the funds sank – and those were the funds supposed to pay out bonuses. To hold back further losses, the insurance companies then had to move money from shares to fixed-interest. Of course, by doing so, they clinched the share losses, and have missed out on stock market gains since 2003.

Now those with-profits funds with little investment in shares are not likely to give returns to policyholders any sort of a decent return for many years. Over a long term shares and property tend to give a better return than fixed-interest. Barclays Capital research shows that UK shares grew by 6.9% per year on average over the last twenty years. Fixed-interest grew by only 5.6%. In 2006 shares went up by 11.4%, whereas fixed-interest fell by 4.5%.

There are wide differences between the best and the others. Prudential was up 12.4% last year, Norwich Union was up 11.7%, Legal & General 11.2%. Conversely Scottish Mutual and National Provident Life managed only 1.96%.

The concept of with-profits policies is likely to fade away in the light of these weakening returns. It is hard to see how anyone starting now would succeed with a with-profits investment. There are better, more flexible alternatives, and funds can be changed on the hoof. With-profits have demonstrably failed to deal with the vagaries of the stock market and the fast moving modern world because of their inflexibility.

The Financial Services Authority now insists that all with-profits offices provide illustrations of maturity values, leaving nowhere for providers to hide their poor performing policies. This enable investors to compare results of all providers.

There are some really poor endowment performers, and endowments were mainly sold as a way of paying off your mortgage – with some supposed to be left over besides. The average is £48,7979, but National Provident (£27,958), Crusader (now Alba Life) (£28,220), Life Association of Scotland (Alba Life) (£24,885); Britannia Life (Alba Life) (£32,506); Eagle Star (£32,461) and Phoenix London Assurance (form Alliance & London) at £34,688 are all way below the average. Once part of Abbey, Scottish Mutual and Scottish Provident have teetered up to £38,005 and £39,713 respectively. All these figures are based on a 25-year plan started as age 30 for £50 a month. Better figures came from Prudential at £39,382, Norwich Union (£47,677), and the best was Wesleyan with £68,417.

For pension holders, of course, the news is bad. Anyone 65 this year who has been paying £200 a month into a with-profits pension plan for the last twenty years will get an average of £112,110. This is down from the 1998 level of £263,716. In addition, annuity rates, which are how insurance companies convert your pension savings into an income for life, have also fallen badly.

Retirement in 1998 could have provided an income of around £26,730. Now it would be a mere £7,906. The worst performers are Standard Life (£92,820), Scottish Widows (£97,231), Friends Provident (£94,105). Scottish Widows managed a comparative fortune in 1998: £311,015.