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How is your with-profits fund? By Rob Griffin
This is a very important time of year for holders of with-profits policies as the major life offices announce what bonuses - if any - they will be awarding. These bonuses - which are paid into the guaranteed fund - are vital ingredients of with-profits These declarations have made pretty gloomy reading for the estimated 10 million people who were sold one of the controversial policies, whether it was in the form of a pension, bond or endowment. Many companies have reduced the rates being paid out; some haven't been able to pay anything at all; still others have been forced to close to new business completely. Theory behind with-profits However, the theory behind with-profits does make sense. You pay money into the policy where it is pooled with the premiums of your fellow policyholders and invested in a mixture of equities, property and lower-risk investments, such as gilts. The with-profits fund is then supposed to protect you from falls in the stockmarket by smoothing out investment returns. Rather than allowing the fund to grow as an ordinary stockmarket investment would, it pays bonuses - holding back some of the returns in good years, so that it can still pay out in leaner years. Such qualities made these funds particularly attractive to people who wanted to produce either a lump sum at a known date in the future - principally endowments - or to provide an income, along with the possibility of growth. The idea worked better in theory than in practice - a number of companies made fatal mistakes, such as investing too heavily in the stockmarket or paying too much out in bonuses. When the stockmarkets plunged seven years ago, triggered by the dramatic collapse of over-hyped technology stocks, many with-profits funds found themselves in dire straits, and they've been unable to get back on an even keel. In addition, the new cautious investment strategies that have since been adopted mean that many funds have not enjoyed the benefit of rising equity markets, which have soared since bottoming out in March 2003. Angry consumers Thousands of angry consumers lodged complaints that the risks were not properly explained to them. The Financial Ombudsman Service is still wading through the disputed cases. Emma Parker, a spokesperson for the FOS, says the number of cases being investigated is now between 60,000 and 70,000 each year. In about 40% of cases, they are being found in favour of the consumer. Although some major houses are yet to announce their 2006 profits, an analysis of those who had already declared indicates it's going to be another year of mixed results. While some policyholders will be quietly celebrating the fact that extra money has been added to their investment, others will be looking at their lacklustre policies and wondering whether it's worth keeping them. Tom McPhail, head of pensions research at adviser Hargreaves Lansdown, doesn't believe this year's batch of bonus announcements qualifies as a doomsday scenario. Ned Cazalet of Cazalet Consulting, insists it's impossible to make generalisations and dangerous to focus purely on bonus levels. In fact, he adds, guaranteeing to pay bonuses can weaken the long-term prospects of a with-profits fund, which is why policyholders need to delve a little deeper into its make-up rather than making a snap judgement based on a pay-out. Keep it or let it go So what should you do with your with-profits policy? Is it worth hanging onto it or should you cut and run? Unfortunately, there's no simple answer. One of the first questions you need to ask is: does the policy still meet your needs? You should consider two main factors: the financial strength of a fund and whether any guarantees are in place. A significant exposure to liabilities reduces a fund's financial strength and that has two implications for investors. The need for these funds to hold reserves in low-risk investments in order to cover the guarantees reduces the fund managers' freedom to make pure investment decisions. Also, when these weaker funds generate investment returns, there's an increased risk that some categories of policyholder will have some of those returns withheld from them in order to subsidise the valuable guarantees enjoyed by other holders. When you are reviewing your policy, one of the most important factors is its asset allocation mix - funds that are mostly invested in equities have the potential to produce far greater returns than those that are more heavily exposed to bonds, but obviously come with a higher level of risk. Then you need to consider what you could get from cashing in your policy today. As market conditions have been tough in recent years, there's a good chance that you could end up with less than the value of your premiums, because the insurance company has to ensure the payout is a fair reflection of your share of the fund. Cashing in, or transferring, a policy is likely to reduce the value of your savings or pension, so you need to think carefully about it. Even if the performance of your existing fund hasn't been great, you might not be able to recover the costs of moving. However, getting detailed information on a with-profits policy can be notoriously difficult, depending on what product you have in place. This naturally makes life difficult for the average investor, who could have thousands of pounds tied up in one of these policies, so it is crucial to speak to an independent financial adviser. How to review your with-profits policy Ask your provider how much it's worth - even though this will be just an estimate Find out whether a market value reduction charge will apply Look at where your policy is invested. If it's mainly in equities you will have a better chance of achieving your goals - but it will come with added risk Check the small print of the policy. In particular, see if there are any dates on which you can exit without paying any surrender charges Find out what benefits or guarantees are in place. You need to be clear what you could potentially be missing out on by cashing-in the policy If you are confused, seek the advice of an independent financial adviser
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