The amount of with-profits business in force remains considerable – with-profits assets across the UK industry totalled more than £300bn at the end of 2014.
So why is it that investing in with-profits products is viewed so unfavourably, and does that view continue to be valid?
In essence, the with-profits concept provides investors with the potential to invest in a wide range of assets and to receive a smoothed investment return. These policies have generally been used for longer-term savings – to pay off a mortgage or for a pension, for example.
In a with-profits fund, policyholder premiums are invested in a pooled fund of assets, a significant proportion of which are usually in the form of real assets promising returns in excess of inflation. There will be smoothing of claim payments to insulate the policyholder from the extremes of market variations.
There may also be a share in the wider profits or losses of the insurer, for example those arising from mortality experience and expense levels. Finally, the with-profits policy will have certain guarantees, for example a guaranteed amount on death or maturity.
The range of investments found in each company’s with-profits fund varies considerably, and in some cases may be a simple mix of equities, property and fixed-interest securities.
In other companies the with-profits fund may include investments in infrastructure assets, emerging markets, venture capital as well as, in some cases, other forms of insurance business.
The smoothed investment returns are delivered to policyholders by means of the addition of regular bonuses, usually in guaranteed form, and a non-guaranteed final bonus at the time there is a claim on the policy.
These bonuses are at the discretion of the company, and there are now a large number of rules and regulations surrounding the use of discretion and the fair treatment of customers holding with-profits policies.
Some companies have gone to the extent of creating with-profits committees, often drawn from independent non-executives, to monitor the use of discretion and ensure fair treatment of policyholders.
If you look back far enough, the investments underlying with-profits policies, almost exclusively, used to be fixed-interest securities, and bonuses were only in regular, guaranteed form.
During the 1960s and increasingly in the 1970s, wider investment policies were adopted, and as equity performance outstripped that of fixed-interest securities, non-guaranteed final bonuses became more prevalent and steadily larger.
Also as a consequence, policyholders found themselves in the happy position that the final payout was higher, and sometimes significantly higher, than they had anticipated. Hence mortgages were paid off and there was money left over, or pensions were larger than expected.
With-profits business was extremely popular through the 1980s and into the 1990s. Investment returns from many investment classes performed strongly through this period and, when there was a downturn (such as Black Monday in October 1987, or Black Wednesday in September 1992) the smoothing concept came into its own.
