For many years ordinary investors were very happy to invest in with-profits as it was perceived as low-risk and simple. From the investor point of view, you got an annual or reversionary bonus plus a terminal bonus when the policy – endowment or pension, matured. This always puzzled me but then maybe it should not because in my experience, investors have very short memories.
I was fortunate to be working in the investment department of a private bank back in 1973. That year when the oil price rocketed, was a real bloodbath. Having seen that, the October 1987 crash (remember the yuppies?) and the bursting of the dot.com bubble in March 2000 were not difficult to spot. In 1975 some companies gave no terminal bonuses at all – but the reversionary bonuses already added could not be taken away.
After 1973 life settled down again and by the time endowment polices were maturing in 1997/1998 some of them had achieved an annual rate of return of 17 per cent! No complaints about mis-selling endowment policies in those days.
Calculating bonuses is very complicated and is done by actuaries. For actuary read mathematician and they are very well paid – who said maths could be boring?? Senior actuaries can easily have salaries of £300,000 and more – all you have to do is 5 years of exams. I once asked an inspector from Standard Life what their method was for calculating bonuses and he mentioned that the formula was 6 pages long!
From 2001 to 2004 the stock market fell in three successive years. Added to this, the regulator the Financial Services Authority (FSA) insisted on a more standardised calculation of insurance company reserves. This meant that the insurance companies were suddenly short of reserves whereas previously their actuaries had said their reserves were adequate. The people who paid for this were with-profits customers as terminal bonuses were waived and if you wanted to get your money out at any date other than the date you originally selected, you paid a penalty called a Market Value Adjuster (MVA) or Market Vale Reduction (MVR). Even when stock markets bounced back last year most companies declared zero or very low bonuses as insurance companies sought to rebuild their reserves.
The result is that the majority of with-profits funds are a poor investment at present and the question clients ask is, should they stay? or pay an MVR and bale out? Since we are not selling a product here, the answer has to be fee-based advice. The most recent case I had involved 10 hours of research.