With-profits investments, endowment mis-selling - by independent financial adviser John Bramwell

With-Profits Investments

What are they?

With-profits investments are a type of collective fund that has an inbuilt smoothing mechanism, whereby, when fund performance is very good, some of the profits are held back by the provider to be paid out when fund performance is lower. This with-profits smoothing takes the form of annual bonuses (reversionary bonuses) and a final bonus at the end of the investment term (terminal bonus). The Financial Services Authority website describes with-profits investments in more detail.

With-profits funds were originally intended for paying off the outstanding loan at the end of the term of an endowment mortgage, together with life insurance to pay off the loan in the event of death before the end of the term. The monthly premiums were set with the expectation that the fund would provide an excess return over the outstanding mortgage debt.

With-profits funds have also been used for cautious investors of lump sums, often inside investment bonds and pension funds.

Are there any problems with them?

Unfortunately stockmarkets performed poorly in the period 2000 to 2003 and many of the providers of with-profits funds had insufficient reserves to continue paying the bonuses.

There have been several repercussions, notably:

Reversionary and terminal bonuses have been reduced or stopped completely.
Penalties called market value adjustments (MVAs), sometimes also called market value reductions (MVRs) have been imposed on surrendering policies to protect the value of the assets of the remaining policyholders.
The equity content of funds has been lowered to reduce the life companies’ liabilities.
Many endowment mortgages are now not expected to pay off the linked mortgage completely.

With improving stock market performance the returns of some of the with-profits policies have been improving and the MVAs are reducing. However, there remains much disillusionment in with-profits policies among investors.

Many funds are now closed to new business and this can adversely affect their performance.

The charging structure of old style with-profits funds is not clear, and there are now many funds with a better opportunity for growth and which have a visibly lower charging structure.

What should I do about my with-profits policy if
it is in a closed fund or is under-performing?

You should assess if it is still appropriate to continue investing in the policy, as there may well be good reasons for transferring to another provider.

For example, some funds have altered to a mix of only fixed interest assets and have no equity content. This may be suitable for some investors - eg. those who intend cashing in the policy soon or want to have a lower risk level and are willing to accept lower returns by not investing in equities. However, there are many for whom this may not be suitable - eg. younger people investing over the long term where a more diversified portfolio with an equity element may well be better.

What should I do if my with-profits endowment
is unlikely to repay my mortgage?

There are several options available, including:

Change to a lower rate interest-only mortgage and use the savings to repay some of the outstanding capital.
Change to a capital and interest mortgage.
Increase the term of the mortgage.
Use other assets to pay off the mortgage.

More information on mortgage repayment methods is given on the page Methods and Implications of Repaying Mortgages.

What should I do if I think I was
mis-sold my endowment?

The problems in the underperformance of with-profit endowments and endowment policies in general have led to claims by investors that they were unaware of the risks involved and that they were mis-sold their policy. If you feel that this could be true in your case then you may be entitled to compensation.

A guide on what you can do has been published on the FSA website.