With-profits are usually capital guaranteed investment policies that spread the returns over the term of the investment. Some returns made in good years will be held back to compensate for bad years.
The returns are paid by way of annual bonuses, but these are not guaranteed until the tenth anniversary of the policy (or the seventh anniversary in the case of Irish Life's with-profits bonds). Policyholders will also be promised a terminal bonus on the maturity of with-profits policies. Alongside 10-year single premium bonds, with-profits policies with a term of up to 25 years may be taken out as a pension or an endowment policy to pay off a mortgage.
One firm may have a higher annual bonus rate than another, but that does not mean it is a better policy. A high annual bonus rate could just mean part of the terminal bonus has been brought forward: the returns will be smoother, but they will not necessarily be any greater. If the annual bonuses declared equals or exceeds investors' share of the fund profits, there will be no terminal bonus.
But if bonus rates fall even lower, the danger is that deposit accounts and other cautious investments will start to look more attractive.
An early exit penalty called a market value adjuster (MVA) is sometimes applied to stop a stream of policyholders from leaving when markets are down.
MVAs, which have been as high as 15 per cent in recent years, are subject to ongoing review and can be applied or increased at a later date. This makes with-profits unattractive to investors looking for flexibility.
According to financial adviser Mr Ian Mitchell, MVAs have altered the whole face of and justification for with-profits investment. Their now "almost ubiquitous" presence, coupled with retrospective reductions of previous years' bonuses by some UK firms, means it is a misnomer to call the policies "with-profits" at all, he argues.
With-profits investments arose traditionally from mutual companies, where investors took a bet on the performance of the company itself. Standard Life's with-profits policies still work like this, with investors receiving "mutuality bonuses". However, the company is under pressure and has admitted it may consider demutualising.
With-profits funds at non-mutual companies today are ringfenced, so policyholders are not exposed to any solvency problems the company might have.
The biggest scandal involving with-profits so far has been the Equitable Life debacle. Around 20,000 members of the troubled UK mutual company saw their with-profits pensions repeatedly cut so that Equitable could pay the bonuses it had guaranteed to former policyholders in the UK. Many policyholders here had believed the Irish funds were ringfenced.
Other insurance companies stressed that it was the poor business performance of the mutual company that pushed it over the edge, rather than the nature of with-profits.
Concern about the health of with-profits also arose two years ago when Canada Life closed its with-profits business, warning that new customers would only end up subsidising the over-generous bonuses awarded to existing policyholders. Last year, Scottish Provident, estimated to have up to a 10 per cent share of the total with-profits sector, closed its Irish operation to new business.
Laura Slattery
