Do with-profits bondholders have any hope?

Sam Dunn reports on the latest crisis of confidence
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The Independent Online

With-profits investors are well used to turmoil: barely a week passes without fresh rumbles of doom.

So it is no surprise that figures from the Association of British Insurers (ABI) confirm the plummeting popularity of with-profits bonds, or that a new report suggests only four out of 19 providers offer policyholders no cause for concern. This guide, written by independent financial adviser (IFA) John Scott & Partners (JS&P), warns that if you have a policy with any of the remaining 15 companies, you should review it urgently.

In more than half of these cases - including Royal & Sun- Alliance, Scottish Mutual and Britannic Assurance - you should seek to get out. JS&P warns that there is no future for these funds.

But if you have a with-profits fund invested with Liverpool Victoria, Standard Life or Scottish Equitable, you should consider your position as it might not be in your best interests to get out of the fund.

Although the IFA's research is intended as a guide, it will add to the jitters that started three weeks ago when David Prosser, chief executive of insurer Legal & General (L&G), said its with-profits business was under review.

"The main fear is that one of the big providers will be the first to say they will stop with-profits," says Ben Willis at IFA Chartwell. "That will then have a huge effect on the others."

The ignominious fall of the with-profits industry - from underperforming endowments and the Equitable Life crash, to three years of falling UK stock markets and the crisis at Standard Life over the insurer's financial strength - has been well documented. But the fortunes of with-profits funds in the investment bond market show just how dire the situation has become.

In 2000, the with-profits bond market was worth some £13bn. By 2002, this had slumped to £10bn, and ABI figures on Friday showed that the amount invested had more than halved last year to an estimated £3.6bn.

Unfortunately, thousands of savers who bought these policies in the late 1990s are still hanging on for dear life, unsure whether to bale out now or hold on in the hope of recovery. Their decision has been made harder by financial penalties and industry trends.

Charges for leaving with-profits bonds, known as market-value reductions (MVRs), can be as high as 20 per cent - on a £10,000 investment, a £2,000 hit.

Eagle Star's MVR can go up to 20 per cent, while L&G says policyholders could be charged as much as 22 per cent on older policies.

Savers have also been hit by several rounds of cuts to their bonuses. Last month Scottish Widows reduced rates on its older bonds by 0.5 per cent, as did Norwich Union. Standard Life cut its annual bonus rates three weeks ago - by 1 per cent on newer policies and 0.25 per cent on older ones.

Early surrender of your with-profits bond before you have held it for five years will usually incur another fine.

On top of all this, life insurers' with-profits funds have great chunks of money stashed in lower-risk investments, such as bonds, in a bid to shore up their position. This has left them poorly placed to exploit an upturn in equities, such as last year's 14 per cent rise in the FTSE 100.

It wasn't supposed to be like this. For years, with-profits funds were sold as a low-risk way to generate greater returns than in a building society account, but without exposure to the volatility of direct investment in shares. They achieved this by smoothing returns and bonus payouts, keeping back surpluses in the good times to cover more difficult periods.

In the case of with-profits bonds, annual bonuses in the late 1990s often hit 5 and 7 per cent. But three years of falling stock markets have put paid to such largesse.

The other attraction was the tax advantages: a higher- rate earner could take up to 5 per cent of his investment from the bond each year and defer paying tax on it.

But now, bondholders' confidence is being undermined. If you hold a with-profits bond and are unsure what to do, first check the financial strength of your provider.

Patrick Connolly, research and investment manager at JS&P, says it's worth staying put if you have a policy with Norwich Union, L&G, Prudential or Clerical Medical.

If you have a bond with a different provider, an IFA should be able to calculate how high an MVR you would have to pay. He should also be able to advise on where you should move your cash.

Check if there's a clause to get out free: many policies have such exit dates on purchase anniversaries. "It would be terrible to pay a 15 per cent MVR and then discover that you can legitimately pull out in several months' time [for free]," says Mr Connolly.

An alternative is to make regular income withdrawals from your bond: many allow you to pull out as much as 7.5 per cent each year without paying a penalty.

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