Investors and savers should check the value of with-profits policies

Being ahead of the game does have hazards, warns Rachel Stevenson. But there are ways out

One of Britain's leading life insurance analysts is advising policyholders to take a close look at whether they should take advantage of the present financial turmoil to cash in their policies. John Turton, at the London-based independent financial adviser BestInvest, says policyholders should calculate how much their policy is worth compared to how well the fund backing the policy has performed.

"If you are ahead of the underlying return, you should crystallise your gain and invest in an alternative," Mr Turton says. "Your policy is being topped up by the reserves of the insurer, who will claw it back when investment markets pick up." But he warns policyholders against comparing payout values between different insurers, and the same insurer's payouts one year to the next, because they are easily manipulated. After months doling out the bad bonus news for policyholders, insurance companies have had to face shareholders in the past two weeks, telling them what profits they have made, how much capital they have and what prospects there are for a recovery in bonuses.

Shareholders have seen the price of holdings collapse amid fears that many insurers have lost so much money they are in danger of going bust. Dividends have been on a precipice, because insurers are entitled to only 10 per cent of what is awarded to policyholders in bonuses. The effects of falling stock markets are now hitting dividend, as well as policy, payouts.

Prudential profits were up 2 per cent for 2002. While the results seemed strong, the company could no longer promise to keep increasing its dividend above inflation and the shares dived 20 per cent. Jonathan Bloomer, the chief executive, could not say what the dividend would be, causing confusion and uncertainty for investors.

Prudential policyholders were told payouts would come down by up to 12 per cent. Friends Provident also took a share price hit when it told the City growth in its dividend would slow, but its policyholders are already feeling the brunt of market conditions, with cuts of up to 16 per cent.

Aviva, trading as Norwich Union in the UK, had already told shareholders it would cut its dividend by 40 per cent last year to retain capital within the business. Its 2002 profits were down 10 per cent, but £1.7bn was paid in bonuses. Some policyholders had bonuses scrap-ped and payouts were down by an average of 20 per cent.

Legal & General is still the darling of the insurance sector, having raised £786m through a rights issue last year to strengthen its balance sheet. Profits were down 7 per cent after the company increased reserves to pay the pensions of customers living longer, but analysts expect solid growth from the company. Payouts have been cut by 10 per cent, but its with-profits fund is one of the best-capitalised in the sector and is the only company to have kept the top AAA rating by Standard & Poor's. City analysts still believe companies such as Prudential, Legal & General and Aviva have the right business models to provide growth to shareholders and policyholders. These companies offer hope of the best returns to existing with-profits policyholders, along with Standard Life, the mutual insurer, which had topped the payout league tables.

But Standard Life has had a tough time, after losing £4.5bn on the stock market last year. Although sales were up 16 per cent in 2002, it is not clear how profitable this has been or what return investments made with policyholder funds have earned.

Bonus cuts in February brought down fund values by 20 per cent and many endowment customers are being told their mortgage will not be paid off. Shareholders and policyholders in companies such as the Britannic Group and Royal & SunAlliance (RSA) have little reason for cheer. Britannic warned in January that it may suspend its dividend and final bonuses, causing its share price to halve in one day, but the easing of solvency fears and rumours that the company is a takeover target have bumped up its price. Last week it closed to new with-profits business, which analysts at Merrill Lynch said was "unequivocally positive" for shareholders. But the dire prospect for bonuses leaves policyholders in the lurch. RSA, which is trying to plug a £700m shortfall in its capital requirements, cut its dividend by 62 per cent to 6p. Policyholders in its now-closed with-profits funds have had fund values reduced by 16 per cent.

And the ability to get hold of any declared bonus is hampered by exit penalties as high as 30 per cent on some with-profit bond contracts. The prospect of bonus levels recovering looks bleak. Insurers are piling out of equities in to less volatile investments, meaning that when markets do pick up they gain less of the upside. Shareholders' and policyholders' interests are closely aligned, and continuing poor stock market performance will mean returns from life insurers will be hard to come by.