Pensioners suffer bonus blow

Investors, endowment mortgage holders and those about to start drawing a pension, will all be hit by falling bonus rates on with-profit policies this year. Jasmine Birtles explains which companies are likely to be hit and what you can do about it

If you have been investing in with-profits bonds, have an endowment mortgage or are looking to start drawing a pension, this year may prove to be a lean one. Life insurance companies that provide with-profits policies such as these are widely tipped to announce cuts in the bonuses they pay out this year. This means that savings and investments will grow more slowly in the next twelve months and that endowments policies and pensions will not reach their projected targets in the short term.

If you have been investing in with-profits bonds, have an endowment mortgage or are looking to start drawing a pension, this year may prove to be a lean one. Life insurance companies that provide with-profits policies such as these are widely tipped to announce cuts in the bonuses they pay out this year. This means that savings and investments will grow more slowly in the next twelve months and that endowments policies and pensions will not reach their projected targets in the short term.

Many life companies are likely to feel the strain. These include Axa, Sun Life, Clerical Medical, Norwich Union, Legal and General, Friends' Provident, Scottish Life, Scottish Mutual, Scottish Widows and Standard Life.

With-profits funds are known for providing steady medium to high growth over a period of time, as opposed to the possible big gains or big losses of the stock market. They are predominantly equity-based but they shelter investors from the vagaries of share movements by using the profits of good years to even out, or 'smooth', the troughs of poor years.

In the 80s and most of the 90s, with-profits funds generally provided healthy returns, but last year financial observers started to sound warning bells about the funds' ability to continue to finance these returns. Some observers are also accusing the insurance companies of being too secretive about their funds' performance, thereby keeping investors in the dark about future profits or losses. Clerical Medical, Scottish Widows and Friends Provident, for example, have all refused to publish the amount of their funds' growth that is being used to bump up the shortfall in the bonuses.

Malcolm Tarling of the Association of British Insurers insists the current poor performance across the industry does not reflect on the companies' competence. "We're living in a low interest rate, low inflation time," he says, "and that means the returns are lower. It's not the insurers' fault, it's the general economic situation. We can't expect higher returns in a time like this."

Anna Bowes of Chase de Vere agrees, and adds that the current low returns should not put investors off with-profits bonds. These are investments favoured by cautious investors who would like a better return than building societies offer but do not want to see their money disappear if the stock market hits a rocky patch. "You have to remember that for such low-risk investments the returns are astonishingly high," she explains. "But with the current economic climate they will naturally be lower at the moment. Equities have been falling over the last year and that has also made companies dip into their reserves to keep the returns up. But thinking long term, these bonds are still a very good investment and it's worth hanging in there."

Certainly in the last couple of decades with-profits funds have generally performed quite well and the bonds have also produced good returns for investors. For example, if you had invested £25,000 in Liverpool Victoria's Single Premium Investment Plan - the best-performing bond for the last two years - when it started five years ago, you would have seen your investment grow to £44,120 this year.

Of course some funds will be more vulnerable than others to the economic climate. Ian Blanchard of Liverpool Victoria is bullish about his funds' prospects. "We have already been reserving on a conservative basis," he says, "so more years of poor stock market performance and low interest rates wouldn't affect us, but it may cause some issues for some other companies."

If bonuses are generally cut this year, though, it is not good news for those depending on with-profits endowment mortgages and pensions. "If you get a red notice through the door from your mortgage provider telling you you'll need to top up your payments, whatever you do don't," warns Janice Thomson of Moneygro Ltd. "Use unit trust savings plans or ISA savings plans instead. Don't add to your with-profits endowment because the returns just won't be good enough."

The same goes with pensions. "If your pension is under-performing it's worth putting more money in another vehicle," she advises, "particularly if you can wait until April and open a Stakeholder pension then."

Thomson is wary of with-profits bonds generally. "They're so mysterious. The insurance industry is extremely resistant to openness so you don't know how well your investment is really doing. If a fund manager screws up it only becomes visible when the fund can no longer boost the returns or when it shows up in the terminal bonuses. I much prefer investments where you can see exactly what your money is doing."