Secrets Of Success: With-profits: is it time to surrender?

Regular readers will know that I sustain an interest in the performance of with-profits policies, although the subject is one of the dullest imaginable. Every year around this time, when the life companies start to announce their latest bonuses, I summon the energy to check the surrender values of my two surviving policies. Originally the purpose was to check on their progress: more recently it's been to work out whether or not it is worth surrendering them.

This exercise has become a chore. The critical issue is not so much what the prospects for the policies achieving their given target final sums are, but whether the opportunity cost of continuing to pay the premiums is worth it. There may be much better choices elsewhere, even allowing for the potential terminal value. (In retrospect, of course, there always are superior alternatives: the issue is whether you can identify them in advance).

Given my argument that many investors would in general do better to take greater control of their own investments (it is not as scary as it might seem, and saves you from paying unnecessary amounts to fund the lifestyles of intermediaries who may know less about investment than you do), you may wonder why I still hold any policies at all.

In my case, the reason has nothing to do with the investment case, but everything to do with the small print, which makes surrendering policies liable to tax if you surrender them within 10 years of a "chargeable event". A chargeable event can arise, for example, if you divorce and retain a policy that was formerly held in joint names. It means that you are liable to capital gains tax on the realised gains in the policy if you surrender before the 10 years are up.

In my case, the 10-year period expires this year, so I have been studying the latest with-profits survey by the trade magazine Money Management with more than usual interest. It is an invaluable source, still available in some public libraries(although the dense tables get no easier to read).

A further reason for checking on the data is that, several years ago, I rashly predicted in this column that, despite all the bad publicity surrounding with-profits, the average policy was likely to continue to deliver better real returns than the average actively managed unit trust. Sadly, that assertion was made before the regulators decided to crack down on life company solvency after the Equitable Life debacle.

My original view was based on the actual, as opposed to perceived, performance of long term with-profits policies that were held to maturity (much better than most people realise), and the fact that the minority of investors who stay the course with their policies for a full term are in effect cross-subsidised by the many who fail to keep policies going. In a historical context, there was nothing much wrong in principle with owning a well-diversified long-term fund that "smoothes" investment returns over the years and provides life cover on top.

The problem with with-profits has turned out to be the high underlying charges in initial years, the false promises on which the idea was often sold and the inflexibility of the product as originally designed. Lack of full disclosure meant that few investors had a real idea of how effectively the policies were managed. Now you can re-create a with-profits policy of your own at relatively little cost, but that's a recent development.

Unfortunately, the regulators' action, which was made with exquisitely bad timing (just as the stock market was recovering from its worst bear market in a generation) has undermined my argument somewhat. One consequence has been a much wider dispersion in with-profits funds results, with well-funded life funds having much greater freedom to enjoy the strong performance of the stock market since 2003 than those less well-endowed.

Those funds with the freedom to invest a higher proportion in equities have naturally benefited from the high equity returns of the past four years, while others (including the rump of the Equitable Life fund) have been limited to investing in bonds and so condemned to low, single-digit returns that make meeting terminal values next to impossible in many cases.

The latest Money Management figures show how severely a combination of the 2000-03 bear market and the enforced move away from equities has hurt with-profits funds. The average pay-out on a typical £50 per month 10-year policy has fallen from about £10,000 in 1999 to £7,000 now. On a typical 25-year policy, it has fallen from £97,000 in 2001 to £54,000. In both cases, however, the figure increased last year, for the first time since the bull market peak, perhaps marking a turning point in the level of terminal bonuses.

The funds that have provided the best pay-outs are mainly those of smaller insurance companies, often mutually owned, that were able to retain high equity weightings. The two that make the most appearances in the top 10 over the past decade, Liverpool Victoria and Wesleyan, both have about two-thirds of their fund invested in equities. The average is 38 per cent.

Over the long haul, the average surviving with-profits fund has produced a compound annual rate of return of 8.4 per cent over 25 years, 7.0 per cent over 20 years and 5.2 per cent over 15 years. This is slightly less than the 9.9 per cent, 8.3 per cent and 6.1 per cent a year achieved by the average all-equity unit trust/OEIC, but higher than the 6.9 per cent, 5.9 per cent and 5.2 per cent produced by the average balanced managed unit trust/OEIC, a more directly comparable animal.

Given that equities may well be close to the peak of the current cycle, this is not a bad turnout. The average real return on 25-year with-profits funds held to maturity has been 4 to 5 per cent, again a fair outcome - and the best funds have produced more; 7 per cent compound in real terms.

As always, the key is to pick your fund well: something I failed to do all those years ago, which is why surrendering remains a distinct possibility this year.

jd@independent-investor.com

Independent Partners; request a free guide on NISAs from Hargreaves Lansdown

News
A model of a Neanderthal man on display at the National Museum of Prehistory in Dordogne, France
science
News
Dawkins: 'There’s a very interesting reason why a prince could not turn into a frog – it's statistically too improbable'
newsThat's Richard Dawkins on babies with Down Syndrome
Arts and Entertainment
Eye of the beholder? 'Concrete lasagne' Preston bus station
architectureWhich monstrosities should be nominated for the Dead Prize?
Extras
indybest
PROMOTED VIDEO
Arts and Entertainment
music
Sport
football
Life and Style
This month marks the 20th anniversary of the first online sale
techDespite a host of other online auction sites and fierce competition from Amazon, eBay is still the most popular e-commerce site in the UK
News
i100
Arts and Entertainment
tv
Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    Quantitative Analyst (Financial Services, Graduate, SQL, VBA)

    £45000 per annum: Harrington Starr: Quantitative Analyst (Financial Services, ...

    Application Support Engineer (C++, .NET, VB, Perl, Bash, SQL)

    Negotiable: Harrington Starr: Application Support Engineer (C++, .NET, VB, Per...

    AIFMD Business Analyst / Consultant - Investment Management

    £450 - £600 per day: Harrington Starr: AIFMD Business Analyst / Consultant - I...

    Business Analyst Solvency II SME (Pillar 1, 2 & 3) Insurance

    £450 - £600 per day: Harrington Starr: Business Analyst Solvency II SME (Pilla...

    Day In a Page

    Middle East crisis: We know all too much about the cruelty of Isis – but all too little about who they are

    We know all too much about the cruelty of Isis – but all too little about who they are

    Now Obama has seen the next US reporter to be threatened with beheading, will he blink, asks Robert Fisk
    Neanderthals lived alongside humans for centuries, latest study shows

    Final resting place of our Neanderthal neighbours revealed

    Bones dated to 40,000 years ago show species may have died out in Belgium species co-existed
    Scottish independence: The new Scots who hold fate of the UK in their hands

    The new Scots who hold fate of the UK in their hands

    Scotland’s immigrants are as passionate about the future of their adopted nation as anyone else
    Britain's ugliest buildings: Which monstrosities should be nominated for the Dead Prize?

    Blight club: Britain's ugliest buildings

    Following the architect Cameron Sinclair's introduction of the Dead Prize, an award for ugly buildings, John Rentoul reflects on some of the biggest blots on the UK landscape
    eBay's enduring appeal: Online auction site is still the UK's most popular e-commerce retailer

    eBay's enduring appeal

    The online auction site is still the UK's most popular e-commerce site
    Culture Minister Ed Vaizey: ‘lack of ethnic minority and black faces on TV is weird’

    'Lack of ethnic minority and black faces on TV is weird'

    Culture Minister Ed Vaizey calls for immediate action to address the problem
    Artist Olafur Eliasson's latest large-scale works are inspired by the paintings of JMW Turner

    Magic circles: Artist Olafur Eliasson

    Eliasson's works will go alongside a new exhibition of JMW Turner at Tate Britain. He tells Jay Merrick why the paintings of his hero are ripe for reinvention
    Josephine Dickinson: 'A cochlear implant helped me to discover a new world of sound'

    Josephine Dickinson: 'How I discovered a new world of sound'

    After going deaf as a child, musician and poet Josephine Dickinson made do with a hearing aid for five decades. Then she had a cochlear implant - and everything changed
    Greggs Google fail: Was the bakery's response to its logo mishap a stroke of marketing genius?

    Greggs gives lesson in crisis management

    After a mishap with their logo, high street staple Greggs went viral this week. But, as Simon Usborne discovers, their social media response was anything but half baked
    Matthew McConaughey has been singing the praises of bumbags (shame he doesn't know how to wear one)

    Matthew McConaughey sings the praises of bumbags

    Shame he doesn't know how to wear one. Harriet Walker explains the dos and don'ts of fanny packs
    7 best quadcopters and drones

    Flying fun: 7 best quadcopters and drones

    From state of the art devices with stabilised cameras to mini gadgets that can soar around the home, we take some flying objects for a spin
    Joey Barton: ‘I’ve been guilty of getting a bit irate’

    Joey Barton: ‘I’ve been guilty of getting a bit irate’

    The midfielder returned to the Premier League after two years last weekend. The controversial character had much to discuss after his first game back
    Andy Murray: I quit while I’m ahead too often

    Andy Murray: I quit while I’m ahead too often

    British No 1 knows his consistency as well as his fitness needs working on as he prepares for the US Open after a ‘very, very up and down’ year
    Ferguson: In the heartlands of America, a descent into madness

    A descent into madness in America's heartlands

    David Usborne arrived in Ferguson, Missouri to be greeted by a scene more redolent of Gaza and Afghanistan
    BBC’s filming of raid at Sir Cliff’s home ‘may be result of corruption’

    BBC faces corruption allegation over its Sir Cliff police raid coverage

    Reporter’s relationship with police under scrutiny as DG is summoned by MPs to explain extensive live broadcast of swoop on singer’s home