Simon Read: Time to put an end to these outrageous 'exit penalties'
Saturday 26 February 2011
There are more than 25 million with-profit endowment policies in force across the country which means there are a lot of people stuck with potentially poorly performing investments. New proposals from the City watchdog may help to make it easier for people to escape from the worst performers.
With-profits policies were once sold in their millions to back mortgages as well as being used as part of pension planning and bonds. The theory behind them is simple: they hold back annual bonuses in good years to pay bonuses when markets do not perform well. By doing so they smooth out investment returns to give savers less of a rough ride than they would experience with direct investment in the stock market. As such they seemed ideal for long-term financial planning such as paying off a mortgage loan in 25 years' time.
But, as many borrowers discovered to their anger, when markets struggled – as happened a decade or so ago – policies couldn't guarantee to grow enough to cover the whole mortgage debt. It left many facing a shortfall and having to make other arrangements to pay off their loan. As a result very few with-profits policies are now sold to repay mortgages, although they are still used as straightforward savings or pension investments.
With policies lasting a minimum of 10 years and up to 25 or more, it can be easy for investors to become locked into a fund that is no longer fit for its original purpose. But with-profits providers have made it all but impossible for people to leave by imposing unfair market value reductions on policies.
The principle behind a MVR is that it should stop someone leaving with more than their share of the underlying fund. That is fair enough, because allowing investors to withdraw with more would mean hitting the remaining investors. But the reductions have become hugely controversial with critics suggesting with-profits firms have been using them as exit penalties.
The Financial Services Authority agrees and is proposing to force with-profit firms to distribute surpluses to investors more fairly and stop them using MVRs as exit charges. The watchdog also plans to strengthen rules requiring with-profits firms to obtain independent advice on the management of their funds.
The moves – planned to be introduced this autumn after a consultation period – should ensure a better deal for policyholders. They won't lead to better returns, however, which means investors still need to examine their policies, especially those in closed with-profits funds. "These are often run to manage liabilities rather than provide reasonable returns," points out Patrick Connolly of advisers AWD Chase de Vere. "If MVRs in poor performing or closed with-profit funds are reduced then more policyholders will undoubtedly exit their with-profits policies," he says.
I'm often critical of the FSA for its slow progress or late action, but it does seem to have got its act together on the with-profit problem. Even though we'll have to wait until autumn for these new proposals to be adopted, they are a positive move. It's also right for the regulator to have a consultation period to give consumers and the industry the chance to express their opinions before changes are made.
In the meantime with-profits policyholders should review their investment and be ready to make a move when it becomes financially more easy.
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