We're all Bond fans now

We may be stampeding to buy long-term investments. But will we be able to stay the course?
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The Independent Online

Investors are once again pouring money into insurance-linked investment products and pensions sold by insurance companies. However, for some savers these products may not make sense because many people are likely to end up cashing in policies early or stopping regular contributions.

Investors are once again pouring money into insurance-linked investment products and pensions sold by insurance companies. However, for some savers these products may not make sense because many people are likely to end up cashing in policies early or stopping regular contributions.

Britain's biggest insurance company, the Prudential, and one of its highest profile rivals, Norwich Union, this week both announced spectacular growth figures for new business, especially for the sale of insurance-linked investment products. In the UK, Prudential generated £5.9bn worth of new business from its combined life assurance, pensions and investment business, an increase of 66 per cent on the same period last year. Even without the acquisition of M&G, the fund managers, the increase would still have been 55 per cent.

Over at Norwich Union, the increase in the UK was 41 per cent for the same kind of products. These two companies will be among the best performers in the industry, but many other insurers are set to report impressive growth in business this year.

There has been a steady increase in new pension business, but by far the biggest driver of this surge is coming from investment business, especially "with-profit" and unit linked bonds (together known as investment bonds), but also the purchase of annuities, unit trusts, and individual saving accounts (ISAs). For investment bonds, both the Prudential and Norwich Union had increases in "regular premium" investment policies under which the saver signs on to make regular contributions. But the real surge has come in single premium policies, where the policy-holder invests a lump sum. Both insurance companies saw such products jump to almost 40 per cent of their total new UK business so far this year.

These single premium investment bonds include unit linked bonds and traditional "with-profit" bonds, such as the Prudence Bond, or combinations of the two.

The rush of money has come mainly from investors who are dissatisfied with the current low interest rates available on conventional savings accounts. With-profit bonds are taking a big slice of the new business. These are traditional insurance company products invested by the insurers in a range of assets from cash to bonds, shares and property over periods of up to 10 years. They earn annual bonuses based on the success of the investments, but these are "smoothed out" by the insurers in order to iron out the bigger fluctuations in the underlying value of the investments. Most reinvest any income in the fund to increase the eventual pay-out but investors can cash in units to generate regular incomes of up to 6.5 per cent a year. Any potential tax liability is deferred on withdrawals of up to 5 per cent each year.

One complaint about investment bonds is that they are not transparent, and investors must rely entirely on the good faith and expertise of the insurance company. Another potential problem is that these are offered as long-term investment vehicles, and can prove costly for those who cash in policies early or discontinue regular payments. All type of investment bonds are designed to be held for some time, usually five to 10 years. The charges are mostly levied up-front to pay commission. This means an investor would only get upwards of 90 per cent of his or her money back if cashing in a policy after only three months.

This is a problem which is already evident with pension policies and endowment policies sold in the late Eighties and early Nineties and which have been lapsed. According to the Personal Investment Authority (PIA), 30 per cent of all those regular premium policies lapsed within their first four years and left policyholders significantly out of pocket because of the up-front charges. The latest set of figures, published this month and referring to policies taken out in 1994, showed little or no improvement in the lapse rate.

Perhaps half of all discontinued policies lapse because of personal difficulties, such as divorce and unemployment. But as late as 1994 there also remained a rump which arose because of the aggressive salesmanship of unsuitable policies and the targeting of individuals in insecure employment. This accounted for the differences between the best companies, whose lapse rate was only around 20 per cent of sales, to the chief offenders, whose rates reached 40 per cent.

The PIA is hopeful lapse rates will fall sharply when the 1996 figures are published in two years. The benefit from the massive publicity campaign to end the worst cases of mis-selling should some through. Plans to introduce stakeholder pensions with low charges will also help to set new standards for the industry and ensure better value.

Your questions answered

Why is so much money being invested this year in insurance-linked investment products such as "with-profits" bonds and unit-linked bonds? These two types of products, together known as investment bonds, are sold by insurance companies and at present offer better returns than the low rates available from banks and building societies.

How can they do that? Unit-linked bonds reinvest your money in units linked to stock market investments. With-profits bonds invest in a mixture of cash, bonds, shares and property. And "combination" bonds invest in all these. With-profit bonds also earn annual bonuses, "smoothed out" to eliminate the ups and downs of stock market gyrations. Larger investments usually earn extra annual bonuses. Fixed-term bonds usually offer the potential of a terminal bonus on maturity.

Are these bonuses guaranteed? No, bonus rates have come down in line with interest rates and inflation. Insurance companies are cautious investors and don't like to be caught out.

Are there charges involved? Yes, the company salesman or independent adviser will expect to get a commission and the insurance company levies an annual management fee. But if you buy through a discount broker you can save money on the initial charge.

Can I make regular contributions? Yes, although the big growth this year has been in single premium policies bought with lump sums drawn out of savings accounts.

Can I get my money back easily and cheaply? Investment bonds are meant to be held for five years or more. If you want to cash in the bond immediately you will probably get less than you invested.

Can I get an income? Yes, certain types of bonds called distribution bonds pay a regular income. Others allow you to cash a proportion of your investments without a penalty and defer any tax on up to 5 per cent a year.

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