I've got just the policy for you, guv. It's a good little runner

It is the level of charges and surrender penalties that is the most important factor determining performance, rather than investment growth
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The Independent Online
Imagine that Ford launches a multi-million-pound advertising campaign to market a car with the quality and second-hand value of an Escort, but at the price of a Jaguar. The motoring press would tear it apart and a discerning British public, which likes to think it knows about cars, would leave most of the company's output in the showrooms. No big manufacturer can afford to ignore consumer buying power without getting a bloody nose.

There is, however, an industry where it is possible to sell poor-quality products at premium prices, and where regulators and consumer bodies have been puzzling for years, with no great effect so far, about why it happens and what can be done.

That industry is life insurance, whose showrooms are full of shiny new models which, when you investigate further, do not appear to have very much under the bonnet.

This week, there was an excellent example of how, in the insurance industry, a first-rate marketing campaign and a powerful brand name can overcome the drawbacks of having a list of products that leave much to be desired in performance terms.

The Pru announced a dramatic increase in sales of its long-term life insurance products, both world-wide and in the UK, helped, of course, by Prudence, the company's appealing new advertising image. The announcement came after the Independent's investigation last Saturday, to be continued tomorrow, into the performance of life insurance companies, using a new rating system devised by John Chapman, a former senior official of the Office of Fair Trading.

Mr Chapman wrote a series of hard-hitting reports on the life insurance industry before he retired this year from the OFT.

It so happens that the Pru languishes near the bottom of many of the performance tables, yet it is right at the top of the industry, and doing better every month, when measured by the value of the policies it sells. If customers were scrutinising the ratings tables, surely the Pru's sales should be on the slide?

This is not meant to be an exercise in bashing the Pru, which is a highly reputable organisation, suffering perhaps from the costs of having a large sales force, which may hamper its efforts to offer the cheapest products.

It shares the bottom of some of the tables with a number of other well- known names with substantial volumes of sales, including Royal Insurance, which has now merged with Sun Alliance, Sun Life, Friends Provident, Britannia Life and AXA Equity & Law (see table.)

In most other industries, the best would drive out the mediocre. Somehow, this separation of the wheat from the chaff does not appear to be taking place consistently in life insurance.

It is true that Equitable Life, a top performer, does have sales comparable with the Pru. But on the whole there is little obvious correlation between product quality and sales revenue.

One reason is that there has always been a great deal of confusion about what makes a good life insurance product. Counter-intuitively, perhaps, it is the level of charges and surrender penalties that is the most important factor determining performance, rather than investment growth.

Charges and penalties can reduce the yield on a policy by between 1 and 5 per cent a year, and in the case of early surrender, by 10 per cent or more. As Mr Chapman points out, it would take a truly miraculous investment performance for a company levying high charges to overcome the handicap and match the returns to policyholders of a company with low charges.

As well as confusion over what makes a good product, until recently there was an almost complete information blackout. Even now, charges and surrender penalties can be obscure and complicated, as with unit-linked policies, or be hidden completely, as in the case of with-profits endowments. The latter are one-sided contracts that allow insurance companies almost complete discretion in deciding final investment returns.

After pressure from the OFT and consumer groups, and after a great deal of huffing and puffing, the industry was finally persuaded to publish what amounts to a proxy value for its charges.

Since last year, companies have had to give projections of early surrender and maturity values. Since they are based on a standardised assumption of investment performance, variations in the cash values projected are a good indication of differences in charges and surrender penalties.

The great majority of policies are lapsed before maturity, making it vitally important to look at the values of policies at several different stages. Our tables rank companies on a combination of early, mid-term and maturity values, to give a fuller picture. These ratings tables cannot yet be regarded as perfect. The information supplied is still far from complete.

There are no mechanisms for ensuring that, over the life of a policy, an insurer sticks to the level of charges and surrender penalties assumed in the projections it makes when it sells a policy.

There are also a number of games companies can play to massage the figures and there is a strong case for tightening the disclosure system, by forcing publication of lapse rates to show which companies mis-sell the most policies. We might even learn from the French system, where there is an initial charge, an annual charge and nothing else to complicate comparisons.

Nevertheless, consumers are beginning to get enough information to pick policies on the basis of quality. Those who buy through independent financial advisers should also be equipped to ask tough questions whenever they are offered products which rank poorly in the tables - questions such as how big is your commission on this well-known dud?

When consumers really do begin to understand the merits of what they are buying, the pecking order in the life insurance industry should begin to change.

Investors in the shares of a life insurer would find the quality rankings of its products a good indicator of future sales success.

The test will be when big-name firms with poor products but good marketing campaigns find their sales falling rather than rising.

How life insurance companies rank

The top five ... and the bottom five

(lowest ranking at top)

Equitable Life Royal Insurance

General Accident Sun Life

Norwich Union Prudential

Standard Life Friends Provident

Scottish Mutual Britannia Life

Sources: John Chapman, The Independent, Money Marketing.

Measured across a range of 15 products.