In the past 10 years, inflation has pumped up returns on investment by an average of 5 per cent a year or 50 per cent over the decade, and helped make the eventual returns look quite generous. In real terms, the performance has been much more modest.
With-profits policies are invested mainly in the stock market, and shares should continue to outperform most other investments over time. But in an environment of much lower inflation, the returns on with-profits policies over the next 10 years cannot hope to match the inflation-boosted performance of the past 10.
Even the projections currently sanctioned by the Personal Investment Authority, which allow pension salesmen to quote forecasts based on 6 per cent or 12 per cent compound growth each year, will look increasingly unrealistic in the face of an inflation rate of just 1-2 per cent. Low interest rates will also reduce the size of the annuities that pensioners can expect their investments to buy when they retire.
The pensions industry argues that it is already letting policy-holders down gently by cutting annual bonuses every year to bring future expectations more into line with reality.
The gap is narrowing every year between the recent performance of managed funds, which are invested in a wide range of assets including gilts and property, and the traditionally more spectacular with-profits funds. With-profits funds maturing last year had outperformed by up to 20 per cent over a 10-year period, but the 1995 gap will already be significantly smaller.
In a climate of increasingly cut-throat competition, however, investors will inevitably be tempted to ignore future projections in favour of past performance, and even slight differences in past performances will increasingly determine where individuals and their financial advisers buy their pensions.
This in where Standard Life, the Prudential, NPI and Sun Alliance, to name but four, face real problems.
There is little difference between the performances of the managed funds operated by the top 18 companies over the past 10 years. But the performance of with-profits policies has varied considerably. The best-performing with-profits policy, from Sun Life has turned £200 a month, building up to an investment of £24,000 over 10 years, into £56,000. At the other end of the scale, Standard Life, for years one of the best performers in the industry, has generated little more than £40,000.
The more worrying aspect for the poorer recent performers is the industry- wide belief that Standard Life in particular has brought some of its problems on itself, by increasing the commissions it pays to financial advisers who bring it business at the expense of the funds it invests on behalf of policy-holders. These commissions are becoming increasingly visible in the light of the new rules on disclosure.
If that is the case, the increased information on commissions that companies must disclose in future will increase the strength of the spotlight turned on past investment performance.
But in the immortal words of the regulators, past performance is no guide to the future, and every investor choosing a pension fund based on past performance is buying a sealed envelope. It should be better than putting the money in a building society. But how much better is something no one can predict, still less guarantee.Reuse content