These policies, designed to smooth out the ups and downs of the stock market, have previously offered investors a fairly soft cushion against any dismal performance.
But reality is catching up fast. Last year, Norwich Union was the first life company to cut bonuses. Returns were 12 per cent lower than the previous year on 10-year policies, and were 5 per cent down on 25- year policies.
The latest annual round of bonus declarations by the with- profits life insurance companies will kick off with Norwich Union on 5 January. And it has been softening up financial advisers to expect the worst. Policies will drop in value again.
Philip Scott, who has taken over as chief actuary as well as heading the investment side of the business, said: 'We want to pay out what the policies have earned, with a degree of smoothing.' And that means there are more cuts on the way.
Last year, the cuts in the annual bonus, which is added to policies each year and can never be taken away, was marked by a change of method. The flat 5 per cent bonus was replaced with a bonus of 4.5 per cent on the basic sum assured and 5.5 per cent on previous bonuses. This had the effect of cutting returns on policies that had not been running for very long to a greater extent than the reduction of the returns on longer- term policies.
This year, there will be real reductions in the bonus rates. 'We have been in the 'too good to be true' category,' said Mr Scott. 'We need to get back to delivering what people are expecting. When it gets uncomfortable for everyone is when expectations get ahead of what you can deliver.'
The Norwich Union fund is invested 55 per cent in equities, 25 per cent in fixed-interest securities and 20 per cent in property. With returns of 15 per cent on equities, 18 per cent on fixed interest and a just-about-positive return from property after taking rental income into account, the fund made an overall advance of 13 per cent during the year.
Currently, returns from the with-profits fund of 11 to 12 per cent are needed to support the annual bonuses alone. But with- profits policies have usually delivered a large one-off bonus as a chunk of the final return. Mr Scott said this should be about 30 per cent of the final payout. 'I feel uncomfortable at the moment; the additional bonus component needs to increase.'
Mr Scott wants to make investors aware that with-profits policies cannot deliver higher returns while investment returns are poor. 'When earnings went up, we paid out. When they went down, we hit the headlines,' he said.
But he is also keen to point out that while returns from with-profits policies are coming down, falling inflation makes them a reasonably safe investment for the medium term.
At the moment, about 90 per cent of Norwich Union's business goes into the with-profits fund, and just 10 per cent into unit-linked policies that give investors an uncushioned ride on the stock market roller-coaster. But within the next few years, Mr Scott expects unit-linked policies to climb to 40 per cent of new business.
Norwich Union - along with many other insurance companies - has stopped selling with-profit bonds which provide an entry into the with-profit fund to those with a lump sum to invest. These can destabilise the fund, as investors will respond to market movements rather than taking their cash when the policy reaches the end of a pre-set period. Norwich Union has no plans to reintroduce these bonds.
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