Left without profit?

IFAs can add value by advising clients on exiting with-profits funds, writes Michelle Cracknell, strategy director at Skandia.

Over the past decade, with-profits funds have declined in popularity. Once regarded as an appropriate investment for many, recent research has demonstrated most advisers now believe with-profits simply cannot be the right fit for every investor.

While with-profits funds might have been an appropriate investment 10 or 20 years ago for certain clients, the market has moved on considerably, and there are now alternative products available that may be better able to meet the individual needs of different investors.

Many current investors in with-profits funds have become dissatisfied with their investments, with just 27% of people stating they are happy with their with-profit policies according to a recent survey of 600 financial advisers.

In addition, advisers say with-profits policies are appropriate only for 11% of clients today, which means many advisers and clients will be scrutinising these investments and hoping to move to a more suitable investment offering better choice and control. Those who are dissatisfied may be looking for an opportunity to exit their investment, and in this area advisers can add real value.

Exit opportunity knocks

There are billions of pounds sitting in with-profits investments. 2010 is set to be a bumper year for exit opportunities, with an estimated £11.5bn of with-profit bonds having an MVR-free exit point – sometimes a time period as short as one day – where clients can get out without facing a penalty. But identifying this MVR-free opportunity can be challenging and clients may well be looking for the support of an adviser well versed in this area.

Exiting a with-profits policy may not always be the right course of action. Advisers will need to formally review the investment to ensure that: the appropriate plans are put in place; the client fully understands and agrees with the action taken; and all activity is documented properly for future reference.

Whether or not a client has an interest in potentially exiting a policy, reviewing the current suitability of with-profits policies is a regulatory requirement when providing investment advice. But reviewing these policies is not an easy process. The opaque nature of with-profits means it is difficult to understand what returns can be expected and the additional complication of MVRs and MVR-free dates make the adviser’s task of reviewing these investments complex and time-consuming. So how should advisers start to tackle this mammoth task and what should they be looking at?

The FSA has outlined a 10-step process that investors should follow when reviewing with-profits funds. The 10 elements advisers and their clients need to consider according to the FSA guidelines are:

• What sort of policy it is;
• Whether the policy still meets the investor’s needs;
• The length of time the policy has been in force and how long is left;
• The expected value of the policy if kept until maturity;
• The benefits the policy offers;
• The current cash-in value of the policy;
• Whether there is a penalty-free exit opportunity;
• What the investor will do with the money if they cash in the policy;
• Whether to switch to a unit-linked fund, as suggested by the provider;
• Whether to move the money to another provider.

The asset allocation of the fund is a key area for review. Many investors will have held their policies for a long period of time. Advisers will need to review the current asset allocation of the fund to see how it has changed, and whether it is still appropriate for the risk profile of the investor.

The past 10 years have seen a significant change in the asset allocation of with-profits funds. For example, the proportion of equities held in some with-profits funds has dropped from about 70% in 2000 to about 30% in 2009.

This change can have a significant effect on the potential returns the fund is able to deliver. As advisers and clients continue to embrace risk-led investing – matching a risk score to the asset allocation of the investment – the lack of control offered in a with-profits investment may lead advisers and clients to reconsider keeping the money in an investment that does not always match the investor’s personal attitude to risk and subsequent risk score.

Dropping annual bonus

Many investors will have been enticed to with-profits in the past due to the annual bonus rate. In the past 10 years, many funds have consistently dropped the amount of the annual bonus paid with many funds holding their bonus rates at one level, despite varied levels of growth found in the underlying assets. By doing this, providers are aiming to rebuild their ‘with-profits balance sheet’ but are doing so at the cost of the investor. Terminal bonuses are also difficult to predict, and with fixed interest now being the largest holding in many with-profits funds, they cannot necessarily be relied upon to boost the final payout.

Charges will also play a part in determining the suitability of a with-profits investment. Because charges are linked to the annual bonus of a with-profits fund, it can be near impossible to determine the actual value of the charges being deducted. With-profits providers will charge for the cost of the guarantees they are providing either explicitly or implicitly within the bonus rate.

Investors should consider whether paying for a guarantee is worthwhile or whether their investment objectives can be better met through an alternative well structured investment portfolio.

While it is by no means always appropriate for with-profits customers to transfer out of their policies, it is essential they are reviewed to check these policies are still suitable for their individual needs. The tax implications of any withdrawals or transfers from with-profits will also need to be considered in detail before recommending any action.

Reviewing with-profits can be a complicated task, but there are tools available in the marketplace that will make the process of carrying out these reviews more efficient and consistent for all clients. These tools can go so far as to identify the current asset allocation of with-profits funds, evaluate potential future performance and identify any up-coming MVR-free exit dates.

While the initial decision to invest in with-profits may have been a sound one, it is essential advisers review these investments to ensure clients hold the best and most appropriate investments for their needs.

In some cases with-profits will remain a valid and suitable investment, but in other cases the client may be better off cutting their losses and moving their investment into a more flexible and transparent arrangement that allows better control and the potential for better future growth.