April 8, 2012 4:09 am
By Pauline Skypala
Article from ft.com
With-profits policies turned out to be the best investment he ever made, an industry contact told me recently (not a fund manager). He paid £80 a month over 30 years (£28,800 in total) and got back £205,000 when he took the money in 2002.
By contrast, the £350,000 he has paid into a defined contribution (DC) pension plan for him and his wife since 1988 is now worth £500,000.
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Shame he did not stick to the with-profits approach – or maybe not. The annual with-profits survey by Money Management, an FT publication, shows my contact cashed out at the right time.
The average payout at maturity on a £50 a month 25-year with-profits endowment has more than halved since 2002, falling from £87,169 to £38,299. Payouts peaked in 2000, when the average was £98,370.
Had my contact cashed in his policies in 2000, he would have made 10 per cent more, he says. Timing is everything in investment – even in with-profits, an approach that is supposed to smooth out stock market fluctuations.
The with-profits sector in the UK is practically moribund, with few companies still open for new business.
The approach was felled by the dotcom bust that brought the long bull market of the 1990s to an end, and by the expensive guarantees life companies had incorporated into policies. They did not have enough capital to support them, having blithely mismatched assets and liabilities for many years by being heavily exposed to equities.
Instead of being steady-as-she-goes investments, supported by balanced portfolios, they became racy growth investments betting on equities to outperform over the long term. Instead of cautiously increasing policy values by annual bonuses, the focus moved to paying big final bonuses when policies matured (which many policyholders did not get, having cashed in early).
And instead of remaining mutual (as most with-profits insurers were), they converted to plcs, paying out large amounts to policyholders in compensation.
Looking back at what went wrong with the with-profits approach is instructive, as there appears to be talk of reviving it in the pensions sector.
Pensions minister Steve Webb has put forward the idea of “defined ambition/aspiration” pensions, a halfway house between defined contribution and defined benefit, modelled on the so-called collective DC approach pioneered in the Netherlands.
Mr Webb has yet to put flesh on the bones of this idea but it is not a new one. I wrote about it two years ago, when investment consultants were lobbying for importing CDC to the UK. Maybe they successfully persuaded Mr Webb of the merits of this plan.
The Department for Work and Pensions poured cold water on the idea in a report published in December 2009, despite its modelling showing average outcomes would be 20-25 per cent better under CDC schemes than under conventional DC. It cast doubt on the ability to manage risk successfully so as to be fair to different generations of scheme members.
This is the key issue with any scheme that relies on intergenerational risk sharing. It is essentially where with-profits broke down.
And because of that breakdown, it is doubtful whether pension savers in the UK would trust financial institutions to be fair, even if they thought they were capable of managing risk successfully.
The fairness problem leaps out from the Money Management survey. The best result for 25-year endowments is Phoenix Assurance’s £185,115 payout, representing a 16.8 per cent annualised return. That may sound impressive, but it is down from £342,949 in 2007.
Such huge payouts are not due to fantastic returns from skilled investment managers; they are simply because there are only a few thousand policyholders left (Phoenix closed to new business in 1986) and they are getting the benefit of the division of the estate – which is the money in the fund surplus to that needed to meet policyholder commitments.
Phoenix Assurance is one of 13 closed with-profits funds taken over by Phoenix Group (sharing a name is coincidental), most of which paid out £20,000-£32,000 on 25-year endowments this year.
Kevin Arnott, director of with-profits management at Phoenix Group, says Phoenix Assurance is unusual and such high payouts are unlikely to be on offer from other closed funds as they wind down. Some funds have no surplus assets, and need support from Phoenix Group just to meet policyholder commitments.
It looks like a lottery.
Risk-sharing is a nice idea in theory, and may work well in some places. Mr Arnott’s judgment is that the world has moved on from with-profits and the cross-subsidies involved are no longer acceptable to UK savers.
Mr Webb’s defined ambition schemes will have to be different in design and practice if they are to fly.
pauline.skypala@ft.com
Article from ft.com
