With-profits guarantees will cost policyholders

Policyholders and shareholders of with profits companies could end up paying for the “money back” guarantees that are increasingly being offered to draw new investors into with-profits funds.

In recent months, insurers including Aviva and LV= have launched with-profits policies that give new investors the option to add a capital protection element to their plans.

The “money back” guarantees are designed to offer “peace of mind” to nervous investors who want better returns than cash savings, but who don’t want to take too much risk. Annual charges for policies with these guarantees range from 0.3 to 1.3 per cent.

The guarantees enable customers to get back their initial investment, minus withdrawals, after five years if they have made regular payments into a with-profits policy.

Customers with guarantees also benefit from any gains that the with-profits funds make on their underlying property, fixed interest or equity holdings.

But insurers conceded this week that existing policyholders and shareholders were exposed to potential liabilities on the guarantees.

Aviva said that any excess cost of its guarantees would be borne by shareholders and not policyholders.

This new guarantee is Aviva’s second foray into the “money back” market. It had to withdraw its guaranteed inflation-proof with-profits policy earlier this year because it had become too expensive to fund.

“Customer charges are expected to cover the cost of the guarantees over time, with any shortfall met by Aviva,” said Richard Kelsall, an Aviva spokesman.

“We only plan to guarantee about £150m of new investments, after which we will review our strategy. We are monitoring these costs carefully,” he added.

LV=, a mutual, plans to fund its guarantee from within its with-profits fund, meaning that policyholders will bear the cost.

“Currently we are comfortable funding the potential future cost of these guarantees within the with-profits fund, so it does not affect our asset management approach . . . we do not have to use hedging or other financial instruments to cover it,” said Nigel Snell, a spokesman for LV=.

“Our overall aim is to generate good value for the new members taking out the guarantees while still providing a good return with controlled risk for existing members in the with-profits fund.”

But he added that, if necessary, action would be taken so as not to damage the capital position of the fund.

Prudential, another insurer, said it operated a separate account where charges for the guarantees it offered were held. This is used to fund repayments.

But if the account “dried up”, policyholders in the Pru Life Fund, financially one of the strongest in the UK, would bear most of the cost, with shareholders bearing 10 per cent of any liability.

“On the flip side, any profit arising from any excess in the guarantee account would also be split 90 per cent policyholder, 10 per cent shareholder,” added a spokesperson.

Financial advisers contacted by the FT this week still had reservations about the funding arrangements for the new money back guarantees.

“Who is cross-subsidising who?” asked Malcolm Cuthbert, head of financial planning with Killik & Co, the wealth managers.

“I would want to know more about the extent of these guarantees, their security and who is going to pay for them.”

Other advisers raised concerns that guarantees could lead to a more conservative management of assets to reduce the risk of a shortfall. Guarantees would also add another layer of complexity for investors in with-profits funds, which use a “smoothing” process to redistribute profits in good years and bad.

“It is difficult enough for investors to keep tabs on performance,” said Henry Denne, head of financial planning with Punter Southall, the independent financial advisers.

“You would have to be concerned if a guarantee was offered on your fund. I would ask what impact it might have on annual or terminal bonuses.”