Finance: Profit bonds and MVR'sPosted on: 16 March 2011 by Rhian Mainwaring
Peter McGahan casts his eye over profit bonds and the billions of pounds at risk!
Profit bonds! Now there is the world's greatest enigma. Not only were they never a good idea, but it is now over ten years since they were really shown to never be a good idea. Yet, today there is over £330bn sitting in such arrangements, fermenting at the expense of the unaware investor.
Today they are defended by some for paying out as much as £7.2bn last year in bonuses! Whilst it’s a big number, and you would notice it missing from your bank account, its relevance is more clear when you place it next to the total amount invested in with profits at £330bn.(1) That is a mere 2.2%.
The concern about with profits is increasing more and more as providers still seem to be allowed to charge a Market Value Reduction (MVR) even in spite of the fact that the UK stock market has soared over the last few years. But the FSA will soon be looking into this.
An MVR is a penalty that applies to profit bonds which allows the insurance company the luxury of simply telling you that your surrender value is less than the current value and they can apply whatever penalty they believe is appropriate. The whole point of an MVR is that investors who stay in the fund are protected against those who leave the fund, especially when markets are under pressure. Nice story, but with profit bonds have been well known for applying an MVR when the reverse of this is true.
With profit bonds had the joy of an upwardly rising market for a long time which should have bolstered the underlying value of the funds. In 2003 the market took a battering and the reserves that with profit bonds should have kept behind them to smooth out the downside of 2003 didn’t exist. They were found wanting in every way and investors were stopped from leaving with profits by the sudden inclusion of the dreaded MVR. Trapped by this, with profit bonds also took the opportunity to smash bonuses and effectively pay out less than inflation. And so, investors were caught between the rock of a penalty for accessing their cash and the hard stone of virtually no income.
Whilst the MVR was perhaps reasonably understandable in 2003 it is unclear how with profits can be applying an MVR today. Since 2009 the FTSE100 has risen from 3530 to 6021, a colossal rise of over 70%, yet some providers insist on bashing investors in with profit bonds with the fashionable MVR. It's staggering. (2)
However, the FSA has stated that it will be analysing MVRs and will consider changing the rules which should effectively take the shackles off the investor to escape the enigma of with profits. The new rules are expected to remove the ability to impose MVRs on the grounds of surrenders to the fund alone.
The tightening of when they will be allowed to place an MVR will put big pressure on with profit bonds and I expect an exodus. There has been a continuous exit, and whilst the stock market has increased substantially over the last eight years, the total amount of money invested in with profits decreased by £90bn from £420bn in 2005, to £330bn in 2009. (1) I have no reason to believe that will not reduce to zero before long.
With profit bonds, in much the same way as many structured/guaranteed products, are actually aimed at investors who are slightly risk averse, or who don’t understand the benefit/impact of risk. They are synthetic in their nature/makeup and cannot really protect investors from the downside risk.
In fact, many experts have expressed concern at the communication that is given to profits customers, especially when they receive their annual valuations. All too often the current value is quoted when it does not include the MVR. And so the investor blindly carries on believing their fund is worth more than it is until they ask for its true value - the surrender value, which will include all penalties including early encashment and MVR charges. A big shock.
If you would like a review of your with profit bond, call Peter on 0845 230 9876 begin_of_the_skype_highlighting 0845 230 9876 end_of_the_skype_highlighting e-mail email@example.com or take a look at our website.
The value of shares and investments can go down as well as up.
Peter McGahan is an Independent Financial Adviser and the Managing Director of Worldwide Financial Planning Ltd who are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.' Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made.
The above represents the personal opinions of Peter McGahan.
All information is based on our understanding of current tax practices, which are subject to change.
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