How with-profits bonds fail investors

Posted on: 10 March 2010 by Mark O'haire

Following on from last week's with-profits bond comments, Peter McGahan uses this week's column to explain exactly how they work - without the salesman and insurance company's noise.

Let's look at why investors invest, how they understand risk, and how with profits are contrived to sell to that fear.

Investors invest to seek a decent return over and above inflation. In the 22 years from 1987 to 2009 cash only returned 28% more than inflation.

As most investors are not fully explained risk and how it can impact them negatively or positively, they are reliant on the 'adviser' who is wheeled in front of them to explain that.

Unfortunately for the average investor there is very little investment expertise available and investment advice can be offered by most advisers with no specific investment qualifications. Most advisers pass minimum levels of qualifications but are allowed to advise freely on complex areas such as investments.

The result is that the advice is very much at a 'product' and 'commission' level. Banks, all of a sudden decided they were investment advisers and this 'product sale' exploded.

A third of all complaints to the ombudsman last year were against just three of the UK's banks. More than half of all complaints came from eight banks alone. Indeed banks and their subsidiaries command the first 14 places in terms of the amount of complaints. Well done.

More than 63% of all complaints were against these 14 banks and 37% from the remaining 99,986 firms (of which quite a few banks were still in there) 79.14% of all complaints upheld on the ombudsman's website were against banks, building societies or their subsidiaries. Less than a quarter of 1% of the complaints were against Independent Financial Advisers.

The Lloyds group must be over the moon with grabbing three of the first eleven places for the total amount of complaints -but their adverts are catchy and nice.

And so commoditised speedy product sales have been exposed. With profits are indeed a symptom of this commoditised 'advice' process.

In order to 'sell' to a customer; this product is designed as a lower risk vehicle but it is not. Think of this in its simplest form of two comparative pots. A managed fund and a with profits fund.

A managed fund is designed to beat inflation but decrease risk by diversifying across different assets such as property, equities, fixed interests and cash. A with profits fund invests in exactly the same assets.

The difference between the two as far as an investor is concerned is that every day the value of your managed fund changes, whereas the with profit bond 'apparently' does not. The actual return you receive from a with profit bond is based on what an actuary tells you he is going to give you from the returns they are making. 

Both the managed fund and with profits are invested in virtually the same manner. A with profits would like to be invested the same as a managed fund, but they are restricted because of the 'guarantees' or 'vague promises' they have to give to other policyholders, so often have to sell out of equities when they have already fallen, and buy them back after they have already risen. Disaster.

With a managed fund you always know what your plan is worth, but with a with profits plan, the actuary holds back your returns and gives them to you over the years.

The idea is that they are supposed to protect you from downsides but that was exposed as nonsense the first time they were put under any sustained pressure. Think about it once again from its simplest form:  A with profit bond cannot pay you out any more than the fund it's invested in performs, so by definition it has to underperform.

The golden ticket they used to wave was the protected downside but when the market fell, with profit funds simply applied a market value reduction to reduce the value of your with profit bond back to what you would have received if you had a managed fund. So it's 'heads the insurance companies win, tails they win'.

I'll bet you have never seen them marketed or explained like that. But 8% commission every bond is hard to miss.

By Peter McGahan

Need Expert Advice?

Peter McGahanPeter McGahan is an Independent Financial Adviser and Managing Director of Worldwide Financial Planning. Worldwide has won 16 Financial Times awards in the last four years. Peter has also been named the top media IFA of the year by in 2009.

Peter comments regularly in major journals such as the Mail on Sunday, Irish News and Sunday Times and is a weekly columnist for FT Adviser. He has also appeared on Working Lunch and the Today programme. In addition he is an expert on international tax matters for a range of international publications.

Worldwide Financial Planning Ltd 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 understanding of current tax practices, which are subject to change. The value of shares and investments can go down as well as up.

If you have a financial query you would like Worldwide Financial Planning to respond to, call 0845 230 9876 or email


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