Policyholders are paying the penalty

INVESTORS face steep penalties for cashing their with-profits polices in early after providers moved to stem outflows.

Standard Life this week joined the ranks of insurance companies to slash bonus payments on with-profits policies and increase charges for those who surrender their policy ahead of time. The charges, known as market value reductions (MVRs), have been extended by most insurers and re-introduced by Norwich Union and Friends Provident to prevent a rush of investors selling out of their funds. Standard Life has increased the number of policies to which MVRs would be applied, including mortgage endowments, where the charge was not previously levied.

With-profits policies work by pooling investors' premiums into a fund which invests in assets including equities, fixed interest and cash. The product features a process called smoothing, which effectively holds bonuses back in good times to level out payments when markets are more volatile. Terminal or final bonuses are paid at the end of the term – typically ten, 15, 20 or 25 years – in addition to the annual bonuses.

The announcements from Friends Provident and Norwich Union affect around 1.5 million pension and bond policyholders in total (although conventional with-profits policies are not affected) while Standard Life's changes affect most of its two million policyholders. But most insurers have cut bonuses this year by between 5 and 15 per cent as markets have nose dived.

"It was inevitable that, in the current climate, maturity values would be affected given that part of the return comes in the form of a terminal bonus that seeks to ensure that each investor receives their 'asset share' over the term of their policy," said Barry O'Neill, chartered financial planner at IFA Thomson Shepherd. "With most of the asset classes held in with-profits funds having fallen in value significantly this year, no amount of smoothing can cater for this."

Consumer group Which? said the increased MVRs were unfair to policyholders.

"This could penalise those policyholders who had only stuck with the fund because of the promise of payouts from the reattribution and special bonuses," said its personal finance campaigner, Dominic Lindley. "It may feed the impression amongst policyholders that, when it comes to with-profits, what companies give with one hand they take with the other."

Andrew Fisher, chief executive of private and corporate wealth adviser Towry Law, told The Scotsman that with-profits providers were conning policyholders. "It is disingenuous to call MVRs penalties because that implies it is bad news to take your money out. They have hidden charges, they perform awfully and having penalties for withdrawing is appalling, but insurers are desperate to hang on to policyholders money."

Some with-profits investors have been well rewarded, however, according to the latest survey of the sector by specialist magazine Money Management. It found that, while payouts generally continue to fall, some life offices still produce strong returns. Sheffield Mutual is the top provider over policy terms of ten, 15 and 20 years. Investors paying £10 a month into a ten-year Sheffield Mutual with-profits policy have enjoyed returns equivalent to an annual tax-free growth of 13.5 per cent. With-profits performance still compares well with other assets, Money Management added. Over 20 years, the average with-profits policy has grown 6.7 per cent a year, with the next best return from UK equity trackers at 6 per cent.

But millions have been let down by with-profits, said Fisher. "Most policyholders were sold them by IFAs because of the commission they pay and only discover when they take their money out that performance has been poor."

The problem with the product is not only performance, critics point out, but also a lack of transparency, with bonus payments and MVRs worked out by actuaries and not produced by a mechanism that investors understand. "Actuaries cannot predict the future so the idea of smoothing is a complete fallacy," claimed Fisher. "The most important thing to do is to seek fee-based financial advice, but the vast majority should get out immediately and have their money managed more efficiently elsewhere."

Investors in underperforming funds should think about how long it would take to recoup the MVR if they were to move out and compare that against how long the MVR is in place, said Adrian Lowcock, senior investment adviser at IFA Bestinvest.

"For example, if the MVR is 20 per cent and in place for three years, an alternative investment would need to return in excess of 6.6 per cent to break even in that time.

"Whilst possible, this would only enable you to break even and you may end up taking on additional risk to achieve the returns required."

If you are considering cashing in your policy, check if it has an MVR in place and, if so, how much. It may be worth waiting for the next opportunity to avoid such a charge, such as the tenth anniversary of taking out the product. Also check the performance of the fund because, as previously mentioned, some are performing creditably. Most importantly, if you are wondering whether you should withdraw your money, independent financial advice is highly recommended.

To find an IFA near you, call 0800 085 3250.