There haven’t been many asset classes that have protected investor portfolios over the last harrowing year or so. Cash is the obvious area which immediately springs to mind – but will “cash be king” going forward in the period of lower interest rates, which looks likely?

With-profit funds, on the face of it, look to have done investors proud in recent times. Or have they? They are back in the news for two main reasons – the lowering of bonuses/reintroduction of market value reductions (MVRs) and potential reattribution bonuses from some of the major players in the UK market. However, the weaknesses of this type of investment are rearing their ugly heads once more.

First, a very brief recap on how with-profit funds pay money into a pooled investment fund with an insurance company who invest in a diversified manner in equities, fixed interest, commercial property and cash.

In the good years not all returns are paid to investors as actuaries announce a lower annual bonus with the idea being that, in bad years, enough profits have been held back to pay a decent bonus rate. Insurance companies call this “smoothing” and the combination of an exposure to real assets without the volatility is a compelling prospect. It was only in the sm++aller print, though, that they mention MVRs (a penalty on investors who wish to exit in difficult times for markets) and their reintroduction – as well as the lowering of terminal or final bonuses – is now commonplace.

It is unreasonable to “bash” almost any asset class in the financial situation we find ourselves in. But those investors that stuck with with-profits after the last bear market are being hit again. After the 2000-03 period, annual bonus rates were reduced dramatically (often down to nil with several household name insurers), large MVRs were introduced for several years and terminal bonuses were slashed.

In times like these, we all have short memories but 2003-07 were excellent years for many types of asset classes. While MVRs mostly fell away and terminal bonuses were reintroduced, headline rates often (in almost all cases) remained very low in spite of the fantastic returns made by insurance companies.

Many advisers warned years ago that insurance companies would rebuild their financial reserves before passing benefits on to investors in respect of higher annual bonuses. Then we get a year like this!

The nature of with-profits means MVRs and lower terminal bonuses are inevitable in this environment. But it is a bitter pill to swallow for the loyal with-profit investors who missed out on the fantastic returns of 2003 to mid-2007.

The reattribution of bonuses from the two largest UK with-profit providers – Norwich Union (NU) and Prudential – have also seen this asset class return to the limelight.

After this annus horribilis one company has made a U-turn in paying out this inherited estate while

one is ploughing on. An inherited estate is money that built up in a with-profits fund over many years, which is above the amount expected to be needed to meet current and future policyholder commitments and other obligations such as expenses.

Norwich Union is still proceeding with its estimated £3.1 billion reattribution to relevant policyholders – apparently equivalent to about 70 per cent of the value of their inherited estate. The bonuses are due to be paid between December 2008 and December 2010. Norwich Union’s website states: “The inherited estate is needed to underpin the security of our funds against substantial falls in stock-market values, and to provide investment flexibility.”

Surely the inherited estate is required by Norwich Union at this time rather than being distributed to policyholders? Prudential certainly think so as they state,

“After an extensive assessment, we have concluded that maintaining the current operating model for the with-profits sub-fund is in the best long-term interest of both current and future policyholders and shareholders. As such, we have decided not to proceed with a reattribution.

The whole of the inherited estate is required, and it will remain as the working capital of Prudential’s with-profits sub-fund, helping to support continued superior investment performance, security and the ongoing financial strength of the fund for the benefit of current and future policyholders.”

The Prudential attitude seems more sensible in this environment. After all, they got things right (by luck or judgment?) last time by coming out of equities earlier than their competitors in 2001 – or, at least, “less wrong”.

For those still in with-profit funds, maybe now is time to review their values, penalties, bonuses etc. Their lack of transparency and make-up means less freedom for you and makes other alternatives worthy of consideration.

Trevor Law is a director with Montpelier Group (Europe) Ltd, the privately-owned independent financial advisers located at Barston near Solihull. E mail: