With-profits have become with-out-profits for many investors
Millions of UK investors are relying on the performance of with-profits funds for their long-term financial well being. Yet with the investments being hit by a growing barrage of criticism in recent years, here is a basic guide to how the funds work.
I've heard the name mentioned, but what exactly is with-profits?
With-profits investments have traditionally been the way most British people invest when they have been looking for higher returns than a bank or building society savings account.
They have been the bedrock of private savings for many people.
An estimated 20 million savers, who are saving into endowments, life insurance, certain pensions and bonds are investing in with-profits.
With-profits is a type of pooled investment fund, which is normally run by insurance companies or mutual societies.
They generally offer some life insurance cover.
They were once seen as an ultra-safe way of saving for retirement or for school fees, for example. But they have lost some of their appeal in recent years, largely due to stock market falls and concern over the transparency of the products.
What do the funds invest in?
How funds are invested - whether in equities, bonds, gilts and property - will vary depending on the fund and its investment objectives.
University fees or paying off a mortgage
An income from savings
Pay for funeral costs
The intention of with-profits is to give relatively cautious investors a taste of the stock market, but without too much risk.
In return for monthly premiums, the insurance company promises to pay a lump sum at the end of the policy's term.
Investors' premiums are paid into a central fund with those of other "with-profits" investors.
What about bonuses and penalties?
A large part of the policy's final value depends on bonuses paid by the firm during the investment period and when the policy matures.
Were you mis-sold?
Do you have genuine grounds for complaint?
Just because the product hasn't performed doesn't mean you have been mis-sold.
To make a complaint for mis-selling you must have been wrongly or inadequately advised
To safeguard the funds' strength, financial penalties are also imposed on savers who wish to withdraw their money early.
These are known as Market Value Adjusters, or MVAs for short.
Firms use MVAs to try to ensure that policyholders who cash in their investments early do not disadvantage remaining policyholders.
The underlying concept behind a with-profits fund is its in-built safety mechanism known as "smoothing".
Smoothing means that in years of good investment growth companies should hold back profits and use them to top up bonuses in years when economic conditions are harsher.
Why is with-profits 'in the dock'?
The immediate problem facing many with-profits investors is poor performance.
The ombudsman has issued rulings on MVAs
Investors can check whether these rulings apply to them on its website, under Ombudsman News (Issue 38)
It will not uphold the complain if finds that: the investment advice was suitable; the MVA was correctly applied; and the policy gave clear information about possible MVAs
However, it may uphold a complaint if an investor lost out as a result of being wrongly advised to invest in a with-profits fund, or where a firm failed to give clear information about MVAs in the policy document
Many with-profits funds, as with other institutional and private investors, were caught out when the technology boom turned sour in 2000.
Funds which were then too heavily invested in stocks were forced to switch into less risky investments to guarantee existing, and often overly generous, policyholders' payments.
At the same time, new and more cautious investment strategies, have meant investors have lost out on rising equity values.
With-profits policies have also been attacked for their complexity and opacity.
Some investors feel that risks were not adequately explained to them when they signed up for the policies: a great many mis-selling cases at the Financial Ombudsman Service relate to with-profits policies.
Meanwhile, it can be difficult for policyholders to get their hands on information about funds and investments.
WITH-PROFITS: KEY DIFFERENCES
Traditional with-profits: Mature on a given date, charges are generally incorporated in bonus calculations, bonuses are declared at set intervals
United with-profits: "Whole life" policies that do not have set maturity dates, charges are more transparent, bonuses are added daily and reflect daily movements in the unit price
There has also been criticism over the way insurance companies treat surplus capital, so-called inherited estates.
Critics have accused firms of using the money as a slush fund to boost the interest of shareholders rather than safeguard policyholders' investments.
The near-collapse of the UK's oldest life insurer Equitable Life in 2000 has also added to the general gloom.
What rights do consumers have?
The FSA has "fairness" rules intended to improve the rights of policyholders.
Policyholders must now be told that a fund has closed to new business within 28 days of its closure.
Firms must also appoint a policyholder advocate to protect the interests of policyholders should a firm decide to give its surplus cash to shareholders.
But Which? has said the changes do not go far enough.
The material is for general information only and does not constitute investment, tax, legal or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.