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money for numpties.

Byline: By Alan Steel

PROBABLY the most frequent question I'm asked is whether there's a future for with profits. As most readers will know, with-profits endowments are still used by many to repay mortgages.

And most with private pension plans of one kind or another are in with profits. Unfortunately, so are a few million people with investment bonds.

Recently with-profit bonuses have disappeared like snow in the sun. To make matters worse, penalties have been slapped on to stop you chucking in the towel. To get an idea of what the future holds, let's look at how, or why, with profits came along.

Apparently, in the mid-19th century endowments - or death-only plans called Whole of Life - offered a fixed guaranteed return. That is now called without profits.

Then some new-fangled building societies arrived in the late 19th century and insurance companies had to go back to the drawing board. They came up with the idea of producing extra returns and some bright actuary - a contradiction in terms - came up with the idea of adding with-profit bonuses.

So the typical with-profit policy offered a guaranteed return known as the sum assured. But from then on bonuses would be added.

I've explained before the idea of with profits was to smooth out returns and not give you a shock one year when you opened your valuation. So actuaries tended to be cautious, even in a really good investment year. For about the first half of last century, the investment process continued to be cautious and then a bright economist called Keynes reckoned it was time to buy shares as well to increase returns. And it worked quite well for a while.

But in the early 1970s something awful happened. Inflation took off and interest rates rose. With profits were attacked from two sides. From building societies who offered higher returns without risk, and from the unit linked industry who allowed investors to spread risk in stockmarkets but without guarantees.

Actuaries had to think again. They started to jack up bonuses to make them look good as investment managers. But long-term with profit plans don't cope with inflation. They offer guaranteed returns, and every time you add a bonus it was also guaranteed. That meant, through time, actuaries were restricted in buying growth investments.

But some companies didn't play fair. They changed the whole structure of bonuses and they pretended to give investment returns higher than you could achieve by direct share purchase.

Well over 20 years ago, Eric Short, an actuary, studied the performance of with profit and unit linked plans coming from the same insurance companies. Over various terms over a number of years the stockmarket linked plans always won.

Short said this was obvious because with profits had to provide guarantees. So we should have smelled a rat when with profit plans were so fantastic.

But where are we now? With profits have been slaughtered over the last few years. The kitty has to be replenished. This will take time.

Personally, I think, in a few years things will be better. But wouldn't be inclined to put fresh money into with profits unless you take independent advice or perhaps look to see what the Prudential has to offer. Personally, I'd go for unit linked plans and forget guarantees. I don't think we could trust the word again.

Alan Steel is Managing Director Of Alan Steel Asset Management Nobel House, Linlithgow
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Title Annotation:Business
Publication:Daily Record (Glasgow, Scotland)
Date:Dec 14, 2004
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