With Profits investment bonds are single premium investment bonds which invest in a fund which benefits from “smoothing” as it increases through the addition of bonuses, as opposed to the rise and fall of invested funds. With Profits bonds tend to be favoured by investors who prefer the smoothed returns available which protect the investment from higher volatility associated with equity investments. They can offer better longer term potential for growth than deposit based funds, hence why a With Profits bond may be suitable for those with a more cautious attitude to investment risk.
How With Profits Funds operate
With Profits bond product providers pool your investment into a fund which is exposed to a diverse mix of underlying assets such as equities, gilts, corporate bonds, property and cash. Each year the product provider reviews the performance of the underlying investment portfolio and declares bonuses, which are added to the investment. These bonuses are known as “reversionary bonuses” and once added, cannot be taken away. The product provider is under no obligation to declare a reversionary bonus, so when investment performance is poor, they can hold back on declaring bonuses.
When markets perform below expectations, the providers of With Profits bonds can pay bonuses out of accumulated reserves. Conversely when markets outperform they can hold back on sharing the profits by declaring lower bonuses. Over the longer term, this has the effect of “smoothing” returns.
There is another type of bonus which is paid once – on full surrender of the bond. This type of bonus is called a “Terminal Bonus” and is discretionary. The amount of Terminal Bonus declared depends on the solvency position of the With Profits fund on the date of encashment. Many With Profits bonds show higher cash in values than the value of the fund within the bond because of the Terminal Bonus which can be added on surrender.
There are two types of With Profits funds: conventional, where bonuses are added by actuaries to increase the value of the fund or unitised where a set number of units are allocated and these units increase in value as actuaries add bonuses to them.
Surrender penalties for with profits investment bonds
With Profit investment bonds have two very different types of surrender penalties. There are surrender penalties which are contractual and so known from outset. These are determined by the amount of time you have held the investment bond for. For example, there may be surrender penalties for the first five years which start at 5% and then reduce by 1% for each year the bond is held. For this reason, With Profits investment bonds are considered to be medium to long term investments not suitable for someone who needs access to their capital in 5 years or less.
The other type of surrender penalty With Profit investment bonds may levy is a discretionary penalty called a “Market Value Adjustment”, also referred to as a “Market Value Reduction”. These are imposed by the product providers during times of poor investment performance and are designed to protect the fund from excessive net outflows. Some With Profit bonds have contractual guarantees not to impose Market Value Adjusters at specific points in the term of the investment bond. This may be on the 10th anniversary of the term of the investment and is known in advance.
Which companies offer With Profit Bonds?
With Profits bonds are typically issued by either a mutual society where the company is owned by the policyholders or by proprietary companies which are owned by shareholders. An advantage of investing in a mutual society is that they do not have the expense of paying shareholder dividends. A downside of this is that a policyholder in a mutual society shares in the future profits and liabilities of the society.
Companies currently offering onshore With Profit Investment Bonds include: Aviva, Foresters Friendly Society, Healthy Investment, Liverpool Victoria, Prudential, Red Rose and Sheffield Mutual. To find out more about these products, visit our “Research and Buy” module. Offshore With Profits investment bonds are harder to find, but the Prudential offer access to With Profits funds via their offshore International Investment Bond.
What to look for when selecting a with profits bond
Assessing With Profit bonds is never as straightforward as comparing unit linked investment bonds. Whilst our Research and Buy module shows you the contractual differences between the With Profit bond providers, comparing past performance is problematic since the bonuses declared depend on the timing of encashment and how long the investor has held the bond as well as the solvency of the fund and product provider. Actuarial and consulting company AKG reviews the following factors when assessing a With Profit fund’s future potential:
- Free asset position
- Size of the company, capital base and with profits fund
- Gains or losses from other areas of business
- Whether the company is proprietary owned or a mutual
- Efficiency of distribution
- Investment policy
- Bonus declaration philosophy
One useful way to research with profits investment bonds is to read through each product provider’s Principles and Practices of Financial Management (PPFM). Since 1st January 2006, all investment bond providers open to new with profits business are obliged to produce a PPFM and it is intended to help clarify each company’s approach to managing their with-profits investments. PPFMs also contain information on a provider’s policy when declaring reversionary and terminal bonuses, an explanation of investment policy as well as information on balancing the interests of with profit policyholders with company shareholders if the product provider is proprietary owned. You can ask providers to send you a PPFM, or you can find them published on the web.
Alternatives to With Profits Bonds
Alternatives to With Profits Bonds include Distribution Bonds and Guaranteed Investment Bonds – both of which offer funds which may be suitable for the more cautious investor. Interestingly, one of the 3 Guaranteed Investment Bonds currently on the market is also a With Profits bond, which is available from Liverpool Victoria. Our Guaranteed Investment Bond section explains more about how guarantees can be added to this With Profits investment bond to ensure the capital is protected.