A choice for life
The case for the with-profits policy
Garnett Hazell
The life assurance industry is expanding rapidly. New companies have reinforced the old to provide an even wider choice of policies to the public. Many of the companies, both old and new — and there are around a hundred — are continually attempting to devise new types of policies; something a little different in concept or detail or merely new ' packaging ' for an old product. This process of product development appears to gain momentum with each Finance Act and new investment trend and should ideally serve to provide every customer with a policy to suit his needs.
From the sales media of this in' dustry, a prospective policyholder -could quickly amass countless leaflets, quotations and forms. Cuttings of life assurance advertisements from the weekend press would soon cover his walls forming a newsprint mural of optimistic claims and qualified promises. Who would blame this potential customer for turning away in confusion to seek informed advice or for putting his savings in a building society where he can understand what is happening?
The person who wishes to use the medium of life assurance for long-term regular savings has, then, an enor
mous choice — the type of policy and the company to provide it. Thankfully, the array of policies can be split with precision into two main classes — the conventional with-profit contracts and the unit-linked contracts. The former are the core of the older office's business-and the latter are the forte of the newer office's business.
The essential difference between the conventional with-profit policy and the unit-linked policy lies In the method of arriving at the maturity proceeds. The conventional with-profit policy will guarantee a sum assured which will, with regular bonus additions during the term of the contract, and an additional final, or terminal bonus, generate the maturity proceeds. In the case of unit-linked policies, a stated proportion of each premium will be used to purchase units in the special fund to which the policy is linked. The proceeds will then depend directly upon the market value of the total units credited to the policy at the time of maturity. The special fund may be of equities with quoted stock market values, or property where market values are more subjective, or in the case of managed bonds a mixture of the various types of investment.
Which of the two classes of policy, then, will give the best results in the future? Past experience may be used as a guide but in fact there is very little of it, for the unit-linked bandwagon did not get well under way until the mid-'sixties. A few unitpolicies have in fact matured and the results are very impressive when compared with conventional with-profit policies. There are several reasons for this. One is that the link concerned was equities and with the benefit of hindsight it is hardly surprising that the investment proved particularly successful compared with a mixed portfolio containing a sizeable proportion of fixed interest securities. Secondly, the older offices may have adopted a cautious approach to their bonus declarations mindful of the risk of distributing capital appreciation 1which could easily disappear and also of declaring a maintainable rate of bonus.
The past experience is not only limited but is in any case water tinder the bridge. Times are changing, investment trends alter rapidly and the attitudes of the older offices are being jolted by the success of unit-linked business. For the future then, is there any intrinsic reason why conventional with-profit policies should prove less satisfactory than unit-linked or viceversa?
Part of the premium for each type of contract will be used to pay the expenses of the office and provide the life cover. In general, there seems to be little reason why the expenses involved should be greater for one or other of the classes of business. The same applies to the cost of life cover. The unit-linked contract will normally state the charges to be made for expenses and life cover — percentages appearing plausibly low but set at levels to ensure profitable operation of the office. The office writing conventional business can, however, pass on any economies of efficient administration by improved bonuses and, of course, administrative incompetence or extravagance can result in poorer bonuses.
The remainder of the premium will be invested and the fruits of this investment will depend upon the investment management concerned. Fortunately, no particular life office lias a monopoly of good investment managers and even if' an office has a first:rate investment team when a policy is taken out, the team will no doubt change during the course of the policy. It is argued that conventional policies place restrictions upon the investment policy, so that results must by necessity be poorer. It is true that the declared bonuses are admitted liabilities of the office, so that solvency margins may be narrower than for unit-linked business, but most of the
older offices have substantial free r! serves to counter this effect. COI; linked policies also present investtner management problems. Liquidity t meet surrender payments may be problem and a dearth of suitable sets to purchase may be another. an example, it will be found that 3 most half the assets supporting th property bond fund of a well-knoV: office consisted of fixed interest sea,. rities and deposits at the beginninge,e this year. In this case, whether he Ii it or not, the bondhandler's proceeo will depend to some extent upon t performance of fixed interest secus ties and deposits. It the final results of each class policy are likely to be similar in tell:. of the market value of the investe' assets at maturity, any discrepascl between the policy proceeds must dif, pend upon the bonus additions ni0 to the conventional policy. Theg bonus additions will be determined st the advice of an actuary. Actuaries 8.0 not by nature squirrel-like — wish!. to hide the fruits of successful In vestment for leaner times. Nor do the) treat lightly the responsibility to glo a fair return to all policyholders. The) may, however, be somewhat cautioe‘ Perhaps this is why no life assuraild, company has failed for over a centurl Armed now with the terminal bonus there is far greater freedom for the .8c tuary to transmit capital appreciab of assets into the policy maturity pet''1 ceeds. This is not to say that transies features of the market will be directi,j) reflected in the maturity proceeds oi conventional with-profit policies btle that these features will be smooth" rather than ignored. In addition, Olt: actuary of an older office will he.P two secret weapons with which to Ole' prove bonuses and compete with Is' unit-linked contract. He may use flit interest on the office's free reserves: or possibly some of the free reserve' themselves, and also the profits gen! rated from the non-participating bt131" ness. For the future, if a prospecti,%1 policyholder can select the type of a vestment which will outdo all othell and obtain a policy linked to this. ,ht can expect due rewards. However.1 a mere mortal, without the blessink, foresight, there is little reason why t!„ proceeds of a conventional with-prof" policy issued by a leading well este!): lished office should fall short of IIunit-linked competitor. What careV said is that because of the smoothld effect of bonuses, the maturity PI ceeds of the conventional policy not reflect as directly as the WV:, linked, temporary fluctuations in th' market values of the various ler vestments. Sometimes a unit-tinke" life policy has had to wait four or 0' years before seeing a real profit.
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