Q : I have just received a statement regarding my With Profits Pension and it has dropped since last year. How has that happened?
A: With Profits investments in either pensions or bonds were a popular choice a number of years ago.
The concept behind these investments was that they were designed to smooth returns over the longer term.
Your investments were held in a number of assets such as property, stock market, gilts and cash and the company that you invested with would decide on an annual basis how much growth would be attached to your investment.
In the years of high returns, they would retain some of this excessive growth, so that in the bad years they would be able to call on those reserves and pay out a reasonable return to the investor.
Such investments became less popular in recent years, due to the market downturn at the beginning of this century.
The reserves that the companies had built up over a long time were rapidly eroded due to the downturn in the stock markets.
These reserves have never really been rebuilt, so the downturn last year in all asset classes has again put these types of investment under pressure.
Typically a With Profits investment will have two types of bonus. The first is the annual bonus which quite often is also guaranteed when it is paid.
The rate at which annual bonuses are paid has been steadily declining, and it is now typical to see this as low as 2% per annum.
Some companies have even elected not to pay any annual bonus. The annual bonus is paid based on the income the fund receives from things like dividends, rental income or coupons from bonds and gilts.
The second type of bonus that is paid under these policies is known as a terminal bonus, and this is paid when the policy matures or is encashed.
The final bonus is there to reflect the underlying capital growth in the investments, and due to the problems experienced last year, the majority of companies have cut their final bonus substantially to reflect the large capital losses they have experienced.
While this bonus is only in effect paid when the policy comes to an end, it has been common practice for companies to illustrate each year what level of final bonus you can expect from your investment. This will probably explain the drop in value you have experienced.
With Profits investments will also be subject to what is known as a Market Value Adjustment (MVA).
This is a reduction imposed by the company at times such as these, when there has been a significant fall in capital values.
An MVA is in place to try and prevent large numbers of individuals withdrawing their investments at once, forcing the company to sell the underlying investments held in the fund at a loss.
Again, in the current climate these reductions can be quite substantial, with some companies imposing reductions of up to 22% depending upon when the policy was taken out. Therefore the options open to you are limited. Going forward it is unlikely that you will see any significant uplift or growth from your investment, as the main concern of any company will be to replenish their reserves.
Equally however, if you can avoid paying a substantial reduction in your investment by way of an MVA you should try and do so.
The main consideration should be why you invested where you did in the first instance, and does this still hold true today?
Raymond Mulligan is managing director of Johnston Campbell, a company of independent financial advisers regulated by the Financial Services Authority. For further information, contact raymondm@johnstoncamp bell.com or (028) 9022 1010.