Unitised With-Profits

Unitised With-Profits

A guide to unitised With-Profits insurance policies

Unitised (UWP) as oppose to Conventional (CWP) refers to the units in the With-Profits fund.

As a side note, conventional with-profits contracts is when we guarantee to pay out an agreed amount when the policy matures. This could be a lump sum (the sum assured) or a series of payments (an annuity or pension).

This guide explains how our with-profits fund works for our unitised with-profits contracts. The conventional will be covered in another article. The information is given below around 10 specific questions.

How does it work?

A with-profits policy shares in the profits and losses of our with-profits fund. We call a with-profits policy unitised when your investment buys units in the with-profits fund.

The company share profits and losses by adding bonuses to your policy. As bonuses are added to your policy, valuable guarantees build up.

The with-profits fund is invested in a wide range of assets including company shares, property and bonds.

Part of the with-profits fund covers the amount we owe to policyholders. The rest of the fund is called “the estate” and provides working capital for the fund.

Smoothing is one of the unique features of a with-profits policy. Investment values can be volatile so the value of the with-profits fund can fluctuate considerably. Instead of simply sharing out what the fund makes or loses each year to policyholders, we even out some of the fluctuations.

Unitised with-profits contracts offer guarantees of the minimum amount of money you will receive on death and certain other dates.

The main factor that affects the amount your policy will pay out is what your share of the with-profits fund is worth. Your share depends on profits and losses earned by the fund over the period of your investment.

How is investment yield determined?

The investment return earned on the fund over the period you invest depends on

  • The effect of any guarantees
  • The way the company smooth payouts
  • Policy charges
  • The business risks the with-profits fund takes
  • The tax we have to pay.

Our with-profits fund pools your payments (less any deductions to cover charges), along with those of all our other with profits policyholders.

The with-profits fund invests in a wide mix of different types of assets, such as:

  • Shares (equities).
  • Commercial property, buildings.
  • Government and company bonds.
  • Deposits.

The investment strategy of the with-profits fund reflects what the Board of Directors (BoD) believes is an appropriate balance between the risks of different investment and the potential reward they offer. Their investment managers aim to maximise the returns on assets, whilst working within the overall investment strategy.

Higher risk assets, such as equities and property, offer the potential for higher returns over the long term than lower risk assets such as deposits and bonds. Currently we invest a significant proportion of the with-profits fund in equities and property in order to try and increase returns for our with-profits policyholders.

The actual mix of assets may change over time, depending on the risks our Board is willing to take and the investment managers’ view on potential future returns from different types of asset.

The amount of risk our Board is willing to take will be influenced by the size of our estate (the excess of our assets over our liabilities) as this offers a cushion against volatility in asset values.

Company assets from outside the with-profits fund may be available both to transfer into the with-profits fund and to support the solvency position of the with-profits fund.

How about bonuses?

Usually there is two types. Regular bonuses and terminal (final) bonuses.

REGULAR BONUS

Regular bonus can be added in two ways. Depending on type of policy bonuses may be added by:

  • Increasing the price of your with-profits units each day and/or
  • Adding additional with-profits units to your policy monthly.

The level of regular bonus can go up and down and there is no guarantee that a regular bonus will be added each year. Usually the level of bonus is announced at least once a year.

Some policies have guaranteed minimum regular bonus rates.
These guaranteed rates may be higher than the regular bonus rate paid on similar policies that do not have the guarantee.

Once regular bonuses have been added, they are guaranteed to be paid on death and on certain other guarantee dates.

TERMINAL BONUS

A terminal bonus may be added to your policy when you leave the with-profits fund, for example when your policy matures, you retire, surrender your policy or switch into another fund.

The level of terminal bonus can go up and down and there is no guarantee that any terminal bonus will be added. We can change terminal bonus levels at any time.

Although we aim to smooth payouts, terminal bonus levels can be volatile and move up and down significantly. This is because we invest a significant proportion of the with-profits fund in higher risk assets (such as equities or property).

We set separate terminal bonus rates for different products. There are also different rates for:

  • Investments that started in different years – the start date for calculating terminal bonus is the date you invested or switched into the specific series of with-profits units. This may be different from the commencement date of your policy
  • Regular, escalating regular and single investments that start in the same year
  • Each series of units available for a product. Different series may have different charging structures.

Where you have made additional investments to your policy, for example an additional single payment or an additional series of regular payments, different rates of terminal bonus may apply to each separate investment.

HOW TO SET BONUSES?

When you make an investment in the with-profits fund we create two types of units for you:

  1. With-profits fund units

The value of your with-profits units may grow through the addition of bonuses.

  1. Shadow fund units

The value of your shadow fund units represents your share of the with-profits fund (your asset share). The value of your shadow fund units will rise and fall reflecting the performance of our with-profits fund. The value of your shadow fund units depend on:

  • How much you have invested
  • When you made the investment
  • The fund’s performance over time, allowing for taxation
  • Charges applied to your policy
  • Various profits and losses (see section eight “Managing risks the with-profits fund is exposed to”).

We use the shadow fund to decide what bonuses should be added to each policy and what level of market value reduction (MVR) we will need to apply, if you surrender or transfer your policy.

Our aim when setting bonus levels is to pay out on average, the shadow fund value of your policy, when you leave the with-profits fund.

REGULAR BONUSES

We aim to set regular bonus rates so:

  • They are sustainable over the long term considering current and future expected investment returns
  • They will not vary too much from year to year
  • Normally there will be scope to add a terminal bonus.
TERMINAL BONUSES

Paying a terminal bonus enables us to pay out your share of profits that have not already been paid out as regular bonus. We aim to pay out, on average, the shadow fund value of your policy under each of the following circumstances:

  • Your policy reaches maturity
  • You want to switch out of the with-profits fund or
  • You want to retire, surrender or transfer your policy.

The things we consider when setting terminal bonus rates include:

  • The shadow fund value compared to the with-profits fund value for groups of similar policies. This allows us to see how much of the value we haven’t given to you already in regular bonuses
  • What we expect investment returns to be for the period we intend the terminal bonus rates to apply
  • The change in payouts for similar policies from one year to the next. We aim to restrict the change in the amount we pay out to policyholders in consecutive years to what we believe is a reasonable level.

What is smoothing?

Investment values can be volatile and consequently the value of the with-profits fund and your shadow fund value can fluctuate quite a lot. This is because we invest a significant proportion of the with-profits fund in higher risk assets (such as equities and property).

Instead of simply sharing out what the fund makes or loses each year, we even out some of the fluctuations. This is known as smoothing. In practice we may keep some of the growth back when investment conditions have been good, so that we can add it back when investment conditions are poor.

Although smoothing helps to even out some of the fluctuations in investment values, it can not fully protect the value of your policy from poor investment returns or long term market falls. When the value of your shadow fund falls, the value of your payout may also fall. On certain guarantee dates the amount we pay out can not fall below the minimum guaranteed amount.

We aim to pay out on average, the shadow fund value of your policy. However, as described above, the actual amount we pay out will be subject to smoothing. Your payout will be between 80% and 120% of your shadow fund value, unless a guarantee applies in which case your payout may be above 120% of your shadow fund value.

Surrendering the policy?

We work out the surrender value of your policy by multiplying the number of with-profits units allocated to your policy by the current unit price and then deducting any surrender penalties. In addition, we may add a terminal bonus to this value.

However if your shadow fund value is less than the value of your with-profits units when you choose to surrender, we may apply a reduction. This is known as a market value reduction (MVR).

If you switch your investments out of the with-profits fund into one of our investment linked funds then, whilst you will not be subject to a surrender penalty, you may be subject to an MVR.

WHAT IS A MARKET VALUE REDUCTION (MVR)?

When you make a switch out of the with-profits fund or withdraw money from your policy the value of your with-profits units can be reduced in certain circumstances by applying an MVR. This is most likely to happen following a large or prolonged fall in the stock market, or after a sustained period of low investment returns. The MVR ensures that investors who remain invested during poor market conditions are not disadvantaged by those who take money out of the fund.

WHEN DO WE APPLY A MARKET VALUE REDUCTION (MVR) AND HOW IS IT CALCULATED?

An MVR is applied when the value of your shadow fund units falls below a certain percentage of the value of your with-profits units. The level is currently 90%. All of the individual payments (a single payment or group of regular payments) you make are treated separately for this calculation.

If you cash in or switch your investment from the with-profits fund when the MVR applies then:

  • If the shadow fund unit value is less than 85% of your with-profits fund value then you will receive the value of your shadow fund units
  • If the shadow fund unit value is between 85% and 90% of your with-profits fund value then you will receive a value between the shadow fund value and with-profits fundvalue.

Please note:

  • The ‘trigger points’ of 85% and 90% can be changed
  • An MVR is dependant on individual values for each policy. Whether an MVR applies and the size of the MVR therefore changes on a daily basis for any policy

 

When the MVR is applying in full, your surrender value will be the value of your shadow fund units, therefore there will be no smoothing on your value at that time and the value may be volatile.

If an MVR applies to your policy when you wish to surrender or switch, it is worth considering what guarantees your policy has because they may be valuable. For example your policy may include dates where we guarantee not to apply an MVR. We strongly recommend you should take advice before acting.

How much is guaranteed?

Our unitised with-profits policies contain guarantees. Any guarantees that your plan has are detailed in your policy documentation.

If you have a guarantee that no MVR will apply on your policy on a certain date, the minimum amount you will receive is the value of your with-profits fund units including all regular bonuses that have been added to your policy, even if the underlying value of your shadow fund units is lower than this. You may not receive the full value of your with-profits fund units at other times.

We guarantee not to apply a market value reduction:

  • If you die.
  • On your selected retirement date or target pension date for pension policies and certain later dates if you change your standard retirement date.
  • On switches out of the with-profits fund.
  • On any cancellation of units to pay for annual product charges.

If you have a pension plan and you retire, switch or transfer out within three years of the selected retirement date, the amount of any MVR applied will be reduced so that the MVR is smoothed in over the 3 years prior to the selected retirement date. The proportion of the standard MVR that is applied reduces as you get nearer your selected retirement date.

For a capital investment bond we guaranteed not to apply an MVR on the 10th anniversary of the date on which your bond started. This meant that if you cashed in your bond on the 10th anniversary date you would have received the full value of your with-profits fund units. After this date, the MVR may apply in certain circumstances. However, if you did not cash in your bond on the 10th anniversary and the shadow fund unit value was less than the with-profits fund value on that day, we enhanced the value of your shadow fund units so that they were equal to the value of your with-profits fund units on that day.

Often the companies guarantee not to apply an MVR on the e.g. 5th anniversary of the date on which your bond started and any subsequent 5th anniversary whilst you are still paying the extra charge for the guarantee. This means that if you cash in your bond on one of these guarantee dates, you will receive at least the full value of the with-profits units. If you decide not to cash in your bond on the guarantee date, we will switch the whole cash in value of your bond including any terminal bonus that applies, to the series of with-profits units that are available at that time. Your terminal bonus will be calculated using the entry date or switch date into the series of with-profits units you hold.

What about expenses?

The charges that apply to your policy are used to calculate the shadow fund unit prices and are considered when setting bonus rates. Therefore the charges impact on the amount we pay out.

What is the risk exposure?

The performance of the with-profits fund is affected by risks that may increase or reduce the value of the with-profits fund. These risks may change over time.

Currently the major risks facing the with-profits fund as a whole are:

  • Potential losses on investments
  • The cost of guarantees made on some with-profits policies being greater than expected
  • Losses on our non-profit business (such as claims being more than expected)
  • Expenses being higher than planned.

Our Board of Directors is responsible for actively managing any risks to the with-profits fund. They approve all significant risks after considering factors including:

  • Whether the risk is worth taking
  • The size of our estate (see the next section)
  • The size of the potential impact on our assets and our ability to pay policyholders
  • Our exposure to other risks.

The estate will normally absorb any profits or losses that arise from the risks the with-profits fund runs. However as a mutual organisation, with no shareholders, any losses (or profits) may ultimately be borne by (or credited to) the with-profits policyholders.

How is the estate used?

The estate is the term we use to describe the excess of our assets over liabilities. Or in other words, what we own over what we owe. It provides us with the money (working capital) to operate our business. We carefully manage the estate so that it is big enough to:

  • Provide enough money, so that we can continue to issue new business
  • Cover the costs of smoothing
  • Meet the costs of certain policy guarantees
  • Meet any excess of expenses over charges to with-profits policies
  • Provide investment freedom so we can invest in riskier assets which have potential for higher investment returns (for example equities and property)
  • Cover one-off exceptional expenses.

Is there room for new business?

The financial soundness of the with-profits fund can be adversely affected if the company issues too many new policies. Our estate is large enough such that currently we do not set any limits on the amount of with-profits business that we sell in any year. We regularly monitor the levels of new business.

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