With-Profits Policies Explained

September 11, 2012

With-Profits Policies Explained

Investment markets go up and down, valuations reacting to not only specific news (for example company results), but also more general economic news such as public sector borrowing requirements (PSBR) and economic growth numbers, and political news at home and abroad. Sometimes it seems that the stock market has fallen for no reason at all, other than market sentiment.

A ‘with-profits’ fund seeks to take away this volatility of investment return by smoothing returns made over a period of time. A portion of profits made in one year will be kept back and added in to poor years. The idea is that the timing of the decision to sell an investment is less relevant to overall return than the time the investment has been held.

How it works

Though there are different types of funds available under the ‘with-profits’ heading – pensions, fixed term endowments, and investment bonds – though they all work in the same way in regards to the with-profits element.

When markets are booming and valuations are rising strongly, a portion of returns made within the with-profits fund is held back. The held back profits are then added to the policy in following years by way of what is called reversionary bonuses. These bonuses are guaranteed and cannot be taken away.

At the end of the policy term, when the fund matures, a terminal bonus is added to the policy, rewarding the policy holder for his long term loyalty. If an investor should want to withdraw his investment early, this terminal bonus will not be paid.


The advantages of a with-profits policy are clear.

For the investor, any fluctuations in investment value are smoothed out. A consistent return is the aim, and his loyalty to his investment, and the management company, are rewarded at the end of the term of the investment with a large balloon payment. Any reversionary bonus added cannot be taken away, and so even if the investment markets fall dramatically, the gains the investment has made in previous years are locked away. The investor won’t lose money because of one bad year in ten.

For the investment management company, the carrot of a final bonus at the end of an investment term is hoped to promote loyalty and a lower rate of early redemptions. With less money being withdrawn from the pooled investment, it is easier to manage and the internal costs are lower, meaning the company’s profits increase.


Though the method of smoothing is seen by many as an advantage, it could also be viewed as a downside of investing in a with-profits fund. If an investor wants to cash in the fund early and when the market is riding high, he may not receive the value he would receive in a more conventional investment trust or unit trust: profits have been held back for following years and all he is guaranteed is the reversionary bonuses already applied to his investment.

However, if the investor wants to sell his with-profits investment at a time when the market has fallen badly, then because he has his reversionary bonuses he would be a winner. In effect he would be taking money out of the overall pot, and leaving less to be added to reversionary bonuses announced in the future. Clearly this is disadvantageous to the remaining loyal investors, and so in such cases a Market Value Reduction would be applied.


Market Value Reduction (MVR)

This is an adjuster applied to a with-profits policy to readjust the value of the fund when an investor wishes to sell when the market is falling, or has fallen. The value of the investors fund would be lower in a more traditional unit linked policy, and the with-profits company adjust fund values for those investors wishing to sell.

In summary, an investor who wishes to sell in strong markets may not receive all the gain, but an investor who wishes to sell in weak markets might have his fund value adjusted down to allow for recent poor performance.

– Other considerations

All investors should regularly review their investments, but doing so on with-profits policies might be considered even more important because of the way the policy works (as well as reviewing the assets held under the policy).

For example, many with-profits policies carry an MVR free date, when an MVR will not be applied to the policy, irrespective of market fortunes. Often this is on an anniversary date, and commonly the 10th anniversary of the policy/ investment. For an investor considering selling, then waiting to this date could save thousands of pounds.

Some policies have a guaranteed minimum pay-out. This will be linked to a specific date, and once more this is most likely to be a policy anniversary date. Some policies will pay the terminal bonus, or at least part of it, upon death of the policy holder.

In conclusion

Whilst the theory behind with-profits policies is strong – smoothing returns and rewarding investor loyalty – and the idea of bonuses on investments that can’t be taken away compelling, care has to be taken when investing in with-profits funds.

MVRs are charged at times when markets are bad, effectively taking away the reversionary bonuses that are guaranteed. Through a period of falling markets or stagnation as we have been witnessed through much of the first decade of the 21st century, reversionary bonuses are cut and when the market does turn around then it takes a while for these bonus levels to build up once more.

When markets are good, and an investor wants to sell, the investor may not receive the ‘real’ value of his investment because gains are being put aside to pay as a terminal bonus.

With-profits policies are not for everyone, but for those investors who will see the investment through to maturity – and therefore are not concerned about MVRs – and may benefit from guaranteed benefits, for example in the event of death, then the reversionary bonuses and terminal bonus could be particularly relevant. However, before considering investing in a with-profit policy, then investment advice should be sought form a suitably qualified financial advisor.