With-profits funds explainedWhat are with-profits?

With-profits policies are among the biggest causes of consumer harm in financial services

With-profits funds are a type of investment designed to offer low risk by using a process known as ‘smoothing’. This means that some of the return from the investments in the fund is kept back in good years and added back to top-up returns during periods of poor performance.

The money you pay into your policy is pooled with other policyholders' premiums and invested into a mixture of equities (shares), property, and lower-risk investments such as government securities (gilts).

How with-profits work

'Smoothing' is achieved by holding back some of the investment returns on the fund in good years, to pay out more than the return achieved in poor years. This pool of money that is held back is known as the ‘inherited estate’.

Between 10 and 20 million consumers are believed to have a policy in some form of with-profits funds – for example an endowment, a personal or employer's pension, annuity or investment bond.

But despite their popularity, we think with-profits policies are among the biggest causes of consumer harm in financial services.

Broken promises

High charges and penalties meant that the supposed benefits of with-profits products have not been delivered in practice. In reality, returns on with-profits for mass-market consumers have often been lower than those delivered by savings accounts.

And with-profits can even mean real losses, as the case of Equitable Life showed. The company couldn’t afford to pay what it had promised to policyholders.

Who owns your money?

Once you invest, the legal ownership of the fund resides with the insurance company - policyholders only have a contingent claim upon it. Given that the directors have significant discretion to manipulate returns and charges, policyholders are vulnerable.

Policyholders who want to switch find it difficult because of the penalty charges, lack of access to advice and poor information provided by many insurance firms.

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