2008 Bonus Season
With announcements in from all of the major Life Offices, this year's bonus season is now drawing to a close. Not surprisingly, given the current economic climate, the announcements have been a real mixture.
The largest single component of the stronger with-profits funds is UK equities and the FTSE finished the year 3.8% ahead of 2006. Overseas equities, which typically account for around 9% of the fund, produced mixed results. Standard Life inform us that their European equities posted modest gains, Asian stocks performed relatively well in a global context and US equities delivered similar results to the UK.
In such a turbulent year no with-profits fund will have achieved significant gains from equities.
In the same way that the equity "bubble" burst we saw a retreat from high property prices especially in the latter part of the year. To illustrate this point the IPD Property Index fell by 5.5% during the year.
In order to provide a counter balance to equity markets with-profits funds invest heavily in gilts, typically around 35% in the stronger funds, which provide a strong base for the high levels of guarantee in with-profits policies. As equity markets fell in the second half of the year we saw gilt values rising as money was moved out of equities. The FTSE UK Gilts All Stocks index grew by 5.27% during the year.
In spite of the economic uncertainty and volatile stock markets, most of the stronger Life Offices have made positive declarations. When looked at in the context of the last few years' declarations, it is easy to spot a strong upward trend in rates. The table below shows the terminal bonus rates for 25 year endowments.
25 Year Terminal Bonus Rates
Legal & General made a particularly strong declaration, increasing both annual and terminal bonus rates significantly.
Although Prudential cut their 25 year terminal bonus rate, they increased rates for all terms through to 22 years and they increased their annual rates across the board. The increased annual rate is a clear sign of their long-term confidence in the fund's future performance prospects. Their 25 year rate cut follows an increase that was ahead of the market last year and the current rate remains higher than 2005.
To see the whole picture, it is worth looking at the bonus declarations in conjunction with the underlying returns on with-profits funds over the last few years.
Underlying Returns on With-Profit Returns
Smoothing creates an investment lag where excess returns from previous years are held back to fund returns in poorer years. The result is that the significant equity and property growth achieved between 2004 and 2006 is not yet fully reflected in bonus rates.
Whilst at first glance the rates announced this year seem to be mixed, they are actually pretty consistent with individual expectations based on with-profit fund performance and financial strength.
David Belsham, chief actuary at Prudential comments on their with-profits returns and explains how they have been able to increase their annual bonuses:
"Now we are showing the benefits of long term prudence, going into a period of market volatility and we are strong enough to put the bonus rates up."
The increasing polarisation between the strong and weak companies means that the strong are well positioned to increase rates further in the future and investors should benefit from the release of the hidden value in these funds over the coming years.
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