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With-profits policies

A with-profits policy is a long-term investment that allows you to share in the profits of the insurance company which manages your policy. The value of the policy should grow over time as your money is invested and bonuses are added by the company. People usually invest in such policies to either get a lump-sum payment at a specific date in the future or to get a yearly income with the possibility of investment growth over time. With-profits investments are available via a pension, endowment, bond or retirement income (sometimes called an annuity), and they usually include some life cover.

What happens to your money?

Money from all with-profits policyholders is combined, or pooled, into a with-profits fund. The insurance company uses the money in this fund to invest in different types of assets, normally shares, commercial property, gilts, corporate bonds and cash deposits. Different insurance companies invest different amounts in each type of asset, and a clear summary of how the with-profits fund is managed must be made publicly available by the company.

How much money you will get back?

Most policies pay out at least a guaranteed amount at the end of the policy. This guarantee will be subject to the conditions set out in your policy documents, for example that you continue to pay all your premiums for the duration of your policy. The payout might be in one lump sum, or a series of payments. The insurer may also add bonuses to your policy each year. This increases the amount of money you are guaranteed to get back at the end.

Bonuses

Bonuses are the way your insurer adds your share of any profits the fund makes from investment growth and other sources to your policy. Typically, there are two types of bonus: the annual bonus (which may also be called a regular or reversionary bonus) and the final bonus (which may also be called the terminal bonus).

  • Annual bonus
    Once a year the insurance company will decide the amount of annual bonus it will add to your policy – the way in which these bonuses are added will vary depending on your policy. Insurers do not have to add a bonus each year. But once an annual bonus has been added it cannot be taken away – provided that you continue to meet the terms and conditions set out in your policy documents. If you decide to cash in your policy early you may lose any annual bonuses that have been added.

  • Final bonus
    A final bonus is calculated when your policy matures and it is used to top up the value of your policy so you get your fair share of the with-profits fund. If you decide to ‘cash in’ your policy early you may also receive a final bonus, but it is likely to be less than the bonus you would receive if you kept your policy to maturity.

How bonuses are decided

The amount of bonus, and whether a bonus is added at all, mainly depends on how well the investments in your fund have performed and how your insurer expects them to perform in the future. But, the insurer may keep back some of the profits from the fund in good years to make up for losses in the bad years, such as when the stock market falls. This is known as smoothing. It gives you some degree of protection from poor market conditions, particularly if your policy matures in a year of low investment returns. This may be seen as an advantage of with-profits policies over, for example, simply investing in shares. But, despite smoothing, if investment returns are poor year after year, this can result in very low annual or final bonuses – or none at all.

Are bonuses guaranteed?

No. Bonuses may not be added if investment returns are poor year after year or if there is a large market fall in one year followed by a slow recovery. But once any annual bonuses have been added they cannot be taken away, provided that you continue to meet the terms and conditions set out in your policy documents.

Ending your policy early

The guarantees that were promised at maturity may no longer apply if you end your policy early. Guarantees can be very valuable so before ending a policy early you should check whether your policy includes any of these guarantees. If it does, consider whether these are so valuable that you would be better off keeping the policy.

For some types of policy, if investment returns have been low, the insurer may also apply a market value reduction or adjustment (MVR or MVA) to ensure you do not leave the fund with more than your fair share of its assets. This may mean that you receive less than you expect but it is done to protect policyholders who remain in the fund.

If you decide to end your policy early and your policy includes some life cover, you will lose that protection. So you should think carefully about the security you need to provide for your family. If you still need life cover you should find out how much it will cost to replace it and be aware that a new insurance company may charge you more. This is because the cost of taking out life cover can go up as you get older and/or your health situation may have changed.

If you are thinking about ending your policy early see What to do with your policy.

Other guarantees or options your policy may include

Some pension policies have a guaranteed annuity rate (GAR). This means that the insurance company agrees to pay you a set level of income each year as a pension when you retire. Rates are lower when interest rates are lower and have also been falling because people are now living longer. This means that your guaranteed annuity rate may be much higher than the rates available in the market when you reach retirement. GARs only normally apply on a particular date, normally your expected retirement date, which would have been specified when you took out your policy. If you retire before or after this date you may lose this guarantee.

Some policies may also have MVR-free dates when you can end your policy early without paying the MVR and therefore receive a higher payout. These dates are often at particular points, like five or ten years after you started the policy, or at a particular retirement age. Your insurer should tell you when these apply.

More information

You will find more information in your policy documents or your insurer΄s guide to with-profits. Your insurer should also be able to answer factual questions about your policy, but it may not be able to advise you what to do. If you are unsure what to do you should speak to a financial adviser.