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Time to surrender life policies?

By Neville Bennett

Friday 4th July 2003

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The woes of the life insurance business may be deepening.

I recently reassessed my policies and noticed one life policy "with profits" had atrophying bonuses. I consulted a professional and determined to surrender the policy and take out straight life cover. I ended up with ample cover at a terrific discount.

Insurance is a complex field, so let it be understood nothing I say subsequently in any way constitutes advice. I consulted an expert. Readers should too.

In the UK the "with profits" sector has tended to beat the stock market. It has made positive returns, while the FTSE All Share Index lost 23.7%. So it looks a good sector to the uninitiated. Few people know how it works and they may expect the bonuses to increase.

Life insurance premiums are used to buy assets, which are then pooled. If the fund grows, it could be said each policyholder's "asset share" has increased. But how could the insurers have announced any bonuses last year when the stock market (their main investment) went down by a quarter? Surely their funds must have diminished. So how did they pay bonuses?

The insurers did not make a profit, so they paid bonuses out of reserves. The companies have always recognised there would be downturns and they prudently establish reserves for that eventuality. But they didn't realised the bear market would be so deep or so protracted.

Insurers like to maintain a good image. They like to pay relatively high dividends to win shareholder approval. They also compete for customers and like to pay high bonuses. Are their reserves adequate for these tasks?

New Zealanders have some insights here. It is well known AMP over-reached itself in the UK market and is having to raise more capital. Tower is desperate for more capital.

The UK insurers are also hard-pressed. The independent Cazalet Financial Consulting group estimates UK insurers have spent £200 billion of their reserves on making payouts. Can they keep on doling out money? That is unlikely and they are cutting bonuses.

It seems their reserves are run down. The implication is compelling. Life insurers have a diminished capacity to protect investors from further stock market corrections. An investment with them is not as safe as it was when they had high accumulated reserves.

Moreover, the insurers have become nervous. They felt their asset allocation left them too exposed to further stock market falls. Most have reduced equities to about 50% of their portfolios. So if the market does pick up, they are in a weaker position to take advantage of it.

Insurers are now trying to re-establish their reserves. This diminishes their power to distribute payouts and bonuses. A new investor cannot expect to benefit from accumulated reserves. So an investor taking out a new policy now may find it performs less well than other investment categories. Insurance is an unlikely candidate to outperform the market.

Should policyholders cash up? Is it time to surrender? Circumstances are different but in the UK there is an incentive to surrender; at least seven major companies pay out less this year on a maturing 25-year policy than they did last year. The incentive differs. Co-operative, Royal & SunAlliance and Teachers Provident do not levy exit penalties or "market value reductions." But Standard and Equitable Life has imposed draconian penalties of 20-25%. Standard admits it does so to prevent an exodus. It is a formidable disincentive.

Perhaps it is time to dust off those life policies and determine if they still suit the investor's needs or could benefit from being rejigged. Insurance is essential. It is important to ensure it is appropriate, cost effective and performing.

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