With Profits

In simple terms when you start a policy you have:

A Life Insurance Sum Assured

• This is the guaranteed amount that is paid out on death

A Basic Sum Assured

• This is the amount that bonuses are calculated on
• For example a yearly bonus of 5% is declared.  Your policy value will be increased by 5% of the Basic Sum Assured
• These are known as annual or reversionary bonuses
• They cannot be taken away once added

A Terminal Bonus

• May also be added at maturity, death or encashment
• Terminal bonus can be a % of the Basic Sum Assured or a % of the existing bonuses already added
• Terminal bonus can be withdrawn at any time and is not guaranteed
• Terminal bonus is supposed to be an adjustment of the underlying investment fund performance compared to the bonuses already added.  For example, if the underlying fund had grown 100% but you had only received annual/reversionary bonuses so far of 50%, you may expect to receive a terminal bonus of another 50% at maturity/death etc.

With Profits Bonus

How are with profit bonuses worked out?

Yearly, annual bonus:

The level of with profits bonus paid will depend on the level of return made by the life assurance company.  These annual bonuses are set each year in line with what the life assurance company believes will be the long term return on the funds invested.  The bonuses added are not necessarily what has been earned on the investments over the year.  This is because bonus payments are not directly related to investment returns.  For example:

• If the life assurance company fund made 10% on the investments, they may only pay out 6%, leaving 4% as a reserve.  
• If, in the following year the returns were only 6%, the company could use the reserves and could maybe keep the annual bonus at 6%.  
• This effectively smoothes out investment fluctuations for the investor.

Spreading risk:

By offering this type of fund, life assurance companies can offer investors exposure to the equity markets without them having to suffer their investment value moving sharply up and down.  This is because once the annual bonuses have been added, normally they cannot be taken away.  

Terminal bonus:

When a policy linked to the With Profit Fund matures or on death there may be another type of bonus paid.  This is called a Terminal bonus and reflects the actual growth the life assurance company has made on its investments and any profits it has held back in reserves during your investment period.  

Terminal bonuses are not guaranteed to be paid and will depend on market conditions at the time.

Let us imagine that you invest in a with profits fund and the returns are as follows:

• Year 1 - If the life assurance company fund made 10% on the investments and the bonus pay out is 6%, leaving 4% as a reserve.  
• Year 2 - If, in the following year the returns were negative i.e down -10% and the company uses its reserves and added another annual bonus to your investment of 6%.  
• Year 3 - Returns on the fund are 5% and the company reduce the bonus that year to 5%.

The Result:

• Actual profits made by the fund over three years are 5%.
• The bonuses added to your policy are 25%
• You think that is a fantastic return, I will now cash this investment in.

Market Value Adjustment:

If an investor wants to surrender or transfer a With Profit policy early, the life assurance company reserves the right to change the amount paid out if market conditions are unfavourable.  This is called a Market Value Adjustment factor or penalty - sometimes seen as MVA or MVAF or MVAP.  

In this example, they have given you more in bonuses than the fund has earned.  Just like a terminal bonus, where they add any reserve profits at the end, if they give you too many bonuses in poor times, they reserve the right to adjust this figure if you encash your policy early.  

Market value adjustment penalties do not normally apply on death or at the maturity date.