Don't let fears over bonuses catch you out

You do not have to be a member of Britannic Assurance's with-profits funds to be rattled by last week's news that the 136-year old insurer is unlikely to make a bonus payment this year. Millions of investors in other with-profits funds will be wondering whether they also will get a reduced bonus or no bonus at all. We answer some of the questions you may have in mind.

Should I bail out of Britannic?

Don't be too hasty. Cash has spoken to three advisers and none of them is urging everyone to leave. 'Britannic is one of the stronger companies,' says Donna Bradshaw of Fiona Price and Partners. 'They are taking action because there has been an unprecedented run on the stock market over recent years. But markets can and do recover.'

Tom McPhail of Hargreaves Lansdowne says: 'I don't think that we are anywhere near the catastrophic situation we saw with Equitable Life.' He recommends that all members of the £6 billion Britannic and subsidiary Alba Life with-profits funds review their situations, but he feels that some will want to stay.

Someone close to the end of their term might be tempted to leave if they calculate their remaining payments against their likely maturity value. But someone at the start of a policy will lose the benefit of their first year or two's contributions, which mainly go on costs, not investment.

Britannic says it applies an exit penalty ('market value adjuster') on a 'case by case' basis - another factor that must be taken into account.

Edinburgh actuary Ronnie Sloan tries to set the Britannic announcement in context: 'All the insurance companies have had negative returns over the past year. The question is how much they can use from previous years' reserves to pad out a bonus this year.'

There are 900,000 members of the Britannic with-profits fund, and about 100,000 in Alba Life. Group finance director Paul Thompson says 'there has got to be stability' in equity markets before a bonus is restored. Stability is estimated by Britannic to be 7 per cent a year in actual stock market growth.

It is possible that this year's bonus will be given after all, if equity returns are good - but this seems unlikely. Last year's Britannic bonuses ranged between 2 and 5 per cent - so this is probably the very best policyholders could hope for in the unlikely event of a sustained stock market recovery in 2003 and early next year.

What are the prospects for bonus payments at other insurers?

Expect 'cuts across the board' from all insurers, says McPhail. He expects cuts of 5 to 10 per cent this year and perhaps cuts of the same size in the spring 2004 bonus declaration season. Insurers tend to phase in cuts in bonuses, he adds.

Average bonus payments over the past five years have been 6.16 per cent (compared with minus 0.02 per cent on balanced managed funds). So, if McPhail is right, then their bonus rates could be cut back to about 5 per cent a year over the next couple of years.

Sloan expects few insurers to declare significantly more than 5 per cent this year, but thinks 3 per cent 'is probably rock bottom for insurers who want to be seen to be moving forward at all'.

Analyst Roger Hill of UBS Warburg believes that some other companies might go for zero or deferred bonuses - particularly 'closed companies' which, like Alba Life and Equitable Life, are merely there to 'run off' existing business but not to take on new customers.

He says: 'Companies that are closed to new business are more likely to put solvency considerations ahead of marketing considerations.

'In South Africa, in 1998, the whole insurance industry went to zero bonuses, saying it was better to do this for solvency reasons. I don't think this will happen in the UK as the industry here is much more fragmented. But big companies will cut bonuses.'

Why has this happened when with-profits funds are meant to smooth out stock market fluctuations?

Insurers have suffered three years of significant losses on their stock market investments. While they have been able to protect policyholders against these losses until now, the industry is starting to feed them through. On top of this, people are living longer - and so annuities are costing insurance companies more than they expected. New mortality estimates from the Continuous Mortality Investigation Bureau, which came out just before Christmas, extended longevity calculations yet again.

Individual insurers have their own problems. Some, like Equitable Life, have given fixed payment guarantees on some pension plans, and these guarantees can prove very expensive in a low inflation environment.

Britannic has had its own difficulties. It restructured in 2001, closed its 2,000-strong sales force, tried to move upmarket to more affluent customers, put itself up for sale but was unable to find a buyer and was without a chief executive for most of last year. But it has not been regarded as a particularly weak player.

It could be that other insurers are hiding even worse losses and results than those Britannic disclosed last week.