Millions of with-profits policyholders hoping for better returns after last year's stock market rally were dealt a blow last week when Aviva, owner of Norwich Union, announced disappointing results.
Aviva's 2.3m policyholders were told its with-profits fund returned just 6% last year, despite a 22% increase in the value of the FTSE 100 index. The average with-profits fund is likely to have managed 14% last year, according to research by Hargreaves Lansdown, the financial adviser.
Aviva, which has four with-profits funds worth £50 billion, said regular (guaranteed) bonuses paid on life and pension policies taken out since 2003 would be maintained at 2.75% and 3.25% respectively. However, the insurer is cutting the returns paid on its with-profits income bonds from 3.25% to 2.5%.
Endowments are maturing at significantly less than last year or even six months ago, with 88% not expected to reach projected maturity values. For example, a typical maturing 25-year General Accident policy into which someone has contributed £50 a month will now pay out £36,979, compared with £38,776 last July and £42,322 in January 2009.
David Barral, chief operating officer, said: "The vast majority of customers who have invested in the Aviva with-profits funds have received higher returns than if they had invested in an average bank or building society account and have been protected against the full impact of volatile investment markets."
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With-profits funds aim to hold back profits when times are good to continue to pay good returns when times are bad. However, they are increasingly regarded as out-dated because of their complexity and lack of transparency.
Andrew Barker, chief operating officer at Skipton Financial Services, an adviser, said: "They used to work fine but nobody would use them today."
While the picture is dismal enough for people in with-profits funds still open to new business, prospects are even grimmer for those stuck in closed, so-called "zombie" funds.
Closed funds often invest heavily in fixed-interest investments to ensure they can meet their obligations, such as guarantees on older policies. Over the longer term, these types of investment are unlikely to match the performance of equities or property.
Guy Vanner, managing director of AKG Actuaries & Consultants, said: "Many of these funds were closed because they were already performing badly. They are now not invested in equities but the whole point of them was that they would smooth out the highs and lows of the stock market. How can they do that if they aren't even in it?"
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It is tricky to get out of these funds as most are currently applying "market value reduction" penalties on any policy cashed in early. Although these are supposed to bring policies back to the value of underlying assets, so as not to penalise those remaining in the fund, the opaque nature of with-profits makes it near-impossible to tell if this is accurate.
The most notorious of the zombie funds are those that were sold by Resolution - a group created by Clive Cowdery to buy up closed funds - to Pearl in 2007. About £80 billion is invested in these funds. Laith Khalaf, pensions analyst at Hargreaves Lansdown, pointed out that many Pearl funds are performing even worse than the Equitable Life with-profits fund.
According to AKG's most recent report on with-profits funds, a 25-year endowment maturing from the beleaguered life office last year produced £30,499. Pearl funds managed between £23,785 and £29,961.
Pearl and Resolution argue the closed funds they bought had little prospect of growth because they had switched heavily out of equities to manage their liabilities.
Kevin Arnott, director of with-profits at Pearl, said the group was taking a more active management stance to try to turn round performance. Two of the funds, including the main Pearl fund, have increased their weightings in equities, while one has reached agreements with policyholders to free it from expensive guarantees and allow greater equity exposure.
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"These are the sorts of things we are doing but none of them is quick," he said. "You can't just erase 20 years of underperformance."
Pearl funds are not the only ones to languish. A 25-year endowment maturing last year from Friends Provident (bought by the new Resolution group set up by Cowdery last year) managed only £27,474. Zurich's closed Eagle Star fund mustered £28,242, while Axa's closed Colonial Life fund returned £30,063 - all less than Equitable Life, said Khalaf.
In some cases, with-profits funds within the same insurance groups perform very differently depending on whether they are open or closed.
Royal London, for instance, has open and closed funds producing very different performances. According to AKG's report, a 25-year endowment from the Scottish Life closed fund produced £32,145 compared with a much more impressive £43,238 from the open Royal London fund. Royal London took over Scottish Life in 2000.
Alasdair Buchanan at Royal London, said: "The £2.5 billion Scottish Life fund has a much higher proportion of pension policies with valuable guarantees, which are also very expensive" The excuse that closed funds must be invested in less exciting assets, with fewer prospects for growth, doesn't stand up. Wesleyan's open fund was top of the endowment tables last year, with a 25-year endowment maturing at £65,957. However, its closed Medical Sickness Society fund came in second with £60,451 - clearly unencumbered by poor asset performance.
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Many advisers are urging investors to pay the penalty and get out of poor funds, even if it means losing some of your investment. You can hopefully make it up in a better fund.