Personal Finance: The bonus at the end of the term

As stocks scale new peaks, life companies are cutting back the annual bonuses on their with-profits plans. Nic Cicutti wonders if terminal bonuses can make up the difference

Annual bonuses, crucial as they are, are not the only component of final maturity values. The terminal payment, which is meant to reflect stock market performance, can be worth as much as 60 per cent of the total fund after 25 years, though this falls to 20-30 per cent for 10-year policies.

Terminal bonuses can vary, thereby adding considerable uncertainty as to the potential value of a policy. Moreover, the interplay between final and terminal bonus can be even more baffling. This year's bonus ritual, where life companies announce how much they will pay out to typical policyholders, is an example.

Ostensibly, most companies that declared their bonuses for 1998 will be paying out more than the previous year (see table). Among the biggest leaps is GA Life, whose payout at maturity on a pounds 50 monthly investment over 25 years goes from pounds 114,554 to pounds 120,784. Yet GA's annual bonus to with-profits savers dropped by 0.5 per cent, leaving the terminal bonus to make up the difference. Similarly, Norwich Union, whose payout this year might be pounds 100,247 on a policy with similar terms, up pounds 7,068 on 1997, is cutting annual bonuses on its pension policies from 7.5 per cent to 6.75 per cent.

The reason for this seeming contradiction - cuts in annual bonuses at a time of soaring stock markets - is that company actuaries, who set the rates paid to policyholders, measure the amount they can guarantee against the yield on long-term gilts, government loan stock.

Because these plunged last year to a low of 6.25 per cent, not seen since the 1970s, actuaries no longer feel confident enough to guarantee high annual bonuses every year. Instead, the actuaries are giving more in maturity payouts - which are not guaranteed.

According to the Institute of Actuaries, life offices have only been able to guarantee high annual bonuses because of unusually high investment growth right back to 1974, when stock markets hit their nadir in the midst of the oil-price shock.

The low yield on gilts reflects a belief, shared by actuaries, that as long as inflation stays low, investment returns from stocks and shares can be expected to do the same.

Nick Dumbreck, a leading figure at the Institute of Actuaries (IoA), said recently: "I think it is absolutely right that companies should be reducing bonuses at this time. It doesn't mean savers are getting less overall - they are just getting less now."

Some actuaries argue that annual bonuses should be even lower. Peter Nowell, chairman of the IoA's life board, added: "My concern would be if life offices tried to keep their annual bonuses right up, which might have an impact on their financial strength. Annual bonuses ought to be below gilt yields."