Personal Finance: Bonuses look on bright side

THE ANNUAL round of bonus declarations from providers of with-profit endowment and pensions policies is under way.

This sets the payouts for policies maturing in the coming year and also puts down a marker for the guaranteed element of policies that will be paying out in future years.

It is a fiercely competitive business, with league tables drawn up to show the highest and lowest-paying companies. Future sales depend on putting on a good show.

At the end of the 1980s, the show had become far too good. The policies got stuck in a groove, paying out amounts that reflected a boom era that had gone.

Then the almost unthinkable happened, and in 1990 bonus rates started to come down, prompting fears that some endowments would not grow enough to repay the mortgages they backed.

This time last year, there were predictions that returns would be shaved again this year. But 1993 has proved a bit of a surprise.

Early results from the first half dozen life offices have shown a tiny increase in the payouts on 25-year policies, and cuts of between 0.4 and 7.6 per cent on 10- year policies.

But behind the simple amount policyholders receive from a maturing policy is a more complex picture.

The final payout is made up from a guaranteed element that builds up over time by the addition of a bonus every year that sticks to the policy until it matures. Then, at the end of the run, a final or terminal bonus is added to reflect the investment performance over the span.

The annual bonuses commit the life office to a level of payout and have to be set with an eye to future returns. The final bonus, meanwhile, is backwards-looking and reflects the investment actually earned by the with-profits fund.

Returns from the stock markets were pretty good in 1993. The average UK unit trust grew by 20 per cent, and the average international trust by nearly 30 per cent.

This, according to Phillip Scott, general manager of Norwich Union, is a one-off. Interest rates were cut and, as bond yields fell, money went hunting in the equities markets and pushed share prices higher. So the with-profits funds saw wonderful returns from bond holdings such as gilts, which they need to give some stability to the fund that is already committed to those guaranteed bonuses. And they did pretty well from the shares portfolio too, so the expected cuts in the final bonuses did not materialise.

Annual bonuses on 10- year policies, which at the start of the year had seemed to be pitched too high, were actually earned last year. But the outlook, with lower inflation, is for lower nominal returns from investments.

Over the next three years, the boom times of 1984, 1985 and 1986 will drop out of the arithmetic for 10-year policies. These years produced returns of around 30 per cent a year from equities, so unless the next three years produce returns to match, the overall mixture will inevitably shrink.

A bulge of investors who took out their 10-year policies in a flurry before the 1984 Budget and the abolition of life assurance premium relief (LAPR) will see returns comfortably over 10 per cent, which is nothing to complain about in the current climate.

THIS time next year, anyone buying an investment will have to be told how much the salesman will earn from the deal - whether they are independents wholly dependent on commission, or tied agents also receiving a salary and perks such as cheap loans, or banks with their own life insurance division.

While this is a welcome small step in penetrating the fog of misunderstanding of what financial products are all about, consumers should not allow their focus to rest on these numbers.

What really counts is the charges that are taken out of your policy or investment, and the value it gives you.