Investment (With-Profits) Policies
In the United Kingdom and other parts of Europe, a with-profits policy, also called a participating policy in the United States, is the term for a specific type of insurance contract that participates materially in the profits of a life insurance company, often a mutual life insurance company.
In this type of policy, the premium paid by the policyholder is pooled with the insurance companys life fund, as it is called in the UK, or general account, as it is known in the US. A large part of the life fund is invested in high return equities, bonds and other properties. The insurance company pays out claims from the pooled assets. Profits are distributed to policy holders in the form of a bonus in the UK, or a dividend in the US.
Originally, this type of policy arose as a means to distribute unplanned surplus, which resulted from a series of years in which death rates were lower than anticipated. Since insurance companies distribute the risk of a claim mutually over a large number of people, they reasoned that it would be equitable to distribute the reward mutually, as well.
As time went on, this type of policy became associated with more adventurous investment strategies, aimed at achieving long-term capital growth. With-profits policies began to be regarded as a form of long-term collective investment, and investors began to choose mutual companies on the basis of such things as financial strength and a record of high return rates.
The bonus rate is contingent upon many factors, including the return rate on underlying assets, and how much has been paid out in bonuses in previous years. In recent years, this type of policy has come under fire with the introduction of MVRs, or Market Value Reduction adjustments, also sometimes called Unit Price Adjustments. Using this adjustment, the insurance company ensures that policy withdrawal payments are in line with the current market value of the assets in the life fund. If investments have performed poorly, the withdrawal value of the policy is reduced per unit, to reflect poor market conditions. Since MVRs always adjust downwards and never upwards, this has negatively impacted the perception of with-profits policies as a steady, reliable investment.