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Kirk Rice Blog

Different Valuations?Written on June 8, 2016 by Peter Sharratt

Financial Services Questions

The Question:

I have an Investment Bond and have noticed over the last few years that the surrender value quoted on my annual statement is higher than the actual value. Why is this?

Peter Sharratt answers:

It would appear that your Investment Bond is invested in a With Profits Fund as this type of fund can pay a terminal or final Bonus upon surrender which increases the value. With Profits Funds are also available via pensions and so you can see a similar situation for a pension where the transfer or even retirement value is higher than the actual value.

A With Profits Fund will typically invest in a mixture of asset types such as UK Equities, Overseas Equities, Corporate & Government Bonds, Commercial Property and a small amount in cash. How well the With Profits Fund performs will be down to these assets and the skill of the fund manager. A proportion of any returns realised are paid to you in the form of a bonus (typically annually) and once paid a bonus cannot be removed. Any returns not paid out as a bonus are retained within the fund and can be paid out in future.

As an example, the underlying assets (as above) may mean the fund realises growth in one year of 9%. The fund manager may pay 3% of this to Investors as a bonus and retain the remaining 6% to cover charges and to act as a reserve for bad years. If the following year the underlying assets drop in value, and the fund therefore realises a negative return the fund manager can still pay a bonus of (example) 2% using Profit retained from previous years. This process means the returns from a With Profits Fund tend to be quite smooth and you will not see large fluctuations in values.

In essence, you do not fully participate in the gains during good years, but equally you do not get hit by the falls during bad years. Over time the fund manager recognises there is profit retained in the fund you are entitled to. This will be paid in the form of a terminal or final bonus, but unlike the annual bonus this can be decreased or removed at any time.  To secure the terminal bonus, the Investment Bond would need to be surrendered OR if the provider allows, switched in to another Fund.  A final point to be aware of is that With Profits Funds can also impose a Market Value Reduction/Adjustment (a penalty) upon encashment but this will generally only be during or shortly after poor stock market performance.

Any reader interested in discussing this topic further can telephone Peter Sharratt on 01344 875000 or email peter.sharratt@kirkrice.co.uk.

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Please note: answers are given for general guidance only and specific advice should be taken before acting on any of the suggestions made.