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According to Bloomberg, a sixth of the UK's long-term insurance savings are in 110 with-profits funds, of which 66 are now closed. In other words, three-fifths (60%) of with-profits funds no longer write any new business, which has lead to them being described as dead-end or "zombie" funds. Perhaps the most disturbing - and certainly the most high-profile - example of a closed with-profits fund is the Equitable Life Assurance Society (ELAS). The Society has produced nothing but bad news for its policyholders since it closed its doors to new business five years ago this week. In essence, ELAS was brought down by its policy of "over bonusing": paying higher returns to policyholders than its funds had actually accrued. The trigger for ELAS' closure was a ruling in the House of Lords that the Society had to honour the promises it had made to 90,000 policyholders who had purchased guaranteed annuity rate (GAR) policies in the Seventies and Eighties, when interest rates were much higher than they are today. After failed litigation against its auditors and former directors, ELAS policyholders have their hopes pinned on winning compensation from the government for failing to regulate ELAS properly. However, as with all legal actions of this kind, the wheels grind incredibly slowly; meanwhile, ELAS policyholders continue to suffer from second-rate returns. One problem with closed or zombie funds is that they almost always adopt a more conservative investment strategy after closing their doors to new customers. This cautious approach leads them to move away from high-risk, high-return investments in shares and towards lower-risk, lower-return assets such as gilts (fixed-interest government bonds). This helps these funds to better match their assets to their liabilities and meet the regulator's solvency requirements. The bad news is that it also fund growth rates and, hence, slashes returns to with-profits investors. A few companies, recognising the potential value locked up in closed funds, have begun to buy up zombie funds in an effort to reduce their expenses through economies of scale, meet their obligations to policyholders, and generate enhanced returns for shareholders in the acquiring business. These "third-party consolidators" quickly acquired the nickname of "vulture funds". So, what to do if your money is trapped in a zombie fund? In effect, you have four choices: Alas, in most cases, if you remove your money from a with-profits fund, you'll be hit by a market value reduction (MVR), which reduces your payout in line with what your pot has actually earned. In some cases, this can means losing a fifth (20%) or more of your fund. Then again, in some circumstances, lump-sum investors have a contractual right to cash in their investment without an MVR being applied, for example, on the fifth anniversary of their purchase. If I had this "get out of jail free" card, I'd be tempted to take my money and run! As always, what you decide to do with money trapped in a closed fund is down to your personal attitude to risk. If you have an above-average appetite for risk, you may decide to pay the MVR penalty and transfer your money. Of course, your hope is that you go on to earn higher returns, which make up for the MVR and, ultimately, produce a bigger payout when your investment matures. Finally, "open funds=good, closed funds=bad" isn't necessarily true, so it's important to look at your fund in terms of its own previous performance, ongoing charges, investment strategy and predicted future investment returns. To help you, the Financial Services Authority has produced a list of ten questions that policyholders should ask before deciding which course of action to take. Also, Appendix A of this report (PDF file) lists all with-profits funds, both open and closed. More: Check out this cheap, simple, flexible investment | Why pay tax? Use an ISA as shelter!
