FOOL'S EYE VIEW
Yield Not Unto Temptation

By Stephen Bland (TMFPyad)
October 1, 2001

I picked up recently on a very interesting article in the Guardian and posted a link to it on the High Yield Portfolio discussion board. It concerns certain high income "bonds" issued in recent years by many leading insurance companies and, following market falls, how the capital of these "investments" (I use the term loosely) is now at very serious risk. An absolutely scandalous situation, because the type of investors attracted to these things would in general be the most risk-averse, such as those who have to depend upon the income in retirement for example.

The reason for the problem is that the high income, around 10%, was achieved by the use of derivatives based on certain market indexes. The design of these was such that the capital appeared to be secure only if underlying markets did not fall by more than a predetermined amount. Incredibly, for what is supposed to be a reliable income product, at least one of these schemes, according to the Guardian, used a Nasdaq index for the derivatives upon which it was based. Others used the FTSE 100.

Anyone with a quarter of a brain must know that the Nasdaq is highly volatile and is no basis upon which to design an income investment. Anyone with half a brain knows similarly that the FTSE 100 can also fall by quite large amounts on occasion. To sell a high income plan to people who probably depend upon that income, with this kind of underlying high risk to the capital, absolutely beggars belief. Even more so when you take into account that the companies marketing these schemes are among the leading insurers in the land, supposedly those that ought to be trusted by probably unsophisticated income investors who, I am fairly certain, would in many cases not fully have understood the nature and risk of these plans.

Any scheme offering a yield far higher than that available on gilts or blue chip equities is automatically suspect and requires careful analysis of how the very high yield is being achieved. Investors have to beware of this. Too often, though, those that do not understand that you rarely get something for nothing in the world of investment are attracted merely by very high headline yields without reading or understanding the conditions. But what is unforgivable is when major institutions, knowing the gullibility of a lot of the investing public, put their names, which many people trust, on products that they must know are outrageously risky just to make some money out if them. The Guardian article tells us that billions were drawn into these schemes. It is cynical to the point of contempt for the poor investors, who may lose heavily.

Have you seen those revolting TV ads whereby insurance companies try to attract your money into their various investments? Assuring people how secure your future will be if only you would let them handle your funds. The worst kind of financial pornography. Promising you the earth and delivering you just that, a handful of earth.

Time and again investors have been let down by insurers. Poorly performing pension plans; endowment mortgage schemes that may be insufficient to pay off the loan in many cases; well-known companies getting into difficulties because of appalling management; and now high yield plans that may lose investors most or all of their capital. These are just a few things that spring to mind. I am sure readers will be able to compile a much longer list of insurance company disasters than I can think of right now, particularly those who are now poorer as a direct result of "investing" with one of them.

In my car this morning on the way to my office I heard someone from the Association of British Insurers, the insurance companies' trade association, commenting about the public not saving enough for their futures. What he meant, of course, was that we should save with them. Well, I am quite ready to accept that in general people have made inadequate provision for their later lives. What he forgot to add was that in too many instances, those that tried to rectify this by investing with an insurance company found that their provision became even more inadequate as a result.

The marketing power of insurance companies serves to generate the idea in many people that they are the automatic choice for investing, whether it is lump sums for income, pensions or whatever. That is what they want you to believe, of course, and they have succeeded in conveying this impression. Quite incredibly their image does not seem to suffer too much from the series of calamities that come to light from time to time. And a more widespread failing that doesn't often surface, the lousy performance of a number of personal pension schemes, because the investor often just does not realise how low the returns can be.

Insurance companies are for insurance and that is about all, in my view. But don't invest with them. Would you ask a plumber to fix your teeth?