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How Does Profit Smoothing Ensure I Get Stable Returns from UK Endowments? Print E-mail

As market conditions continue their uncertain course, you might be asking if you invest into UK Traded Endowments, how this will affect your investments.

 The UK Insurers operate in a heavily regulated environment and all the indications are that whilst underlying performance is likely to be affected, the consensus is that there are no nasty surprises lurking in any cupboards.

 Whilest UK Insurers are not entirely shielded from market volatility as their underlying assets include both equities and property, the stronger UK Insurers have out-performed the market and they are in a good position to do so.

 Solid investment returns made over the last 5 years have boosted the value of with-profits funds and due to the time lag caused by "profit smoothing", much of this return has yet to be distributed to the UK Endowment policyholders.

How does profit smoothing work?  Profit smoothing simply means that during years when UK insurers achieved good returns, they do not give out all their returns as bonuses, but keep a portion as reserves. Thus, when bad times come and they might even get negative returns from investing, they can draw on the reserves to continue to give good bonuses to UK Endowment policyholders.

For instance, AVIVA (CGNU) in the last 5 years achieved total returns of 54% from their investments, or average of 10.8%. If AVIVA only declares bonus of say 7% each year, it means that over the last 5 years alone, AVIVA has managed to set aside 19% returns in their reserves, which is available for them to draw on during years when their investments might not performed well.

These 19% reserves are in addition to the reserves that have been built up over many years to allow greater investemtn flexibility and a greater level of smoothing.

This reserve allows UK Insurers to continue to provide "smoothed returns" (stable returns) during periods of extreme volatility such as we are seeing at present.

Furthermore, as markets recover, the stronger life companies will be in a good position to release part of the reserves to policyholdrs through increase in bonus payments.

No wonder during times of uncertainties, actually UK Traded Endowment are sought after as one of the few "safe haven investments" which provide stable returns and high 90% Guarantee by UK Government backed Financial Services Compensation Scheme.

 
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