An investor that has a regular savings plan from an offshore insurance company (or a lump sum portfolio bond) may see a surrender value on their statement and wonder what this means and how its reached.

For many investors they will often see a plan value or policy value, then believe this is the cash amount in their hands. This is not often the case with the surrender value being the cash amount you could get on that statement date. Here we explain the difference and how surrender values are calculated and possible reasons for the difference between plan value and surrender value.

Signing up to a defined journey

The starting place for any investors that has a contracted savings plan for a set number of years is that if you do not complete payments for the period or hold the policy for the full term then surrender values will be considerably lower than plan value. This is due to the products are designed to be held for the contract period and fees are applied assuming the arrangements at the outset will continue for the full period. This could be 25 years in some worse cases. A simple way to think about this is it is like agreeing on day 1 to join a motorway for a defined journey and agreeing not to take any earlier junction than the one you agreed to at the outset. If you come off the motorway early the tolls for the full journey will still apply. An adviser should not encourage an investment if the client would not be happy with going to the junction they agree – it is possible to agree an earlier junction then carry on further as this offer flexibility for pay as you go for the functions after the one you signup for at the outset. That’s why 5 years savings plans should be favoured over a 25 year plan.

The truth on fees for savings plans

Fees on regular savings or insurance wrapped portfolio bonds are not always fully explained or clear. Usually instant access is explained, and whilst getting money out can be possible, it is not always said that fees are based on the agreement at the outset and amount expected to be subscribed over the full period.

How are surrender values influenced?

When purchasing a regular savings plan from an insurance company or a portfolio bond the main factors that can cause the surrender value to be considerable less than the plan value are:

  • how far through the contract period you are – the shorter the period the lower the surrender value
  • whether the contributions have been maintained at the level agreed at outset – if premiums were stopped the lower the surrender value will be. If premiums were stopped very early after commencing a savings policy the plan may be have a surrender value near zero
  • any enhancement to the premium allocation (meaning the adviser has given up commission to fund enhanced allocation) – any reduction in the adviser fees reduces the clawback of commission from the client so surrender value can be higher where adviser commission is reduced.

How these factors influence surrender value

When buying a savings plan the product provider assumes payments will be made over the life of the plan. They set fees at that commencement which is predicated on a set subscription amount, on a set frequency for a defined period. If any of these are stopped or reduced by the client fees become higher and can result in lower surrender value.

Stopping paying contributions before the end of the contract period means that fees can eat into the plan value and cause the surrender value to be a lot lower than the plan value as the additional cash flows didn’t materialise as outlined in the original contract plan.

When an adviser recommends an insurance savings plan they will receive a commission paid from the product provider. This initial commission is often calculated by taking the premium and calculating an annual equivalent (so a monthly savings plan will be multiplied by twelve or a quarterly savings plan multiplied by four) which is multiplied by the length of the contract and up to 5% of that amount is paid shortly after commencement of the insurance savings plan. It can often mean a savings plan with a few hundred per month can earn the adviser thousands in commission shortly after client signing to the plan.  The insurance company often pays this amount out but recovers it will fees over the total length of the savings contract. To covers their risk of early exit they will apply exit fees if the client chooses to withdraw early and this can mean

Let us show you an illustrations of each of these situations.

 

This is the outcome where a plan is held to maturity. Where low commissions are taken, an affordable premium advised at commencement and a short duration contract can result on the surrender value matched to the plan value.

This situation can cause confusion at maturity as a plan value is not what the client receives with a surrender value at a marked level lower. This is caused as fees are applied assuming all premiums were going to be paid so as a result the end value is not at plan level as weight of a heavier fee load impacts a lower pot of money that has been paid.

Early surrender of a policy brings forward the whole contract fees to the early exit date. In addition any fees that need to be recovered for the commission paid out are also borne by the investor.

Sadly an common situation where the adviser has not explained the policy clearly. The client has the double whammy of having fees based on making contributions that have stopped and taking the culminations of the whole life of the contract by surrendering early. These are the situations that can be avoided if proper advice is offered in advance by an adviser.

Our use of savings plans?

Nowadays, there is greater flexibility than insurance based savings plans so we favour more flexible solutions like fund supermarkets or stockbroking accounts. Where we do use insurance based savings plans we encourage shorter contract lengths and affordable contributions and always explain the fees and consequences for openness. We do service clients in these policies to help them maximise value. If after reading this article your would like to learn more or speak to us, please get in contact.