I received the headlined quote in an email from a 35 year old American couple that bought an Investment Linked Assurance Scheme through Friends Provident.   

zurich warningBut was the couple really scammed?  Investors need to read the fine print behind any investment scheme. This particular product labels itself as an “investment” insurance policy, promising 101% of what an investor deposits, upon their death.

Of course, that sounds good.  But think about it for a moment.

The company promises 1% more than what you deposited or the market value of the investments upon death, whichever is highest.  I’ve taken this directly from the Friends Provident website:

“In the event of the death of the Life Assured (or the last surviving Life Assured if the policy is written on more than one life) while the policy is in force, 101% of the cash-in value of your plan will be payable.” … read the product summary

Fees charged to investors are high, but much can be found in the prospectus:

  1. 1.2% annual administration charge
  2. 1.6% annual establishment charge (for the first 5 years)
  3. 2.59% expense ratio (See Average Channel Island  Fund fees on page 1287, in the article by Henri Servaes, Ajay Khorana and Peter Tufano, called “ Mutual Fund Fees Around the World”: … read the article.)

Assuming that they have already paid the bulk of their annual establishment fees (charging 1.6 percent annually for the first five years) they will pay combined investment fees of roughly 3.79 percent annually, when adding up the annual administrative charge with the annual expense ratio for the funds.

This couple, after reading one of my earlier posts on Friends Provident, wanted to take action, by selling their investments, and reinvesting with a company that won’t drag them over the coals.  But Friends Provident paid their advisor a large upfront commission.  To recoup that money, the company needs to keep this couple in their product, so they can reap perpetual fees from their clients.

My new online friends have a dilemma:  Their investments have a market value of $150,000 U.S., but if they withdraw their money now, they’ll pay a penalty of $45,000 to Friends Provident, while receiving just $105,000. 

Should they do it?

As Americans, with Vanguard’s indexes, they could pay as little as 0.15 percent for a diversified portfolio.  With Friends Provident, they’re paying roughly 3.79 percent in annual fees.

Let’s have a look at what those fees could do to the 35 year old couple, over the next 30 years.  Assuming a stock/bond market return of 9 percent annually, they would make 8.85 percent annually with Vanguard, and 5.31 percent annually with Friends Provident.

Let’s have a look at what would happen if they pulled their money out, taking that $45,000 hit, and then investing with Vanguard.

Investment Company

Investment

Annual return over 30 years

End value in 2041

Vanguard

$105,000

8.85%

$1,336,725

Friends Provident

$150,000

5.31%

$708,238

 You can see, above, that despite taking that $45,000 hit, the comparative results with a low cost company like Vanguard would easily outstrip the results of a high-cost company like Friends Provident.  The decision, of course, is up to them.  But they need to be aware of the fact that according to Nobel Prize winner William Sharpe, fund investments (on aggregate) earn the markets return, before fees.  Over time, they will under-perform the market in direct proporation to the fees charged.

But these new friends of mine have an option:  they’ve told me that they can withdraw as much as $90,000 today, without a paying a fee.  And later, they can withdraw more money, paying a lower penalty as more time elapses.

If they want to pay lower fees, they could invest that $90,000 with Vanguard or Assetbuilder, and concentrate on building those accounts, while limiting their losses with the money they leave behind, with Friends Provident.

Unfortunately, from what I understand, they will have to keep contributing money to Friends Provident, based on the contract they have signed (bizarre, I know!) but the pain of selling their money later is abated, as the penalty to sell “early” isn’t as severe later on.

Expatriates often invest without reading the fine print on a prospectus.  Here are some rules to invest by:

  1. You should never pay a fee to either buy or sell your investments (with the exception of a small fee to buy exchange traded index funds.
  2. You should never have to pay a penalty to withdraw your money
  3. You should never have to pay an ongoing administrative charge (or an “establishment charge” as Friends Provident coins it)

You should also teach your friends not to fall for costly schemes that can cost them hundreds of thousands of dollars over their lifetimes.

Further Reading:

 Costs in the Mists of Time: South China Morning Post

Royal Skandia’s high commissioned Investment Linked Assurance Schemes are similar to those sold by Friends Provident and Zurich International

 Hong Kong Consumers Angry After Being Sold Complex Insurance Product ILAS:  South China Morning Post

 ILAS Products Under Scrutiny:  International Advisor

 The Real Cost of an Offshore Pension Plan:  Noto Financial Planning

Tony Noto once sold  ILAS products (much like Zurich and Friends Provident’s) until he recognized how much they took from investors.  In this article, he explains how they work.