With-Profits Annuities: How They Work and Why They Declined

The with-profits annuity was a product of its time — the early 1990s, when with-profits funds were generating strong returns, annuity rates were generous by modern standards, and the idea of linking retirement income to investment performance seemed both natural and attractive. By 2026, with-profits annuities account for less than five per cent of new annuity purchases and the market has effectively been abandoned by most major insurers. Yet hundreds of thousands of people remain in receipt of with-profits annuity income, often with limited understanding of how their income is calculated or why it may have fallen in the past fifteen years.

This guide explains the mechanics of with-profits annuities, the Anticipated Bonus Rate (ABR) that is central to understanding the product, the role of reversionary and terminal bonuses, and why the product made sense in one era and became problematic in another.

The Core Mechanics

A with-profits annuity works differently from a conventional (unit-linked or fixed) annuity in the following way:

When you purchase a conventional level annuity, the insurer calculates a fixed income based on the premium, your age, and current interest rates. That income is guaranteed and does not change.

When you purchase a with-profits annuity, the insurer does not commit to a fixed income in the same way. Instead, it sets an initial income based on an assumed growth rate — the Anticipated Bonus Rate — and then adjusts the income each year depending on how the with-profits fund actually performed relative to the ABR assumption.

The key relationship is:

• If the fund performs above the ABR, income increases.
• If the fund performs at the ABR, income stays the same.
• If the fund performs below the ABR, income decreases.

This adjustment mechanism means that with-profits annuity income is not guaranteed to remain stable — it can rise in good years and fall in poor years, within the constraints of the with-profits fund's smoothing mechanism.

The Anticipated Bonus Rate (ABR)

The ABR is the assumed investment return that underpins the initial income calculation. A higher ABR assumption generates a higher initial income — because the insurer is pricing in stronger future growth — but creates greater risk of subsequent income reductions if the fund underperforms.

A lower ABR generates a lower initial income but is more conservative — if the fund performs above the ABR, income increases from a more modest base.

At the time with-profits annuities were most actively sold (mid-1980s to late 1990s), ABRs of five to seven per cent were common. With-profits funds at that time were genuinely achieving returns above these levels, leading to annual bonus declarations that increased policyholder income year on year. For those who bought in this environment and maintained the ABR assumption through the 1990s bull market, with-profits annuities delivered well.

The problem came with the equity market declines of 2000 to 2002 (the dot-com bust) and again in 2008 to 2009, combined with persistently low interest rates from 2009 to 2022. With-profits funds — which had built up significant equity exposure through the 1990s — were damaged, and the investment returns needed to sustain the ABR assumptions of the 1990s were not achievable. Policyholders with higher ABRs saw their income fall — sometimes substantially — in the years following the 2000 and 2008 downturns.

Reversionary Bonuses: The Ratchet Up

With-profits annuities typically include both reversionary bonuses and terminal bonuses. These concepts are shared with with-profits whole-of-life and endowment products but work somewhat differently in the annuity context.

Reversionary bonuses are declared annually by the with-profits fund manager (typically the insurer's board and actuarial team). Once a reversionary bonus is added to a with-profits annuity policy, it cannot be taken back. This is the "ratchet up" mechanism — declared bonuses become part of the guaranteed floor, even if the fund subsequently performs poorly.

This means that a run of good years can permanently increase the income floor, and future poor years can only reduce income back to the new higher floor — not below it. For policyholders who benefited from a decade of strong bonus declarations in the 1990s, this provided meaningful protection when the market turned.

Terminal bonuses (also called final bonuses) are a share of the surplus accumulated in the with-profits fund over and above the reversionary bonuses. They are discretionary and not guaranteed. In the with-profits annuity context, a terminal bonus may be applied in each year when the fund has performed well, boosting that year's income above the level implied by reversionary bonuses alone.

Smoothing: The With-Profits Promise

The defining characteristic of the with-profits structure is smoothing. Whereas a unit-linked investment rises and falls directly with the underlying assets, a with-profits fund smooths returns over time — holding back some surplus in good years to maintain income in bad years.

For with-profits annuity holders, smoothing means that one bad year on stock markets does not typically translate into an immediate income reduction of the same magnitude. The with-profits fund's actuaries will absorb some of the loss through the fund's reserves and may reduce bonuses gradually rather than immediately.

However, smoothing is not unlimited. After a prolonged period of poor returns — as in 2000-2009 — the reserves are depleted and the income adjustments become unavoidable. Policyholders who bought with high ABRs in the 1990s and experienced both poor fund performance and declining bonus declarations found their income falling in real and sometimes nominal terms over multi-year periods.

Major Providers and Market Decline

In their heyday, with-profits annuities were offered by most major UK life insurers:

• Prudential: Historically the largest with-profits insurer in the UK, with substantial WPA books still in force through its with-profits fund (now partly managed by M&G).
• Legal & General: Offered WPAs through the 1990s, now predominantly a conventional annuity provider.
• Aviva (formerly Norwich Union / CGU): Significant with-profits legacy business.
• Standard Life: Had a major WPA book; merged into Phoenix Group.
• Equitable Life: The most notorious example — its closure to new business in 2000 and subsequent inability to meet its guaranteed annuity rate obligations exposed the systemic risks in with-profits funds, contributing to widespread reputational damage for the entire sector.

By the 2010s, most major insurers had stopped writing new with-profits annuities. The combination of prolonged low interest rates (making it almost impossible for with-profits funds to generate the returns implied by 1990s-era ABRs), regulatory capital requirements under Solvency II (which made with-profits guarantees expensive to hold), and reputational damage from poor outcomes led to market withdrawal. New with-profits annuities are now rarely sold.

Reviewing a With-Profits Annuity You Already Hold

If you hold a with-profits annuity — whether inherited from a pension you have consolidated, or one you chose in the past — the most important information to obtain is:

1. Your current ABR: This tells you what investment performance is needed to keep your income stable.
2. The with-profits fund's current performance: Request the annual bonus declaration and any available fund performance history.
3. The current bonus rates (reversionary and terminal): Are bonuses being declared? Have they been reduced?
4. Your guaranteed income floor: What is the minimum income guaranteed regardless of fund performance (this is often the original purchase income minus any ABR excess that was reversed in subsequent years)?

With-profits annuities cannot normally be surrendered once in payment — you are locked in for life. There is no mechanism to convert a with-profits annuity into a conventional annuity or into drawdown. This makes it critical to understand the product fully, as the income implications of your ABR will persist indefinitely.

When With-Profits Annuities Made Sense

At their best — bought in the late 1980s or early 1990s with a moderate ABR, into a well-managed with-profits fund — WPAs delivered genuinely superior outcomes. Retirees who bought in this period often experienced rising incomes throughout the 1990s, building a permanently higher reversionary bonus floor before the market turned. Some of these policyholders will have received lifetime income that significantly outperformed a conventional annuity bought at the same time.

The product was rational given the information available at the time. The problem was not the concept of with-profits annuities per se — it was the combination of excessively high ABRs, equity-heavy with-profits fund investment strategies, and in some cases inadequate reserving that created catastrophic mismatches when markets declined.

Current Relevance

With-profits annuities are primarily relevant today in the following contexts:

1. Reviews of existing policies: Many people with with-profits annuities have limited understanding of how their income is calculated. Annual statements are often opaque. Obtaining clear documentation of the ABR, bonus history, and current fund performance is the starting point for any review.

2. Pension consolidation: When consolidating multiple pensions, an adviser may encounter a pension with a with-profits element or a policy that includes a WPA option. These require careful handling.

3. Complaints and redress: Some holders of WPAs from providers with poor fund management — notably former Equitable Life policyholders who received government compensation — have grounds for reviewing whether mis-sale claims or policyholder rights actions are relevant. This is a specialist area requiring dedicated legal and actuarial input.

4. Estate planning: WPAs typically include death benefit provisions — often a capital protection or guaranteed period element. Understanding the death benefit terms is important for estate planning.

Compliance Notes

With-profits annuities remain regulated products under FCA rules. The insurer's with-profits fund is subject to the Principles and Practices of Financial Management (PPFM) document, which must be published by the insurer and explains how bonuses are determined. Policyholders have the right to request the PPFM and to raise complaints with the Financial Ombudsman Service if the insurer has not acted in accordance with it.

The with-profits fund actuary and the with-profits committee (or equivalent governance body) are responsible for ensuring the fund is managed fairly between different generations of policyholders. If you have concerns about your WPA, the insurer is required to respond and the FOS and FCA are available as escalation routes.

Nothing in this guide is personal financial advice. With-profits fund performance is not guaranteed. Individual WPA terms vary between providers and policies.

How Global Investments Can Help

Global Investments assists clients who hold legacy with-profits annuity products as part of broader pension reviews. We can help you obtain and interpret the documentation needed to understand your WPA — including the PPFM, current ABR, bonus declarations, and fund performance history — and integrate this into your overall retirement income picture.

For clients considering whether any action is available in respect of an underperforming WPA, we can refer to specialist actuarial and legal advisers with the relevant expertise. Please seek regulated advice before taking any action in connection with a with-profits annuity.