Beware advisers who bear investment bonds

Complaints double in a year as an 'epidemic' of mis-selling rages – so investors must ensure products offered suit their financial needs.

Problems surrounding missold investment bonds have reached "epidemic" levels, according to independent financial advisers.

Distrust of the products is also growing according to the most up-to-date figures from the Financial Ombudsman Service, which show that complaints about unit-linked and with-profits bonds almost doubled in the past year to 2,783 and 1,213 respectively.

In one high-profile case, insurance giant Zurich received a dressing down from the ombudsman after an adviser encouraged a man to unnecessarily move £292,000 into an investment bond, which reportedly came with £17,500 in commission.

But while the products are not new, sky-high commissions continue to lure advisers into recommending bonds, although they are often inappropriate for the investor. Not only do most bonds carry exit penalties for cancellation within five or six years, they are not always tax-efficient and carry risks which the investor may not be fully aware of.

"It happens too frequently, largely as a by-product of the bonds being used as a one-size-fits-all solution to solve an investor's problem," Roddy Kohn, director of independent financial advice firm Kohn Cougar, says.

"Some financial advisers make it look as though they are giving choice to the investor, but they don't have the experience or product knowledge to recommend anything else but an investment bond. There's a real epidemic of mis-selling," Mr Kohn added.

With advisers able to receive commissions as high as 8 per cent of the sum invested, consumers should beware of accepting recommendations to buy an investment bond.

Diane Needham, an independent financial adviser at Meridian Capital, who specialises in advising the elderly, says people come to her having been mis-sold investment bonds. A recent case involved a woman in her early eighties, who had been told to invest her entire life savings – £150,000 – in an investment bond that had a five-year lock-in period and generated £12,250 in commission for her former adviser. To make matters worse, the woman was then advised to withdraw the maximum level of capital each year in what was then a low-risk investment strategy, so the value of her fund crumbled, leaving her in dire straits when she needed to go into care.

"It doesn't take a rocket scientist to work out that if you are going to take investment income from day one, [the fund] hasn't actually earned anything yet. So it stripped her capital and she had a significant shortfall for about 18 months after the initial investment was set up. She lost a small fortune in money," Ms Needham said.

Ms Needham helped the woman get her money back by complaining to the ombudsman, but it took nine months and caused undue stress to the woman, who now suffers from dementia.

But it is not just the elderly who have become victims of inappropriate sales; all age groups and financial backgrounds are at risk. Martin Bamford, director of the Cranleigh-based independent financial advice firm Informed Choice, says a lot of the confusion comes down to the way sales information is outlined to potential investors.

A "smoke-and-mirrors" approach is used to disguise the commission and potential benefits are exaggerated, he says. "It is much less clear when you are taking commission out of an investment bond that the money is actually coming out of the investment, unlike a unit trust or an Open Ended Investment Company, where it is clear any money coming out is being charged directly to the money being paid in," Mr Bamford said.

A 51-year-old, self-employed woman recently came to see Mr Bamford after discovering that her £308,000 inheritance – which she had been advised to invest in three bonds, Hartford, MGM and Sterling, by a different financial adviser several years earlier – had plummeted to just £241,000, despite being sold to her as a low-risk investment.

Again, Mr Bamford suspects the motivation for the bonds' recommendation related to upfront commissions, but says she might have avoided the loss and bond exit fees had she used another strategy. "A far more efficient investment strategy would have been to maximise the annual ISA allowance (£10,200 for the over-50s) and invest the surplus in a portfolio of unit trust investment funds, using up her capital gains tax allowance to make capital withdrawals when needed," Mr Bamford says.

Despite the welter of complaints to the ombudsman, and growing alarm at investment bond performance, the financial services industry is still heavily targeting advisers. Arthur Childs, managing director of Arch Financial Planning, says he is offered big incentives to sell the bonds. "Even within the last year we have had major providers writing to us, saying: 'You can have 7 per cent commission upfront' for selling these bonds, which is completely inappropriate," he says.

But, as with many financial products, it is not the investment bonds per se which are to blame, rather the way they are sold. Bruce Jamieson, principle of Jamieson Financial Management, for instance, says there are occasions when an investment bond can be "extremely useful" – such as when someone has used up their capital gains tax allowance – and it would be wrong to tarnish all sales with the same brush.