Customers face penalties of up to 28% for cashing in policies

Some of Britain's largest insurance companies have raised the penalties they charge customers who want to cash in their policies early to as much as a third of the value of the policy, according to a survey published yesterday.

Some of Britain's largest insurance companies have raised the penalties they charge customers who want to cash in their policies early to as much as a third of the value of the policy, according to a survey published yesterday.

Scottish Equitable, which is owned by the Dutch insurance giant Aegon, imposed an exit penalty of 28 per cent on one policyholder, while Legal & General levied a 24 per cent charge and Scottish Widows, part of Lloyds TSB, imposed a 22 per cent penalty.

The findings were compiled by Money Marketing Online, which looked for the first time at the levels of exit penalties policyholders have been suffering in recent months.

It found that of insurers willing to admit to using the unpopular penalties, 24 companies have imposed them on customers since January.

Equitable Life, the stricken mutual, became the first major insurer to impose exit penalties as it tried to preserve capital, but insurers admit the practice has become much more widespread in recent months, following further falls in the stock market.

Insurers argue it is prudent to impose exit penalties, technically known as a market value reductions (MVR), on with-profits policies to make sure each policyholder receives a sum that fairly reflects the value of his or her assets, and does not take assets belonging to those remaining in the fund.

This process often requires an adjustment because the valuation on a with-profits policy at any point in time is a smoothed figure, taking into account the possibility of future upwards or downwards movements in the stock market. The idea is that if the policy is held to maturity, good times will balance out bad times to produce the final smoothed figure.

Insurers say that because the stock market has performed so poorly for the last two and a half years, the actual value of most people's policies is below their smoothed value. So they need to impose an exit penalty on those leaving now to protect the "fair share" of those staying in the fund.

Scottish Equitable, which has a £2.1bn with-profits pension fund, admitted it did impose a penalty of 28 per cent on one policyholder.

A spokesperson for the insurer said: "That is the highest MVR we have ever imposed and it was on a customer who joined when the FTSE was very high two years ago and who wanted to leave recently, when it has been very low."