Head to head: Should active member discounts be banned?
Differential pricing between active and deferred members is almost invariably a bad idea and the sooner the industry dispenses with this shady practice, the better. Whether you call them active member discounts or deferred member charges depends on your standpoint. Either way, differential pricing is a deliberate ploy to exploit the information gap that exists between the industry and its customers. It also involves a cross-subsidy between different groups of individuals,imposing a higher charge to another group. To some extent, this always happens in business.
You cannot expect all customers to only pay precisely their fair share of costs. What counts as a “reasonable smoothing” of costs will always be, to some extent, a matter of judgement. What marks out the practice of differential pricing on group pensions as unacceptable is the extent to which it is applied and the reasons for its use.
For the sake of disclosure, I should point out that Hargreaves Lansdown had used differential pricing in the past. We do not any longer. I have seen instances of char-ges doubling when a member leaves service. There is no objective justification for this kind of onerous increase in costs. Most schemes operate solely on an annual management charge basis these days, so all administrative costs are recouped through a fund charge. However, a deferred member does not cost twice as much to service as an active member. In fact, given that a deferred member may well have a dormant account whereas an active member requires administration on a monthly basis, you can make a reasonable case for deferred members having lower charges. The principal motivation for using differential pricing is that it makes the scheme look cheap. This enables the consultant to pitch an artificially low price to the employer. The employer in turn can pitch an artificially cheap pension to their employees. This is achieved by robbing Peter to pay Paul.
The argument that it is up to scheme members to switch when they leave is disingenuous. It also deliberately ignores the wealth of experience the industry has in member inertia. The fact is that members are unlikely to switch. Indeed, the pricing of the scheme is predicated on the assumption that they will not, so to use this as justification would be dishonest.
The Pensions Regulator and the pensions minister are right to speak out against this sharp practice, particularly in view of the impending auto-enrolment programme which will raise the stakes as millions of newcomers are introduced to the world of pensions. I hope that the FSA will take up this cause and present a united front of intolerance in the face of this unsavoury behaviour.
Tom McPhail is head of pensions research at Hargreaves Lansdown
Active member discounts have long been a part of the pension landscape. They offer employees and ex-employees who make regular monthly contributions a clear incentive- through lower fees- to keep up payments.
However, there is a growing movement against this practice. The Government seems committed to destroying active member discounts in the name of what it believes is fairness.
The latest evidence of this attack came last month when the Pensions Regulator issued a statement entitled, The role of trustees in DC schemes. It sought to remind scheme trustees of their responsibilities, which “extend to deferred members.”
The regulator cautioned: “Excessive charges in a DC scheme can significantly reduce a member’s fund. Charging structures must be applied fairly to all categories of membership. The regulator does not view active member-only discounts (or deferred member penalties) as being fair and, therefore, acceptable.”
This text is unequivocal according to the regulator, active member discounts are unacceptable. The basic argument against active member discounts is that they disadvantage deferred members. In the sense that their fees may rise, this is true.
But DC pension scheme fees can be very low in the first place and it is entirely possible that a person ceasing payments may only face a small increase.
Nest, for instance, will probably have an annual management charge of just below 0.5 per cent. It is perfectly plausible that a deferred member could find their fees rise to this sort of level.
There is no doubt that there can be a problem with active member discounts where, in extreme cases, fees for deferred members can treble. It has been claimed this is happening more in the runup to RDR as advisers and providers engage in a commission bonanza that serves their interests rather than the consumer.
Such actions are clearly unacceptable. But to effectively ban active member discounts in response to what is only a temporary issue is like taking a sledgehammer to crack a nut.
It will end up being to the detriment of consumers the exact outcome the authorities are trying to avoid. We are able to secure these discounts for active members because they are making regular contributions to the scheme. This lowers the costs of running the scheme, allowing insurers to offer enhanced terms.
It is only fair that the people who enable these discounts benefit from them. But the Government and the regulator are so obsessed with charges that they have lost focus on the outcomes.
John Deacon is director and head of employee benefits at Helm Godfrey