The Government will face fierce opposition if it tries to impose a cap on exit charges on the pensions industry, experts warn.
Providers will battle to avoid having to make expensive updates to archaic systems and push to ensure any new controls apply to all financial products that charge for closing accounts.
Insurers say they will use the Treasury’s consultation, published last week, to highlight how exit penalties are not just a legacy issue but a “new problem and a growing one”.
In addition, senior industry figures warn the Government could set a “very dangerous precedent” if it forces insurers to rewrite contracts written decades ago.
In June, Chancellor George Osborne announced the Government’s intention to consider taking action on “excessive” exit charges as part of an investigation into why savers’ access to the new freedoms was being blocked.
Now the Treasury has launched a 12-week consultation on how exit fees, the transfer process and new tighter advice requirements are frustrating the freedom and choice agenda.
In December 2014 the Independent Project Board set up by the Association of British Insurers found £26bn of pension assets being charged over 1 per cent.
And it revealed around £3.4bn exposed to potential exit charges of 10 per cent if savers left contracts immediately. The ABI says nearly nine out of 10 people making use of the freedoms will not face an early exit fee.
But pension providers say the Government should also focus on other parts of the industry where similar fees are levied.
An insider at a major provider says: “The debate has become far too narrow, in terms of what exit fees are and charges in general. We have an issue with modern platforms and their early account closure fees or per line of stock fees or uncrystallised funds pension lump sums transaction costs – these are equally barriers to accessing freedom and choice.
“Platform exit fees can add up to hundreds or thousands of pounds and ignoring that and just concentrating on old insurance policies taken out in the 1980s and 1990s is wrong.
“The consultation allows the industry to educate the Government on the charges you can suffer in modern products too. The assumption is that exit charges are an old problem, but it’s also a new problem and a growing one as well.”
Some firms have introduced fees in conjunction with launching some of the new pension withdrawals options. For example, Royal London charges £184 if customers make two or more UFPLS withdrawals.
Fidelity charges DC customers £100 per withdrawal if there are more than three in a year. DC members that want to make more frequent withdrawals can transfer to the Fidelity Sipp, where they can make withdrawals for free.
Customers exiting Hargreaves Lansdown’s flexi-access drawdown products within the first year are hit with a £295 plus VAT fee, which drops to £25 plus VAT after a year.
Likewise, some direct-to-consumer platforms charge customers who transfer out. AJ Bell YouInvest, Barclays Stockbrokers and Tilney Bestinvest all help new customers meet the cost of other firms’ exit fees, but also charge customers who exit.
All three pay up to £500 towards exit fee costs. But AJ Bell charge £25 per line of stock in exit fees as does Bestinvest, while Barclays charges exiting customers £30 a line.
Aegon regulatory strategy director Steven Cameron says: “While you could read the consultation as focusing on the old world, it does not specifically exclude the new world and if those practices take place they should be considered here too.
“This all points to the fact you need a flexible approach because a flat cap doesn’t reflect the underlying rationale behind some of the exit charges and the rationale for more modern exit charges may be very different to the rationale for older products.”
Insurers face hefty costs if they are forced to change the terms of contracts and their shareholders will suffer an unfair write down, says EY senior adviser Malcolm Kerr.
Kerr helped design some of the products potentially affected. He says: “It’s a very dangerous precedent to say that someone can step in 30 years after a product has been sold and say the contract terms are unfair.
“There is potentially a really material impact, both from a systems and financial point of view. You are essentially saying that when a contract is agreed between two people – where there’s absolute clarity on what the embedded terms are – someone else can come along and say we don’t think this is a fair contract.”
Kerr adds it would be “extraordinarily challenging” to change old administration systems to reflect new charges.
He says: “Most insurers would have to manually calculate a transfer value and that would need to be checked – a very expensive process.”
Charge cap: the options
The Treasury wants views on what models or level of exit fees should be considered “excessive” or unfair. With-profits funds have been carved out of the investigation.
Three options are being explored: introducing a cap on all early exit fees, either at a fixed percentage or monetary amount; a flexible cap, limited to pots above a certain level, for instance; and a voluntary approach.
Providers appear to favour a flexible arrangement. A Number 10 spokesman has been credited with suggesting a cap set at 2.5 per cent was preferable, but the consultation does not mention a specific figure.
Royal London head of corporate affairs Gareth Evans says: “Something providing flexibility around historic contracts would be helpful. The consultation doesn’t mention a figure, that’s sensible because there are complex exemptions.
“For example we have historic products that have tax-free cash well in excess of 25 per cent and that’s safeguarded by having early closure penalties. There’s a case to be made that valuable benefits, that are costly for providers to offer, are preserved and penalties in place to pay for them are preserved.”
In addition, any cap would have to be fair to all customers and take into account the different charging models used in the past. While some customers opted to pay low charges upfront which were recouped over the lifetime of the policy, others paid the bulk of fees at the outset.
Kerr thinks legal problems around forcing firms to change contracts could force the Government down the voluntary route. But industry insiders warn competition laws could prevent firms agreeing a common set of charges.
One suggestion offered in the consultation is allowing firms to waive or reduce exit fees where members transfer within the same company or pension scheme.
Two providers who spoke to Money Marketing on condition of anonymity say firms would be more likely to voluntarily remove charges if they were retaining the business.
One says: “You could interpret the treating customers fairly principle as saying if you waive fees for anyone, you waive for everyone.
“But there’s a rationale in saying if someone is transferring to another one of our products, rather than moving away, then we’re retaining those funds under management. Therefore we might choose to waive an exit charge in those circumstances.
“We shouldn’t let treating customers fairly stop providers from giving enhancements to certain groups where that’s commercially viable, even if they can’t offer it across all customer groups.”
Despite these unsolved issues, consumer groups will likely push for the reform timeline to be accelerated.
Ex-Which? financial services team leader Dominic Lindley says: “There is still likely to be a long wait before all consumers can access their pension without paying excessive penalties. Even if this consultation results in a decision to cap exit charges the FCA will then have to issue another consultation before it can introduce any rules. The Government should look for some way to speed the process along.
“Rather than waiting for this long consultation process the Government should immediately name and shame the providers levying exit charges.”
David Trenner, director, Intelligent Pensions
Policyholders were not charged at the outset to cover set-up costs, so it is only fair that they pay at the end! It would be absolutely wrong for government to reduce charges on such policies which would benefit policyholders at the expense of those whose policies were ‘front-end loaded’.
Jamie Smith-Thompson, managing director, Portal Financial
Government intervention is not always welcome, but with exit charges seeming to be a lottery based on who the provider happens to be something needs to be done for consumer protection.
It’s a very dangerous precedent to say that someone can step in 30 years after a product has been sold and say the contract terms are unfair. There is potentially a really material impact, both from a systems and financial point of view. You are essentially saying that when a contract is agreed between two people – where there’s absolute clarity on what the embedded terms are – someone else can come along and say we don’t think this is a fair contract.
The Government may run into legal problems if they try to enforce scrapping or capping exit charges and they might have to ask providers to do this voluntarily. So those companies either have to impose the original charge and live with any bad PR that might result from that, or reduce the charge, and that’s diminishing shareholder value.
In the past, most insurers with direct sales forces and most intermediaries would have sold these kind of products. I worked on these products back in the days before the RDR when commission were payable.
It was a straightforward calculation, you’re paying x amount of commission – say equal to the first two years’ premium – and then constructing a product that enabled you to recover those costs over the term of policy. This would generate enough money to cover commission, other expenses as well as getting a return on the capital deployed.
Describing these charges as a “rip-off” is inaccurate. They were built into a product, explained very clearly, and the reason they look expensive is commissions in the market were high at the time. If you told an insurer they can no longer recover those charges that could lead to a reduction in the embedded value of that line of business.
It would also be extraordinarily challenging to change old systems to reflect new charges. Most insurers would have to manually calculate a transfer value and that would need to be checked – a very expensive process.
Malcolm Kerr is a senior adviser at EY