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‘Dangerous precedent’: Providers prepare fightback on exit fees clampdown

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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.

Early exit

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.”

Dangerous precedent

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.”

Adviser views

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.

Expert view

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

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Comments

There are 9 comments at the moment, we would love to hear your opinion too.

  1. The irony is that those with the exit penalties only have the pension in the first place because they were sold it, and the charges reflect the fact someone was paid to do that important job. That nasty commission hungry salesman got them to take out that awful plan they got tax relief on when they paid in and grew tax free to a tidy sum to fund their retirement.

    The great news for future governments is they wont need to worry about exit penalties as the next generations wont have pensions……

  2. If politicians wish to turn the clocks back, then they can give back their excessive expenses from the days of the gravy train.

  3. As I’ve said before, the government will find itself on a sticky wicket if it tries arbitrarily to override contract law. It can’t just declare that longstanding contracts must be torn up because their terms don’t accord with the new free access legislation. The response of the affected providers is likely to be: Okay, if that’s the way you want to play it, we’ll see you in court.

  4. I don’t think there will be a court in the land that will find in the Governments favour on this. Retrospective changes up to 30 years down the line???? Kiss my sweet *ss

  5. Michael Sturgess 7th August 2015 at 11:56 am

    Exit penalties on older pension policies are primarily a feature of those policies that allocated “initial” or “capital” units of the Allied Dunbar type in the first year (or two) of the regular contribution (applying also to subsequent increments). Contrary to what Malcolm Kerr asserts above (that these were “explained very clearly”), having advised many clients over the years on the impact and application of capital unit charges and their attendant early encashment penalties that they signed up to when taking advice in the past, it is blindingly obvious to me that none had the faintest idea of the connection between the commission paid to the advisor and the construction of the capital unit charging structure.

    I don’t think it is unreasonable to conclude that such policies (which were sold in bucket loads) were deliberately designed to disguise the impact of commission – much easier to talk about a (mysterious)100% capital unit allocation in the first year that to explain to a client that he would be losing 60% of his first year’s regular contribution in charges. It is probably also not unreasonable to conclude that by any standards of fairness, most of these policies would not have been bought had consumers been properly appraised of the thorny impact of charges and had been shown how to minimise these. The question now is having signed up to charges that they did not properly understand, under sales practices that were geared to generating commission, anything can or should be done about it.

  6. I wonder if the Government will help out on the profit margins of car dealers? I recently bought a new car and I have no idea what the profit margin of the dealership was. That’s not very transparent. Perhaps the profit margin could be limited by decree? If they can do it in this industry, why not in others?

    • This is an old canard and with respect it misses the point. When we buy a physical product consumers can take a view on whether it represents good value. For example there was a report of a hotel selling bottled water at £26 a bottle. Clearly that had a heavy mark up but if you are daft enough to buy it then that’s your choice.

      Investment management is a continuing service. You are given money, you invest it and charge for that service. The problem is that providers don’t present their charges in a simple way. If I invest £50,000 with you what I would like to know each year is how it has performed and what I’ve been charged in terms of actual cash not some obscure percentage. I can then decide whether I’m getting value for money

  7. Simply moving the goalposts for political advantage.

  8. Here’s a thought about reducing charges for modern contracts. The offer to the government should be if you get rid of lifetime allowance and save us all the expense that entails we’ll get rid of exit charges

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