The problems have their roots in the design of stakeholder pensions. This design was rapidly adopted for most GPP plans and the inherent flaws were exacerbated by the widespread use of initial commission. The publication in January 2006 of “Polly put the kettle on” (Cazalet Financial Consulting) highlighted vividly both the flaws and the consequences. The flaws were (and still are) in the product design. The stakeholder requirements are to have full fund values payable at any time and an “AMC-only” charging structure. For the customer, this can provide excellent value in the short term, since the fund-based charges are clearly very low in the early years. But the provider has to retain the scheme, with ongoing premiums, for a long period before there is any chance of making a profit.
What the Polly report did very effectively was to combine financial modelling of GPP schemes with the real world experience of persistency. It identified the average persistency of GPP policies as around four years and it showed that the typical timescale for a scheme to move into profitability could easily be upwards of 20 years.
The Polly analysis has been widely available for several years and has not been seriously challenged. So why are some providers still using this approach and still paying significant levels of initial commission? Perhaps it is related to a focus on sales volumes and market share figures rather than the profitability of the business being written.
But the reality is that the only way for stakeholder or GPP business to be profitable is for it to be kept in force for a long time – a very long time if initial commission has been paid.
That is not easy in the real world and it is even more difficult when schemes are switched from one provider to another on a regular basis, hence “Polly put the kettle on, Suki take it off again”.
There is inevitably some collateral damage from such activities. The market can be distorted, with reduced business for providers who operate sensible business models. And other charging structures can emerge which may not be in the best interests of customers.
Hopefully all this is about to change. The latest stage of the RDR has consulted on the extension of scope to include GPPs. This makes perfect sense, since the flaws in the individual pension market are pretty much mirrored in the GPP market.
Scottish Life head of communications Alasdair Buchanan