Once upon a time, pension charging was simple. Insurance companies set charges so they were sufficient to cover costs, with a small profit margin. Whether your policy remained in force for one or 40 years, you were expected to pay your way, and that meant front-end charges were high.
There might be a nil or reduced allocation period, or the first year or so of contributions might buy capital or initial units with high annual management charges. For these units, the real value was lower than the face value because of surrender deductions on early encashment.
Charges overall were more expensive than we would expect today, reflecting higher commission payments, lower levels of automation and fewer economies of scale, but they were not excessive. At the time, most of the major insurers were mutual organisations.
Steve Webb’s recent challenge highlights, however, that older charges may be onerous for those who only contributed for a short time but still have policies in force, and we need to look at that carefully.
Pension charges changed dramatically between 1995, when hard disclosure was introduced, and 2001, when stakeholder schemes were launched.
It was no longer politically acceptable for providers to charge everyone the cost of administering their policy. Instead, charges became a percentage of the fund each year, so that those who pay in a small amount for a short time are heavily subsidised by those who pay in large sums for an extended period.
In any other industry that would be considered extraordinary.
Imagine the response if I suggested to Tesco that it should give me groceries for a 10th of their true cost, in the hope that I would remain a loyal customer for the next 40 years. But that became the norm with pensions, and creates a difficulty with pounds and pence displays of charges on yearly statements.
Consumers will struggle to understand why charges increase substantially each year when they receive no extra services, and when the reason is explained they may feel aggrieved about subsidising less-consistent savers.
Ironically, we will come full circle in 2013, when the RDR will bring a much closer correspondence between charges and the incidence of costs. Differentiation of charges will also reveal that, except for basic pensions of the type used for automatic enrolment, providers’ administration charges are generally a relatively small part of the total.
Finally, there are hidden charges. These are generally not charges at all but unavoidable costs incurred by investment managers, such as stamp duty. They are currently reflected in the overall investment return.
There is certainly a case for making them publicly available, and not just for pensions. However, they must be presented in context and, as Ed Miliband discovered, a high total implies an active investment manager and not necessarily any consumer detriment.
Charges are emotive and make for easy political sound bites. The reality is that, in general, pension charges are reasonable and fair, and have been reducing with increased automation.
Providers now need to greatly improve clarity on what we charge and why, and to examine our cupboards for possible skeletons. We must also demonstrate that, especially where charges and costs are higher than those for basic products, our customers are getting value for money.
Ian Naismith is head of pensions market development at Scottish Widows