Chancellor George Osborne’s pledge to set a cap on “excessive” early exit fees for pensions has sparked a wider debate on how firms charge customers for leaving products.
The Chancellor’s intervention focuses on people being “blocked” from the new pension freedoms but there are calls for the principle to be applied across financial services. However, pension experts say the FCA will face stumbling blocks in defining excessive fees and creating a one-size-fits-all cap.
So, what constitutes an unfair charge? Will the regulator be able to override contracts written decades ago? Can a cap be set at a single level? And what are the wider implications for the industry?
A Treasury consultation launched in June debated whether a cap should apply to all fees or be on a flexible basis, and whether it should be voluntary or mandated.
A subsequent FCA report revealed while around 84 per cent of people aged 55 or over would pay no exit fee at all, 670,000 would.
Now Osborne has placed a duty on the FCA to introduce a cap to stop people “either being ripped off or blocked from accessing their own money by excessive charges”. The Chancellor left it to the regulator to decide where the bar is set.
Before the announcement there was fierce debate over whether the Government should be allowed to override old contracts sold with charging structures based on a payback set to normal retirement ages.
EY senior adviser Malcolm Kerr says: “Nobody ever got rich by selling pension products, the process was so inefficient. It’s a little worrying the regulator can simply say we are
going to change the terms of these products.”
But Tisa policy strategy director Adrian Boulding says fees should be waived following the “completely exceptional” introduction of pension freedoms.
He says: “It’s a bit sad the industry hasn’t stood up to the plate and made the changes. As the Association of British Insurers has said, there aren’t many people with exit fees and for those that have them they are not very large.
“It isn’t actually very difficult for insurers to swallow hard and take it on the chin. They need to say ‘the game has changed, customers might want their money at the drop of a hat and we won’t charge them any more than the administrative cost of winding up the account’.”
Boulding, previously a long serving director at Legal & General, says this cost could be just £25 or £50. The FCA study found around half a million people of all ages facing early exit penalties of £1,000 or more.
Hargreaves Lansdown head of pensions research Tom McPhail agrees fees should be fixed to the cost to firms of winding up contracts.
He adds providers should plan to have enough customers staying for many years to allow
for a few leaving very quickly.
He says: “Business models built around hitting people with hefty back-end fees in the early days just doesn’t look right in today’s post-RDR world.”
Experts say imposing a percentage cap would be too simplistic, given the range of contract types and providers.
FCA data shows the average administrative cost of transferring a policy to another provider is £201, while paying cash to a customer costs £172. However, both fees drop by around two-thirds for the largest 15 providers.
Rowanmoor head of pensions technical services Robert Graves says: “Our charges are based on a whole list of activities, everything from setting up, investing and transferring are all in pounds and pence figures.
“On that basis if the regulator came up with a percentage figure that might not necessarily work. If we charge £150 to exit a £100,000 fund that’s small, for a £3,000 fund that’s a much higher percentage but we’re doing the same amount of work.”
Kerr adds: “Ideally to assess the right level of exit fee you would need to assess on an individual level but that’s almost impossible to do without costing a great deal of money and slowing down the process. I suspect there will be a one-size-fits-all approach and can’t see it being a single sum, it will probably be a percentage. It looks like a kneejerk reaction, it’s going to be a lot more complicated to implement than it looks.”
The impending cap begs the question whether controls could be enforced in other areas where there is evidence fee structures are acting as a barrier to free movement.
McPhail says: “The logical place to end up seems to be going beyond this, why draw a line under the over- 55s? Once you accept the principle, it is then hard to justify retaining exit penalties for young customers. It’s about having access and control over your money.” When the Treasury opened its consultation some life companies arg-ued any new cap would also have to apply to platform exit charges or the new fees levied by providers to use UFPLS, the new withdrawal option.
But Royal London head of corporate affairs Gareth Evans says: “Let’s be clear this applies when people are trying to exercise the freedoms post-55. It doesn’t apply when someone is say 45 and just wants to get out of a contract, there fees ought to apply. Otherwise the industry would be presented with a lot of difficulties.”
The regulator has previously indicated with-profits funds are not in scope. However, there are calls for wealth manager St. James’s Place to redraw its controversial charging structure which includes a 6 per cent exit fee on pension and investment bonds. The charge declines by a percentage point each year until there is no charge after six years. Wingate Financial Planning financial planning director Alistair Cunningham says: “I don’t know how SJP can continue charging the way they do with the abolition of commission. The initial exit penalties confirm that they are clawing back commission and other initial set-up fees.
“I’m more keen on implementing the spirit of the RDR changes and getting rid of commission by another name than I am looking back retrospectively to contracts than are mostly more than two decades old.”
Yellowtail Financial Planning managing director Dennis Hall says: “You will either face an entry fee or an exit fee, and SJP realise the path of least resistance is not to frontload charges. That wouldn’t be allowed if you are an IFA but somehow SJP are allowed to continue with a model that pulls the wool over customers’ eyes.” SJP declined to comment.
Syndaxi Chartered Financial Planners managing director Robert Reid
Steve Webb brought in the 0.75 per cent cap for auto-enrolment but the problem was he never gave a proper definition. On an exit fee cap, it is crucial the FCA gets the definition right. There should be a very clear statement that you cannot charge people for moving their money, with the exception of investment lock-ins. The other question is when the control is applied, at the point of taking benefits or at any point in the contract? There is a world of difference between the two.
Intelligent Pensions managing director Steve Patterson says
When looking at this, it is important to understand how and when these policies were written. Most will date back to the 80s or older when costs were much higher and initial charges were smoothed out over the lifetime of the policy, which would have been to age 60 or 65 typically. If all the charges had been deducted upfront, rather than over the course of the policy, pension savers might have received annual statements that showed virtually no value, despite the individual having paid in for a year or longer, which is a major disincentive to save.
Tisa policy strategy director Adrian Boulding
We have to see this as a once-in-a-lifetime event. The Government has been loud and clear that ordinarily in the UK we have strong respect for property rights but this is so completely exceptional because the ground rules for pensions has changed fundamentally. It is right to say we should view things differently than we normally would because of the freedom and choice reforms.
Caps come in for two reasons. One is to solve inefficient markets, like auto-enrolment. The other reason is because things have changed fundamentally since the contract was taken out. That is what has happened here. When people bought a pension plan they believed their money was locked up for the long term, so taking out a contract with terms that said an exit fee would be levied if the customer leaves early was appropriate.
The Government has said now that you can get your money at 55, and people would not have taken out a contract that had exit charges and restrictions. In terms of recouping commission costs, the industry has to put up with this.
Many years ago contracts said commission would be paid to an adviser every year from sale to age 65, but the insurance company has to accept if you make a deal like that and the ground changes beneath them, charges must also change.