The complexities of the FCA’s cap on early exit charges mean it is likely to only scratch the surface when it comes to tackling punitive pension charges.
The regulator has decided to impose a 1 per cent cap on existing contract-based personal pensions, which will come into effect from 31 March.
But the cap appears to be limited in its scope. St James’s Place, which levies early exit charges of up to 6 per cent, is adamant that the cap will have no impact on its business. With-profits funds also appear to be untouched by the cap. Separately, Money Marketing has been told of instances where closed-book providers are operating effective early exit charges of up to 35 per cent.
As the nuances of how the cap will work in practice are laid bare, questions are being asked of its true impact on the market, and whether a cap set to cost the industry tens of millions of pounds was the right way to go.
Outside the cap
The FCA was given the duty to cap early exit charges by Parliament, and its decision to set the cap at 1 per cent follows a consultation in May and separate work by the Treasury. New schemes entered into after 31 March cannot impose any kind of early exit charge.
Following the policy statement last week, advisers have been quick to question how the cap would affect SJP, which is well known for operating early exit charges of up to 6 per cent. Clients pay the early exit charge upfront, which reduces by 1 per cent a year over the first six years.
Analysts at BNP Paribas set out how SJP’s early exit charge works in a recent analysts’ note. They say: “The early withdrawal charge is initially recognised upfront with part going towards the SJP partner’s upfront advice fee and part covering set-up and other costs.”
In June, SJP told Money Marketing the advice firm would be unaffected by the proposed cap, and continues to maintain this stance.
Earlier this week a spokesman said: “SJP is fully compliant with the rules and this change will have no impact to its business.”
Threesixty managing director Phil Young says in literature he has seen from SJP, top-ups to investments are treated as new business and therefore trigger a new contract with a new six-year exit charge.
Young says he struggles to see how the exit charge can be imposed, given the way it is structured.
He says: “It would be a different situation if clients were offered two ways to pay, a larger amount upfront with no exit fee, or discounted but with an exit fee, with the latter creating a e a loss if a client broke that contract.
“It may be that the SJP exit charge is potentially unenforceable, because on the paperwork that I’ve seen at no point do they offer an alternative way to pay. I think legally SJP is on a sticky wicket.”
SJP declined to comment further to explain how the exit charge complies with the cap, or to clarify the position on top-ups.
Early exit charges are defined in legislation as charges incurred by members of personal or stakeholder pensions after age 55 but before their expected retirement date for accessing their pension benefits. Money Marketing understands that any charge that meets this definition will be subject to the 1 per cent cap, regardless of what costs the charge is supposed to cover.
The scale of exit charges
As part of the legal process of setting a cap on early exit charges, the Government has stated that market value adjustments, where providers apply a reduction to the value of with-profits funds if they are accessed early, will not be subject to the cap.
Red Circle Financial Planning director Darren Cooke says: “The truth is I’m not sure how much impact the cap will have. You are still allowed MVAs, and generally speaking a lot of the exit charges on the older style schemes are MVAs.
“With the older plans, capital and accumulation units were charged at different rates, so I am not entirely sure how the ban impacts those. They can give rise to a much higher penalty to transfer out. That was the contract the client signed up to at the time. The rules have changed, but those contracts haven’t.”
Online pension manager Pension Bee, a service to help members consolidate their pensions, says it is important to distinguish where the cap applies and those it will not help.
Chief executive Romi Savova says: “The 1 per cent cap really applies to people drawing down their pensions, those over the age of 55 who are attempting to access pension freedoms. The types of exit fees we come across are when people are trying to move their money from one provider to another.”
She says in the worse case examples Pension Bee has come across, exit fees have been up to 35 per cent (in that case, the exit charge was levied by Phoenix).
Savova says: “There are a handful of providers who frequently charge exit fees when customers are attempting to leave. Customers may find themselves in contracts charging an exceptionally high exit fee, and the magnitude of that number can be very hard to swallow.”
Accurate cost estimates?
The FCA has estimated the cap could cost providers between £46m and £89m over four years, and compliance costs to the industry of £17.4m. Money Marketing understands this was based on provider data and existing information, though the FCA declined to explain its calculations further.
Last year the regulator published an indication of the number of policies in force which carried early exit charges as part of its pension freedoms work.
It found that as at 30 June 2015, 358,000 consumers aged 55 or over would face a charge of 0 per cent to 2 per cent, 165,000 would face a charge of 2 per cent to 5 per cent and around 147,000 would face a charge greater than 5 per cent.
Of the eight providers approached by Money Marketing, two gave details of the number of policies with exit charges above 1 per cent. Phoenix has around 70,000 policyholders over the age of 55 who have an exit charge of 1 per cent or over, while Zurich has 30,000 customers.
EY senior adviser Malcolm Kerr says: “It is difficult to establish what the impact of the cap will be on the industry. Intuitively, the FCA’s numbers look quite low relative to my understanding of how the products were created.
“The commissions on these products were a factor of the term these products were set up to run. The commissions were greater the longer the term, and the penalty for exit would be greater as a result.
“On the assumption the FCA has the finer detail about the age of policyholders, and what age the policy was written to, then the cost is significant but not substantial. But if the FCA has not yet had the opportunity to really cost out the implications, then those cost calculations are still a work in progress.”
Young suggests providers may have submitted cost estimates at the higher end of the scale as it was in their interests for the cap not to go ahead.
He says: “Costs will relate to providers understanding how the cap affects their existing terms and conditions, and potentially having to rewrite some of those as a result. Then there is the administration of the cap, changing processes, communicating it to clients.
“There are some legitimate costs involved in an exit. The question that remains unanswered is whether or not the exit charge is a rough proxy for the cost of administering an exit, or whether the FCA is saying there should be no profit built in.”
Debating the cap
Firms across the pensions market are unconvinced about the cap, but for different reasons.
Savova argues a better approach would have been to scrap exit charges altogether, and apply this across the board rather than solely for those over 55.
She says: “The cap is a positive development, but it is targeting a very specific part of the market and unfortunately it is ignoring a large proportion of people attempting to save for the future. Policy initiatives in pensions, such as auto-enrolment are not really compatible with the existence of exit fees to the tune of 35 per cent. It is a contradiction that the FCA has not focused on eliminating or capping exit fees overall.
“Often, we will see high exit fees accompanied by very high annual management charges. Customers are stuck between a rock and a hard place because their options are to take a high exit fee, or bear a high management charge which risks eroding the value of the pension.”
Cooke is concerned about what the cap says about the regulator intervening in markets.
He says: “This may be the thin end of the wedge. We have seen another announcement from the FCA that it wants to investigate fund charges. The regulator has previously said it does not want to get involved in costs, and that should be down to market forces. But now it is saying market forces aren’t working, so should be regulated. Is the FCA a cost regulator or an ethics regulator? Or are they both?”
Kerr agrees, saying the cap represents the FCA applying “21st century principles to 20th century contracts”.
He adds: “It is a worrying trend. None of us want to see a market being exploited, but equally we want to see a market where competition works, rather than regulatory charge caps. A window has been opened here, and personally I wish it had been kept closed.
Expert view: Counting the real cost to the industry
The real cost to the industry of the 1 per cent cap on pension early exit penalties is likely to be significantly higher than current estimates. During the consultation, the costs were estimated to be in the region of £46m to £89m over a four-year period, with an additional £17m of compliance costs. However, these figures are based on the difference between a 1 per cent cap and whatever the exit charge was previously. What they do not take into account is hundreds of millions of pounds of pension savings are due to be unshackled in March next year and the case for switching that money into a lower cost arrangement will become significantly more attractive.
The crucial point is not only do these old schemes have exit penalties, they also have annual charges that are significantly higher than more modern plans. A typical advised pension of £200,000 will be hit with a 1 per cent exit charge of £2,000. This still sounds a lot but it would be entirely feasible that investors could lower their annual charge by at least 0.75 per cent by moving from their existing scheme to a platform pension or a Sipp, in which case the client could be financially better off in less than two years and almost £60,000 better off over a 20-year period. With more people remaining invested and using income drawdown, the actual figures involved are going to be very attractive for many when advisers start to review their client’s pensions as the new 1 per cent cap approaches.
The immediate cost to pension providers might sound manageable at an industry level, but the real cost will come in the form of lost future revenue as advisers switch their clients to new arrangements that offer them a better deal, whether they want to access the pension freedoms or not. The 1 per cent cap is a hugely positive move by the regulator and provides advisers with a significant opportunity to restructure their clients’ pension savings that previously would have been locked in outdated schemes that have no role in the market today.
Billy Mackay is marketing director at AJ Bell