The axe is falling on pension exit fees but the FCA and Department for Work and Pensions are coming under fire for bowing to industry lobbying.
Last week the regulator announced the cap would be set at 1 per cent for existing customers, and banned outright for new business. The DWP has signalled it is likely to mirror the changes for occupational schemes.
While some say the cap does not go far enough and call for a “zero tolerance” approach to exit fees, others warn legally binding contracts “can’t simply be ripped up”.
The FCA estimates a cap at 1 per cent could cost the contract-based industry over £100m in the four years after it takes effect in 2017. But experts say closed-book firms will disproportionately feel the pain as expected streams of income are suddenly shut off.
Questions are also being raised over whether it is appropriate for the FCA to take this kind of action which will see decades-old contracts torn up.
The FCA and DWP’s proposed 1 per cent cap is the culmination of years of pressure from consumer groups and modern firms without legacy products.
They argue penalties keep customers trapped in products while providers say most charges are in place simply to recoup commission paid out when the contracts were sold 20 or 30 years ago.
In January 2016 the Chancellor George Osborne handed the FCA a new duty to cap pension exit charges that were preventing customers from accessing the pension freedoms.
After consultation the FCA has opted for a 1 per cent for existing contracts and a total ban on exit penalties for new products. New rules will stop penalties below 1 per cent being raised to meet the cap.
The regulator predicts a 1 per cent cap will lead to an extra 37,400 early exits, an increase of 25 per cent. It adds a 0 per cent cap would “not materially increase the benefit but the impact on firms would be significantly greater, while a cap at 2 per cent would offer significantly less protection from the deterrent effect of the charge”.
But many say the FCA has not gone far enough.
Citizens Advice chief executive Gillian Guy – whose organisation runs part of Pension Wise – calls for a flat £50 cap to cover administration costs only.
We hope the cap can be brought up to a zero tolerance of exit barriers in due course
She says: “Sky-high exit charges can be a barrier to people making the pension choice which is right for them.
“The FCA’s decision to abolish exit charges for new pensions is really good news for those consumers which will help them make the most of the pension freedoms.
“But a 1 per cent cap on current schemes is too high, this means someone with an average pension pot of £30,000 could face a £300 exit fee if they move to another provider. A standard £50 fee to cover the administrative costs would be much more reasonable.”
Hargreaves Lansdown head of pensions research Tom McPhail says: “A 1 per cent cap is something of a victory for corporate vested interests. We hope that the cap can be brought up to a zero tolerance of exit barriers in due course.
“The cap also only applies to those exercising the pension freedoms. Those wishing to transfer old, expensive private pensions to improve their value for money, while they are still building their savings, will not benefit from the cap.
“This penalises those who are doing the right thing by saving but are hamstrung from making competitive choices which would help their hard earned money work much harder.”
McPhail adds the firm wants a guarantee from the regulator so customers transferring today can recoup any charges over 1 per cent once the cap comes in next year.
Ripping up contracts
The move to force providers to limit or scrap exit charges, while clearly being driven by government, represents a new direction for the regulator.
Firms will be pushed into rewriting contracts, leading to concerns the FCA is increasingly prepared to interfere to an effort to do the Government’s bidding.
Law firm Pinsent Masons pension partner Simon Laight says: “Banning exit charges completely for new contracts won’t hurt the industry much – most modern contracts don’t have exit charges.
“However closed book firms, who bought back books assuming a certain level of charges income, will find this difficult. They have paid money for an income stream and now find the Government is retrospectively taking away part of that income stream.
He adds: “This is Government interfering with firms’ property rights, in the name of public policy.”
Intelligent Pensions head of pathways Andrew Pennie says a cap at 1 per cent is a “bold move” that will help the industry promote the benefits of pensions.
But he thinks the Government might run into difficulties when it comes to implementing the new rules.
He says: “What is most interesting is how this can be put into practice for existing plans, which are legally binding contracts. You can’t simply rip them up at the detriment of those savers who are not looking to transfer, so it will be interesting to see how the life offices and other providers deal with this and respond to the consultation paper.”
In March a host of providers announced pre-emptive action on charges. Money Marketing revealed Standard Life were capping fees at 5 per cent, with Aviva and Old Mutual Wealth quickly following suit.
Scottish Widows went further, scrapping fees entirely, though only for personal pensions not workplace schemes.
The Association of British Insurers says only two in 10 customers have policies with early exit charges, adding most fees are 2 per cent or less.
Closed book firm Phoenix Life said there was “no evidence” exit charges are stopping its customers using the pension freedoms. A spokeswoman says the provider’s stance has not changed despite the regulator’s action.
Maximum cost, including implementation and lost revenue, over four years if a 1 per cent cap is applied.
Extra number of transfers from pension policies as a result of a 1 per cent cap, an increase of 24.7 per cent on today.
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When this was being debated before the decision was made I read representatives from various pension companies trying to say that only a small number policy holders affected were affected and that this was an isolated issue. But for those affected it can be a large cost to their pension while it is a drop in the ocean for insurers. I have always been in favour of a cap but I think it is fair providers can retain some of the fund.
Has the FCA gone too far with its 1% cap?
Exit fees were typical product features back in the 80s. In those days commission was directly related to the number of years a pension contract was scheduled to run. And the commissions were high; they had to be because persuading people to put money away for 30 years or more was no easier then than it is today.
If the pension product was exited early, there was a penalty – normally the discounted value of the charges that would have been payable had it run to the agreed retirement date. This was always disclosed in the marketing collateral and policy documents.
Policy documents confirm the details of the contract between the insurance company and the policyholder. And the FCA now propose to alter those terms without reference to either party. This is a very dangerous step that could establish some form of precedent. And the 1 per cent limit is a very blunt instrument.
The FCA and the FSA have both stated on more than one occasion that they are not price regulators. This makes sense. But what they are now proposing is even worse. They are proposing retrospective price regulation relating to contracts that were agreed more that 30 years ago.
One might say that this is a price worth paying to ensure consumers have pain free access to pension freedoms. But who is paying the price? On the face of it insurance companies, but not in reality. It will be shareholders who pay, and given the institutions involved that will be you and me and just about everyone with a long-term investment.
Malcolm Kerr is senior adviser at EY
The proposed 1 per cent cap on pension early exit penalties for those aged over 55 is spot on apart from two elements – its level and who it applies to.
Removing any arbitrary early exit fees completely and applying this to all would make the market more competitive and result in better outcomes for pension investors.
The removal of early exit fees is being pitched as an extension of pension freedoms but ironically the proposals are diluted significantly by restricting the positive benefit only to those wanting access to the new flexibility.
There is no doubt that early exit penalties are one of the main barriers to accessing pension freedoms for hundreds of thousands of investors but once the decision had been made to address that, landing on a 1 per cent cap seems odd.
Why 1 per cent? It is an arbitrary figure and means people with larger pension savings may be subsidising those with smaller funds.
A better outcome would be to remove the charge and stipulate that charges may only be applied where they are commensurate with the work required to process the transfer. These can then be consistent for everyone and it will be easy to assess whether the charges levied are fair and reasonable in relation to the work the provider needs to undertake.
Limiting the changes to those over 55 meets the objective of providing access to pension freedoms but it still leaves swaths of people under 55 locked in products that are expensive with limited and dated investment options.
Applying the new rules to the entire market should be the natural thing to do. Older style products should be capable of standing on their own feet, if they meet the needs of the customer then fine. If they don’t, irrespective of age, investors should be free to benefit from freedom and choice for all.
Billy Mackay is marketing director at AJ Bell