I am writing with regard to a paper called To Switch Or Not To Switch, That Is The Question, by Isaac Alfon of the FSA's economics of financial regulation team.
The article quite rightly addresses the question as to why the introduction of stakeholder pensions has done little to persuade investors to switch away from plans with punitive charges.
This is in response to Isaac Alton's findings on behalf of the FSA that only 1 per cent of about four-five million personal pension policyholders have switched. Perhaps I could enlighten him as to why.
As an independent financial adviser with the appropriate qualification and authorisation to allow me to advise clients on pension transfers, I have quite rightly to adhere to the FSA guidelines on such matters when advising my clients.
As such, if a client seeks my advice, I have to obtain up to date information on that policy from his existing insurer. Once this is received, I have to prepare a comprehensive report which has to cover all aspects of a potential transfer. The three critical areas, as notified in the FSA guidelines, are as follows.
Whether the investment risk is affected by any such transfer. Here, one is looking for guarantees contained in a client's existing policy, in particular, whether the policy contains guaranteed annuity rates. In addition, if the client is invested in a with-profits fund, the situation regarding accrued bonuses to date, together with terminal bonus eligibility, needs to be carefully assessed.
Bonuses accrued to date are guaranteed, payable at a client's normal retirement date. Therefore, any transfer effectively means forgoing these bonuses.
Second, one has to investigate the difference in charges between the client's existing policy and any proposed provider who will receive the transfer.
Third, one has to look at the situation if the client subsequently died immediately after the transfer has taken place. Most personal pension policies undertake to return the full value of the fund to a policyholder's dependants if death occurs before retirement.
If the existing insurer, for example, states a current fund value of, say, £100,000 and there is no penalty on transfer, then all well and good. However, if the transfer value is only quoted at £75,000, then two problems immediately present themselves.
First, the client would suffer a financial penalty of £25,000 at the point of transfer. Second, if the client died following the transfer before the new provider could provide sufficient fund growth to make up the difference between the fund and transfer values, the client's dependants would suffer financially.
By far and away, the vast majority of insurers levy a penalty on transfer. It is their way of recouping the charges from the policyholder that they would otherwise make up to retirement if the transfer did not take place. I would venture to suggest that this is one very important reason why advisers such as myself would not recommend a transfer due to the extortionate penalties imposed by insurers at the point of transfer.
Is the FSA aware of the way these insurers levy these penalties and, if so, what are they doing about it?
If the FSA is there to protect the consumer, it should be taking these insurers to task to enable consumers to switch more easily without having to suffer such financial penalties.
This accounts for the very small number of policy-holders who have switched their existing funds to stakeholder. Even if they wanted to switch using the same insurer, that insurer still applies these penalties.
The other area of transfers that precludes so many taking place is the general fear of advisers to recommend such transfers. The subject of pension transfers has, and continues to be, a contentious issue.
Advisers can lay themselves open to accusations of churning by the FSA purely for the perception that “greedy” advisers are only in it for commission. If only this was true. To advise a client properly, the report one prepares involves an adviser in about four hours work.
There is then the follow-up meeting of probably two hours and then the resulting admin in dealing with the transfer, conservatively estimated at another two hours. A bare minimum of eight hours work.
If my time is costed at £100 an hour, it has cost me £800. The average transfer is about £25,000. Insurers pay 4 per cent commission, that is, £1.000. Therefore, I might make a profit of £200 if I am very fortunate. There is, of course, the alternative that my client could pay me a fee.
Please tell me how many of these typical clients with average transfer values of £25,000 can afford to pay fees? Most tell me to keep all the commission instead as in their words: “You will more than earn it.”
Therefore, it follows that if the FSA wants more policy-holders to switch to lower-cost stakeholder pensions, then they need to make the process easier and stop existing insurers levying huge penalties on such transfers.
Last, please can we get away from the concept of “greedy” advisers. I fail to see how we can be accused of this when for an average transfer, as outlined above, we might make £200 profit. Twenty such cases would yield £4,000. How on earth can this be called greed?
The whole question of transfers needs to be addressed from the point of view of the interest of the consumer. This we do in an unbiased, independent way following a clear process, as outlined to us by the FSA.
To assist the consumer and at the same time ensure that advisers can earn a living out of advising, needs urgent attention by the FSA. It would be interesting to hear other views on Isaac Alton's paper and then perhaps we can find a way forward.