DSS proposals for ringfencing with-profits in stakeholder pensions make their inclusion impractical, according to pension providers.
The fundamental problem for including with-profits is that whatever capital is put into a stakeholder sch eme has to be ring fenced. But the essence of a with-profits fund – to provide smoothing and a capital guarantee – is capital, so the question is how will that capital be allocated?
Under the DSS proposals, any money that the provider puts into the scheme as a ring fenced fund must be used to benefit stakeholder with-profits policyholders. But this money has to come from somewhere.
The obvious solution for most providers would be to use a loan from their existing with-profits fund to provide smoothing initially for the stakeholder fund but this subsidy would lead to an outcry from other non-stakeholder with-profits policyholders because DSS rules state they would not see any interest on this loan.
Scottish Life head of communications Alas dair Buchanan says: “In the beginning, we will have to use other with-profits funds to smooth with-profits in stakeholder when there is nothing in the fund but why would other with-profits policyholders be happy for this to be the case when they put in but do not get any return? It is a one-way option and why would policyholders or shareholders be happy for this? So we said at the outset it was not practical to use these rules.”
In response to providers' concerns, the ABI entered into discussions with the DSS to establish some workable ground rules and clarity for including with-profits under stakeholder.
A letter issued by the ABI last December provides written confirmation from the DSS that stakeholder and non-stakeholder assets can be invested in the same fund, as long as they are clearly identifiable by some kind of “accounting ringfence”.
The letter sets out to provide clarification of how capital can move across the ringfence in a with-profits fund but the issue of how non-stakeholder policyholders are to receive interest is not addressed.
ABI pension team policy adviser Debra Weekes says providers could have a sub-fund from existing with-profits funds for stakeholder contributions but it depends on how different providers set this up.
The key limitation is that the cost needs to be made within the 1 per cent limit but the way the funds are set up and the way interest is paid on the capital will vary according to the provider.
Buchanan says it is not clear how the providers would recompense non-stakeholder with-profits policyholders for running the risk of loaning money to the stakeholder fund.
He says: “The letter seemed to say it could be done by an accounting convention that offers with-profits on the basis proposed and use accounting convention to notionally split the two. On face value, it does not seem to make an awful lot of sense.
“The ABI was involved in discussions and can form a view about how the solution was created but providers have come to it cold and a letter does not give us the confidence we need to believe that with-profits is viable. We need more detail and in proper legislation rather than a letter.”
The ABI says it is waiting to see whether the with-profits changes appear in the amended DSS regulations due at the end of January. Weekes says the DSS wanted to make sure stakeholder assets were completely identifiable and all assets were payable to it, which is why it agreed to make the change.
She says: “We felt the regulation required support for with-profits funds and the DSS said it was happy this could be done within the same fund. It has accepted the principle, which we have in writing, but I am not sure about a legislative change. We are still waiting to see the amen ded regulations.”
Providers are not giving up on with-profits under stakeholder, however. They are searching for different options that might meet DSS approval, where they can use alternative funds and bypass the problems of ringfen cing and delivering returns to non-stakeholder with-profits policyholders.
Scottish Equitable director of pension development Stewart Ritchie suggests one method would be to have capital associated with the ringfenced fund without going in it so you can demonstrate that the money is there without having to go through the final step of ringfencing it. The DSS allows regulation to reflect the servicing of capital that was happening within the stakeholder ringfence.
However, Ritchie says there are still a lot of issues that need clarification, not just from the DSS but also from the FSA. He says it is vital that providers remember they still have to get explicit approval from the FSA about how with-profits will work and whether it is reasonable for policyholders' expectations.
He says: “The DSS is perfectly entitled to state the rules for withprofits as it sees fit but it is not an island and providers need to be clear what the FSA requirements are going to be in this new set of circumstances.
“It is up to each provider offering with-profits to satisfy themselves that they are operating within DSS rules but also the FSA rules. The difficulty is whether the capital can only ever be used on behalf of stakeholder with-profits or whether it can be used for other purposes.”
However, some providers say they have not given up hope of being able to set up with-profits under stakeholder and are already offering with-profits personal pensions and group personal pensions within the 1 per cent stakeholder limit. Legal & Gen eral and Friends Provident will both be running with-profits pensions alongside their stakeholder offerings.
Not all providers envisage problems. Standard Life is considering offering with-profits within stakeholder although nothing has been formally announced.
General marketing manager John Hylands says that, whatever happens, the arrangement would have to be different to the normal with-profits arrangement.
Turning to the considerations for offering with-profits, Hylands says: “First, we are a mutual company and not running with-profits business for shareholders. The second consideration is making sure there is a real benefit to the members to make with-profits stand out as being different to the other funds and doing it within the charging constraints.”
The industry has to sit it out now to see whether the amended stakeholder regulations, issued at the end of this month, will include the required changes on with-profits rules. If they fail to do so, the option of offering other with-profits pensions within stakeholder limits might prove a popular alternative.