An active issue

Active member discounts have been troubling politicians and consumer groups and dividing providers. John Lappin finds out why

Departing employees such as Wernham Hogg’s David Brent could face higher pension AMCs

Active member discounts (AMDs) starkly divide opinion in the pensions industry.

For some they represent a reasonable charging structure, rewarding long serving employees but not overcharging deferred members. Opponents say that deferred members end up paying a substantial cross-subsidy and that, taken to extremes, this imposes a very unfair, long term charge on their pensions savings.

They also fear the discounts may also be indirectly funding high commissions in the run up to January 2013 and thus are distorting the market long term.

Some concerns at AMDs have been raised in political circles. The Department for Business, Innovation and Skills queried the charges in a ’Call for Evidence’ paper last summer when it was formulating its negotiating position on the European Union’s Consumer Rights directive. The FSA received submissions calling on it to ban AMDs under the RDR, though it has ignored them to date.

The issue was also debated at the beginning of March in the House of Lords’ legislative committee examining the Pension Bill.

Prompted by consumer rights champion Which?, Lib Dem peer Lord German proposed an amendment requiring the Secretary of State for Work and Pensions to provide guidance on deferred member charging levels. The move was supported by Labour peer and former Nest deputy chair Jeannie Drake but was rejected by the Government.

DWP minister Lord Freud argued that the Government was already doing enough on charges citing Nest and planned guidance for default scheme charges under auto-enrolment.

Freud added: “The DWP has done some robust research on defined contribution schemes sold in the 2008-09 financial year. That showed that – somewhat to our surprise – charges typically do not exceed 1 per cent across the market, including trust-based and contract-based schemes. Where different rates were applied to active and deferred members, this tended to be in the form of even lower rates for active members, which begins to suggest that a true discount is emerging for active members, rather than a penalty for deferred members.”

But campaigners remain unconvinced. Which? principal policy adviser Dominic Lindley argues that deferred member penalties would be a more accurate term and does not see why these charges are needed.

He also points to lapse rates on GPPs of 60 to 64 per cent within four years, based on FSA figures. “That means a lot of people are going to be paying these penalties,” he says.

Lindley fears a market failure. He says with employers making the choice, there will be no competitive pressure to protect deferred members’ interests and argues that the FSA or DWP should step in.

“Once auto-enrolment comes in, it is important they have proper standards, not excessive charges or penalties. The market is pressurising life offices into these deferred member charges so people are not going to get a good outcome from their pension savings.”

Lindley also argues that post-Nest, charges of 1 or 1.5 per cent will look very high.

“No one is looking out for the interests of ex-employees or deferred members. The employer is not going to be that interested. Insurance companies – their job is to make as much money as possible. You can’t rely on the person in the pension to move out, so you need to look at regulatory tools or other ways of controlling the advice in the run up to 2012,” he says.

Fund manager and DC pension provider Fidelity agrees with much of the sentiment. Head of DC business Julian Webb says: “We don’t put in those types of structures. We believe it is fundamentally unfair to deferred members. Those deferred members will probably keep their benefits within the plan and suffer these additional costs which could be over 10, 20, 30 years up until their retirement.”

Webb has seen examples where the active member pays 0.8 AMC and the deferred member could be paying as high as 1.2 or 1.4 per cent which he thinks unjustified.

“For many years the industry has been pricing at a premium for high turnover but now a life company sees it as attractive business if a client comes to them with high turnover because they can charge deferred members at a higher rate,” he adds.

Fidelity would like to see an emphasis on full disclosure not just at commencement but when a member becomes deferred, with worked examples given and members able to switch to lower charging plans.

Life offices offering the discounts say they offer switches, defend the AMD as an employee benefit and argue that they do not charge deferred members excessively.

Steve Jackson, group pensions marketing manager at Aviva says: “We offer active member discounts across our GPP proposition. We offer a flat rate AMC as well – offering choice to employers to write the scheme in the way that they want. So typically we might offer a scheme with the choice of a 0.7 per cent flat charge or an AMD which is 0.5 per cent for active members and 1 per cent for leavers.

“Employers like the ability to offer something better to their active employees and it allows them to set up on a charge that wouldn’t have been available to them.”

Jackson says: “We operate AMD in both the commission and non-commission market. We see it as offering more choice in the market.”

He adds that if a leaver continues to pay £20 or more into a pension they still get the lower charge. He believes the 1 per cent charge in a good pension proposition still offers value.
Adam Potter, head of corporate sales at Aegon, argues that under a mono-priced structure, it can be the active members who pay more, with deferred members benefiting from the economies of scale offered by the larger funds of those that stay.

Companies are relying on the apathy, lack of understanding or ignorance of the former members who stay in the higher charging arrangement and don’t understand they can avoid this

“A member staying with an employer and paying regular contributions will pay up to two times more than one who leaves and stops contributing after five years.

This goes against the aim of most employers, to offer an attractive package for people they recruit and retain. Members also want to be rewarded for their loyalty to their employer and persistence in saving toward their retirement,” he says.

Potter adds that its discount will continue once a plan has been in force for ten years, even if regulator contributions stop.

As with Aviva , if a member leaves the Aegon employer scheme and transfers to an individual pension plan, they still receive the discounted charges if they pay regular contributions of £20.

Potter adds that members paying contributions but stopping after 5 years pay roughly the same as members paying contributions throughout.

Scottish Widows head of pensions offer development Peter Glancy says: “Our pension products are used by employers who are trying to attract and retain good staff. They are trying to get a good deal on the pension for them. I think it is reasonable for employers to get the best deal for people working with them.”

Glancy says that when it comes to deferred members the firm applies a decency test.

“We look at our stakeholder pension which starts at 1 per cent and goes up to 1.5 per cent. We wouldn’t want to see the inactive charge go above stakeholder level. We are providing a real incentive for good people to stay with company while people who leave are still getting a discount compared with people who make a retail purchase.”

But other life offices query whether the plans offer value in practice. Scottish Life’s head of communications Alasdair Buchanan believes the disclosure of the charges and options, while improving, still leaves a lot to be desired. He says advisers and providers need to be sure where they stand in terms of TCF.

“The charges have to be spelt out when they are set up but also spelt out when an individual does something to trigger the charges. It should be spelt out what they can do to avoid those charges. At the moment, that will vary from provider to provider.”

Buchanan questions the mechanics of the plans and suspects they rely on investor apathy to make financial sense for providers.

“They rely on the higher charges that former members are paying to subsidise the reduction that the active members pay. This cross subsidy isn’t clear. If you have a provider offering active member discounts paying initial commission, the only way this makes sense is if they take at least as much money on charges as they would have on a single AMC. But if they are fully disclosing the fact that charges will go up for former members, and they explain you can avoid this by switching to stakeholder plans, then virtually all former members would do that. It’s the rational thing to do.”

“Companies are relying on the apathy, lack of understanding or ignorance of the former members who stay in the higher charging arrangement and don’t understand they can avoid this.”

Some advisers agree. Robert Reid, managing director of Syndaxi Financial Planning, who has been involved in discussion with the regulator on adviser and consultancy charging, agrees with Buchanan’s assessment that the plans rely on high turnover. He also agrees with Which?’s characterisation – that the structures are penalties not discounts.

“They are penalties. They won’t be properly disclosed when people buy in, I would be surprised they spot them when they leave. They are not getting a fair crack of the whip.”

Companies are relying on the apathy, lack of understanding or ignorance of the former members who stay in the higher charging arrangement and don’t understand they can avoid this

But some corporate advisers say that if used correctly the plans have merit.

Lee Hollingworth, head of DC consulting at Hymans Robertson says: “Our view is that they are a useful mechanism within scheme design provided they are set at fair rate. Why does an employer have a pension scheme in the first place? It is the classic argument – recruiting quality employees and retaining their services.”

He says that legally employers have no obligation to former employees but there is a moral one. He believes it comes down to the lever rate and that 50 or 60 bps extra is a “reasonable contract”.

However the fee-charging firm sees abuses with commission.

“My worry is they are still being used as a lever by advisers using active member discounts to finance their commission payments. It is open to abuse where you fudge the numbers to pay for the commission. It looks like the individual is getting a good deal but when they leave the charges go up over 1 per cent.”

“There is a ’buy now while stocks last’ move out there from insurers and some advisers in terms of employers not having to pay a fee. The AMD allows them to structure a plan that looks competitive but isn’t on the leavers. It is a marketing ploy by certain insurers and advisers.”

Buchanan believes the market is being distorted: “If you accept there are flaws with commission then those flaws are being perpetuated. It distorts the market by making something attractive to employers, providers with initial commissions. Which party is suffering? If members were aware they could lower charges it would be providers, but if things are not properly explained or you rely on apathy, then it is individuals.

Which? has similar concerns. Lindley says: “The employees will be paying some kind of commission to an adviser chosen by the employer, so what kind of competitive pressure will there be to keep those charges down?” he says.

However Glancy says: “There are two intermediary models, one commission based, one fee based. In one the employees are paying, in the other the employer is paying. It is really a decision for the employer. Do they have the cash flows to pay a fee? If they don’t, but they still want the employee to benefit from a pension, they should move to a commission model. Is it still a good thing, if the employer is paying into a pension which might be 4, 5,6 per cent and there is 10 or 20 bps on the advice? The employee is still much better off.”

Friends Provident believes that the critics’ concerns could be addressed by making 1 per cent a maximum.

Martin Palmer, head of corporate pensions marketing, says: “We believe the scheme AMC that is applied when the member leaves their employer’s scheme should continue to be 1 per cent or below (in line with the stakeholder cap). This means that their benefits remain in a good value plan compared to the charges they would receive in an individual personal pension. We apply this principle when setting up new schemes with active member discounts.”

Buchanan believes the FSA should be more specific on the subject of AMDs than it has been. “The FSA should spell out that providers and advisers should make it explicitly clear not just at point of sale but point of change, what is happening and what the individual can do to avoid higher charges. That situation should be specifically acknowledged,” he says.

But the FSA has refused to comment on the specifics of AMDs, and instead draws advisers’ and providers’ attention to its regulations on clear, fair and not misleading communications.