For each policy/account set-up, providers aim to recoup costs of acquiring the business, such as commission, sales and marketing costs, policy set-up, investment fees, and ongoing servicing costs. Finally, an allowance is made for other fixed and variable costs of the business together with a profit margin. These components are all factored into determining the product charges.
The allocation of expenses within any business cannot be an exact science. It is necessary to be pragmatic, which inevitably leads to some crosssubsidy. This approach is common in most other commercial enterprises.
Since the introduction of stakeholder pensions in 2001, the market has moved to recovering costs via a single annual management charge (AMC) on its funds and removed exit fees. These products tick the simplicity box but raise concerns over fairness. For instance, should an employee who leaves the company pay the same level of charges as active members?
The AMC levied on members who leave with small account values will not cover the ongoing costs of managing the account, reporting values and ultimately settling the claim. To date, these unprofitable accounts are subsidised by the charges levied on active member accounts. This situation is creating unease in the market, with a requirement that charges be distributed more equitably. However, going back a few years, advisers sought a level playing field from providers, namely that active members and deferred pots in respect of leavers were treated the same, i.e. they had the same level of charges allocated. This was typically part of the adviser’s due diligence on the provider market and was a requirement to win business.
It appears that this debate is still evolving. This has led some providers to respond by establishing differential rates of AMC. Active members are rewarded by paying a lower AMC, effectively a ‘discount’ on charges, often referred to as an active member discount. Those who leave service and make their accounts paid-up may lose the discount on all or certain contribution types held in their account.
The driver behind this evolution is a requirement to provide ‘fairness’, however, that is defined between active members and leavers. Secondly, it can help the sponsoring employer promote the scheme and secure greater payback from the benefit being provided. If the employer can evidence that costs are discounted for employees then this must be good news.
On grounds of equity amongst members there is justification for discounting charges for active members but it presents a moral dilemma. The introduction of higher rates of charge for leavers undermines the status quo, even though actuarially justifiable.
Within UK plc staff turnover is over 25%, within certain industries the rates are sub 10% whereas other industries are way over 50%. This is taken into account by some providers in underwriting enquiries, it raises significant issues around the on-going pricing of contracts. In today’s environment, schemes with high turnover are more expensive to administer, as all employees receive a flat AMC charge, and many leaver pots still incur significant administration costs. If in the future, leavers are charged more, then this dynamic changes which will change providers pricing models.
What will happen to the millions of leaver pots? Will we see the emergence of an active roll-over market as in the US? If so, what are the implications for pricing if leavers take their accounts with them? This could have the impact of increasing costs with resultant higher charges, and/or lower commissions being available.
No doubt a debate will run on this issue, and we must be sensitive to the expectations of all interested parties, and the responsibility to treat customers fairly. Above all, there is a requirement on both advisers and providers to be clear on what the charges are and when they apply.