Update on the retail distribution review

If you read nothing else, read this…

  • The ban on commission on group personal pensions set out in the Retail Distribution Review may lead to greatly increased charges on members’ pension pots in the early years.
  • Charges on an average GPP of £200 a month could rise from £5 to about £360 in the first year.
  • This will dissuade many employees from joining their employer’s pension, particularly if they plan to move jobs frequently, and will devalue the perception of pensions as a benefit.
  • It is hard to see how advisers can give individual advice to members without upfront charges rocketing further.

The FSA’s new rules on group pensions advice, forcing a switch from commission to a fee-based system, threaten to make schemes less attractive to employees, says Ceri Jones

An employer setting up a new group personal pension (GPP) plan will soon have to agree a fee with its financial adviser instead of remuneration by commission, under new rules from the Financial Services Authority (FSA). The rules also apply to other group pension arrangements, such as group stakeholders and group self-invested pension plans (Sipps), and investment products linked to occupational schemes. In practice, this could make pensions less attractive to staff.

The rules are part of the FSA’s decision to ban the payment of commission on all investment products under the Retail Distribution Review (RDR) from 2013. Its policy document Delivering the retail distribution review – corporate pensions: final rules introduces the consultancy charging system. In theory, this has a lot to commend it, but in practice, it will mean upfront charges for advice on each employee’s plan.

Consultancy fees will be discussed with the employer, not staff, and will apply regardless of whether the employee receives advice.

Most employers will want to pass on these charges. The FSA policy document states: “Where an employer is unable or unwilling to pay fees direct to an adviser, the employer and its adviser would negotiate and agree the cost of the adviser’s services as well as how these would be paid from employees’ GPP funds. The adviser’s services could include advice to the employer on choosing a scheme provider, assistance in processing scheme actions, such as salary deductions or distributing key features and other documents to employees, as well as advice to employees.”

If employers do not absorb some of the advice costs, staff will suffer a hike in charges in their early years of membership. Current commission costs are typically spread over the period of each employee’s plan at a rate of about 0.4% a year of the value of the fund, with long-stayers subsidising staff who leave after a few years. Based on a typical contribution of £200 a month, the cost to the employee in year one is about £5, rising to £82 by year four as the fund accumulates. Under the proposed charging regime, the cost to the employee in year one will be £360.

Burden on employees

Doug Johnstone, chairman of Creative Benefit Solutions, says: “This will be a massive burden on employees who leave plans with relatively short periods of membership. An employee who leaves service within a year of joining the plan would be faced with an increase from £5 to £360. They would also face another consultancy charge if they join a new employer’s plan.”

The reason the charging structure will change so starkly after the new rules apply is the regulator’s decision also to ban factoring, which currently allows pension providers to spread GPP charges over a period of years. The new rules say charges must be paid up front, although advisers can agree to spread them, perhaps over one year.

Savers could face upfront charges of up to 35% of the first year’s contributions into their employer’s pension plan. Once this impact becomes known, more staff may refuse to join a scheme, particularly if they are considering changing jobs regularly.

Andrew Tully, senior pensions policy manager at Standard Life, says: “Making things clearer for customers – what charges they are paying and what they are receiving in return – is a positive. However, if advice is paid for from employee funds, it will be difficult to reconcile costs for staff joining or leaving the scheme. For example, if you agree advice for setting up and running the scheme is going to cost staff who join £20 a month for 48 months, then what happens if they leave after six months? It will be difficult to extract costs from an employee for a pension for which they are no longer a contributing member.”

Removing consultancy charges

Taking consultancy charges out of employer contributions may soften the blow, but it is still money being deducted from staff reward. John Lawson, head of pensions policy at Standard Life, says: “Consultancy charges are likely to be taken out as fixed per member each month to pay off the cost of advice received by the employer at the outset. Prospective members are unlikely to be put off joining because the benefit of the employer contribution will usually more than outweigh any consultancy charge.”

Noel Birchall, national consultancy director at JLT Benefit Solutions, adds: “I think advisers will have to structure charges in line with the services they are providing, with less coming from scheme joiners.”

If the FSA allows advisers to continue receiving a big chunk of the early years’ contributions from new joiners to schemes they set up several years ago, then advisers might reduce charges on new GPP plans, but the FSA has not yet decided its view on this.

Many advisers may leave the industry, and the market will contract further. Large schemes will be more attractive to advisers than small and medium-sized ones with not enough staff to generate worthwhile fees. This is already an issue in the GPP market, where many providers will not quote on schemes with too few members.

Many employers may level down their pension provision in the face of the difficult economic climate, their pending obligation to auto-enrol all staff, and the demise of many final salary schemes. Smaller employers could move to the government’s national employment savings trust (Nest) if it is introduced as planned in 2012. Ironically, Nest has been set up as a trust-based scheme to avoid the issue of the cost and provision of advice.

Any extra adviser workload would also be reflected in the charges. Nicholas Round, managing director of Murray Round Wealth Management, says: “If GPPs are seen as a valued benefit, then employers should accept the costs. Costs can be transparent, which should help confidence in pensions.”

Throwing out the good with the bad

  • The current charging structure of most GPPs makes them one of the best-value investments for the end-investor, a situation that came about when stakeholder plans were introduced in 2001 and insurers had to make GPPs more competitive.
  • Historically, GPPs do not break even until years 15 to 17, with longer stayers subsidising short-term staff.
  • By changing the remuneration structure, the Financial Services Authority (FSA) has made these plans potentially more profitable for insurance companies, rather than helping employees.
  • The FSA considered the relative value of GPPs in its review, but concluded that the current commission-based market model is not sustainable, adding: “Providers offering initial commissions are subsidising these payments from their own funds and, if scheme and member persistency levels [remain] poor, will not achieve economic returns on GPP business.”
  • The FSA says the fact that new GPP business is concentrated in a handful of providers that pay initial commission indicates commission bias, and business is often churned.
  • Association of British Insurers data shows the number of GPP contracts in force is almost static, despite providers reporting new business.

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