Pensions: The ghost of scandals past ...

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Most people still do not realise that some personal pension plans offer a very good deal to all their plan holders, while others provide an appalling deal to many, and sometimes most, of their customers. It is not just the published charges which eat up the benefits, John Chapman explains. Transferring your pension plan, stopping payment of premiums and retiring early can all seriously damage your wealth in stealthy ways.

Three years into a new regime featuring disclosure of charges, it is clear that the regulations have not made the best of it. They have focused on requiring lengthy descriptions of products to individual consumers. They have made no effort to make or encourage comparisons of the effects of charges, which was the real aim of disclosure. As a result, the bulk of consumers are unaware that they should steer clear of the many poor products that are being vigorously sold.

The danger signals were clear two years ago. Given the different incidence of charges, and the manipulations to finance high maturity payouts for the few through penalties on the many stopping early, Office of Fair Trading (OFT) reports had pointed to the importance of comparisons of the effects of charges at early, mid-way and maturity stages of plans.

To stimulate debate, I suggested ABC ratings at three stages in the life of plans. An AAA rating would indicate good returns at all stages, while a CBA rating would indicate poor returns when stopping early, moderate when stopping mid-way, and a good maturity payout for the small minority reaching that stage.

After much discussion with the industry, Money Marketing, a leading paper for independent financial advisers (IFAs), adopted the ABC rating system and has used it in its two product surveys for the last two years. Sadly, however, the national newspapers, with the notable exception of The Independent, have given little publicity to this rating system. The financial regulators have not encouraged its use or the use of any rating system. Hence disclosure has been a botched job.

What makes pension plans so complicated and so different is the variety of charges used by companies to recoup their, often very different, levels of expenses. There are initial charges of around 5 per cent, and annual fund management charges of around 1 per cent. In addition, there can be heavy charges through reduced allocations of premiums, or through "capital units" which are valueless unless held to maturity and which attract swingeing annual levies if so held. There are also introduction and annual fees, and often significant penalties if you transfer your plan, retire early, or simply stop paying your premiums and go "paid up", leaving what the company accords to you to grow with their investment performance.

The ABC system of rating does not tell you how many people are likely to affected by charges at such stages on different pension plans. Here the persistency figures published each year by the Personal Investment Authority are increasingly useful. These show that on average, after three years, 34 per cent of pension plan holders with direct sales force (DSF) companies had stopped paying premiums, compared with 22 per cent of plans sold by IFAs. Three-year lapse rates varied from 10 per cent with Standard Life to 55 per cent with Guardian. I have assumed follow- on lapse rates averaging 8 per cent each year for DSF sales and 6 per cent for IFA sales. On such a basis the proportions of 30-year plans held to maturity would vary from over 20 per cent with some companies to only 5 per cent with others.

Persistency figures can be combined with projected transfer values of each company, assuming a 9 per cent a year growth in funds. For a 30- year plan with premiums of pounds 200 a month transfer values after two years vary greatly, from pounds 5,408 with Equitable Life to pounds 1,390 with Abbey Life. For each company a break-even year can be derived, when the transfer value indicated by projections exceeds the accumulated premiums paid. The proportions of plan holders stopping premiums before breaking even and their average losses are shown by company in the table. It appears that on average over a third of plans result in losses on transfer, and that with some companies the proportion may be over 60 per cent.

Most plan holders, however, do not transfer but go "paid-up", ie they stop paying their premiums for various reasons and leave their net savings to grow to their maturity date with the same company. Unfortunately, the disclosure regime has somehow failed to require the disclosure of paid-up values accorded by companies. Luckily, a survey by the IFA Alan Lakey, published in Money Management in November, has revealed what these paid-up values are. In most cases they are the same as transfer values, but in about a quarter of plans they are much higher. But such figures are illusory; many are only pitched higher so that companies can maximise their charges, typically through annual levies on notional capital units. Another revelation of this survey is that some paid-up values at the same level as transfer values also include extraordinary charges, as indicated by the low maturity values arising from them.

The projected rates of return for plan holders going paid-up at various stages can now be estimated, assuming 9 per cent annual growth. At two years they vary from 8 per cent a year or over with Equitable Life and Marks & Spencer to under 2 per cent with Allied Dunbar and Lincoln. After five years the gap ranges from 8.3 to 5.8 per cent a year, and after 20 years from 8.3 to 7 per cent a year. Although the gap narrows, the crucial point is that those sold policies with high-charge companies face an enormous handicap compared with those with low-charge companies. Many of them will stop paying premiums early and receive very poor returns, whereas if they were with a low-charge company they stand to get a good return whether they stop early or not.

The proportions of plan holders likely to receive returns of various levels can be estimated. Those receiving appallingly low returns of under 5 per cent a year are shown in the table. With several companies over a quarter and even towards half of plans result in such poor returns.

A new indicator can now be introduced. The "average plan return" can be calculated from the projections of returns from going paid-up in any year and of those stopping in those years.

As shown, such projected returns vary from over 8 per cent to under 5 per cent. The average plan return reflects the charges, their levels and structures, and lapse rates. It picks up features like paid-up plans having no value until say a year's premiums have been paid, which may elude the ABC ratings. The average plan return does not, however, indicate the structure of charges, as the ABC ratings do. In effect, the two approaches complement each other to present a useful picture.

Of course, the actual returns will depend on investment performances as well. Any company with consistently bad performance should be required to explain itself. But in the early years, when the effects of charges can be so great, variations in performance can have only marginal effects. Towards the later stages of the life of policies investment performances will be more important, but closing a gap of 1 per cent a year for each of 20 or 30 years is a pretty tall order.

The table also shows the new income for regular premium pensions for each company. It is worth adding that in 1966 the four companies at the bottom of the table for which figures are available, ie Allied Dunbar, Barclays, Skandia and Lincoln, achieved sales increases of 11 per cent, 16 per cent, 73 per cent and 22 per cent respectively.

What does the table tell us? Can companies, as the fog lifts on their activities, continue with charging and selling practices resulting in substantial proportions of their plans bringing losses or very poor returns for their plan holders? Can the regulators maintain their line that they are only interested in selling practices, not in what is being sold? Can they defend the apparent error in not requiring the effects of going paid up to be disclosed?

Can the Government really continue to subsidise the vast numbers of plans with losses or poor returns? Can all such parties scandalously continue to sit back while hundreds of thousands of consumers are sold poor-value pension plans because they not had the interest, energy or guts to do anything effective about it, like giving widespread publicity to a rating system for a start?