Last week the Serps bomb exploded, as news emerged that contracting-out incentives for low earners do not cover the administration charges levied by some life insurance companies. An analysis by Coopers & Lybrand, the accountants, of figures compiled by the Department of Social Security concluded that at least 2.4 million of the 6 million people who have personal pensions should never have been advised to contract out.
Some 40 per cent of all those who opted out of Serps had gross annual earnings of less than pounds 10,000 in 1991/2. They will be worse off because they do not earn enough for their pension contributions to outweigh the charges imposed by the life insurance companies operating their pension plans.
A further 85,000 people who have contracted out were too old to benefit except 'by pursuing a risky investment strategy'.
Moreover, all those who contracted out have exposed themselves to an investment risk, rather than receiving a guaranteed, inflation-proof income regardless of the stock market's performance. And the past few years have amply demonstrated just how bumpy a ride equities can be.
It is hard to avoid the conclusion that the real beneficiaries of the move to create an alternative to Serps have been the life insurers rather than the people whose interests they are supposed to be serving.
Indeed, Coopers & Lybrand calculated that the industry receives an annual pounds 100m in commission from the pounds 2.7bn paid out by the DSS to personal pensions each year.
The Securities and Investments Board, which has begun preliminary discussions on the problem with the DSS, must now deal with yet another blow to the reputation of the life insurance industry. The senior financial regulator is already trying to unravel the problem of transfers and opt-outs from occupational pension schemes after commissioning a report from KPMG Peat Marwick, the accountants, which provided damning evidence that the established rules of good selling had not been met.
Published last December, the 24-page report examined 735 representative pension transfers (lump sum payments from occupational schemes) and opt-outs (where employees who are still eligible choose to opt out of their employer's scheme). It concluded that 91 per cent did not comply with the regulatory requirement to provide best advice.
Some 54 per cent of transfers were deemed 'unsatisfactory', 8 per cent 'suspect' and 29 per cent both. The KPMG report concluded: 'There is no automatic connection between a client's file not evidencing compliance and the client suffering financial disadvantage, but non-compliance will in some circumstances result in financial disadvantage.'
Precisely how many people are involved and how much financial damage they have suffered is still uncertain, although the SIB expects to have a clearer idea by the summer. In the meantime, however, the life insurance industry has been doing its best to back away from the problem. 'It's an immensely powerful sector and reacts very defensively,' notes Jean Eaglesham, head of the Money Policy Unit at the Consumers' Association.
In February Godfrey Jillings, chief executive of Fimbra, the regulatory body for independent financial advisers, said he had a 'gut feeling' that as few as 3 per cent of the 500,000 pension transfers since 1988 were wrong. The SIB was notably unimpressed by Mr Jillings's gut feeling, but the Association of British Insurers also claims that only a small percentage of people have been affected. 'The vast majority of personal pensions have been properly sold,' a spokesman says. He insists that only a minority were 'mis-sold' - the industry euphemism - although adding: 'obviously a minority is too many'.
John Denham, Labour MP for Southampton Itchen, is more pessimistic. 'Given the KPMG report, I don't see how the numbers could be so low,' he says.
Mr Denham, who last week tabled a parliamentary motion censuring the Government for its role in promoting personal pensions, adds: 'What I fear is that the industry is preparing itself for a very bloody battle and is deliberately talking down the problem. It is trying to reduce the bill.'
Certainly, the numbers being bandied about are big. Some commentators have estimated that the bill for compensating people who were wrongly advised to transfer or opt out of occupational schemes could be as high as pounds 1bn. Correcting the Serps fiasco would lead to a still bigger tab.
Gareth Marr, an independent financial adviser and deputy chairman of Fimbra, believes this is mere speculation. 'It's totally irresponsible to put a figure on it,' he says. 'Nobody knows whether we've really got a problem, how big it is and what to do about it.'
Nevertheless, Mr Marr readily concedes that 'the standards in the financial services industry were not the way anybody would wish them to be back in the 1980s. The last six years have taken an awful lot of rogues out of the system.'
However, it would be wrong to suggest that the problems are confined to the sale of pensions, or that they are new. As early as 1991, a survey conducted by the SIB showed that between a quarter and a third of savers were terminating life assurance and pension policies within two years of starting them, even though the products were designed to run for 10, 15 or 25 years. Terminations after just one year ranged from nearly 14 per cent for with-profits life products to 22.3 per cent for unit-linked products (including endowment policies and savings plans) in 1990. Terminations over the first and second years rose to 23 per cent and 37 per cent respectively.
The picture for pensions was broadly similar, with nearly 30 per cent of with-profits and more than 36 per cent of unit- linked pensions terminated within two years of being taken out.
Commenting on these findings, Sir David Walker, then chairman of the SIB, remarked: 'Companies relying on direct sales forces show a higher overall attrition rate in the first year . . . than those dependent on the independent sector for business' (at 21 per cent and 15 per cent respectively). However, 'even the independent sector must feel concern at the apparent mismatch between its advice and the stamina of a segment of its client base.'
This was clearly a polite way of saying that the extraordinarily high drop-out rate suggested the life insurance companies were mis-selling many products. Yet progress on the problem had been remarkably slow until last December's report by KPMG spurred the SIB to act.
In January, it announced that those who sold life assurance products would have to disclose their commission on the sale after January 1995; they would be given the option of doing so from July 1994. The SIB also required that investors be given more information about surrender values on policies and that illustrations of a product's performance should reflect the company's own charges.
Last week the SIB published a report setting out further safeguards to raise the quality of sales practices. These include a cooling-off period for pension transfers and the mandatory use of transfer value analysis.
But there are plenty of people who believe that the SIB has skirted the fundamental issue. 'The commission-driven system is at the heart of the problem,' Ms Eaglesham says. She points out that it pits the interests of the client against those of the salesman.
With commission of 3-4 per cent on single-premium products and as much as 50 per cent on regular-premium products in their first few years of operation, the salesman has a vested interest in pushing regular premiums. And most customers are unaware that the bulk of the payments in the first few years are consumed by hefty up-front commissions.
'The difficulty is, we have let customers believe such services are 'free',' one industry insider argues. He believes that the provision of financial services on a fee-paying basis would result in a more ethical industry, and frankly admits that buyers must beware.
Mr Marr agrees that there is 'a potential conflict of interests, and in the past this has often worked against the client'. Nevertheless, he insists there is nothing intrinsically wrong with the commission system. 'Some clients are simply too embarrassed to ask what a financial adviser is getting paid,' he says, but with enforced disclosure this difficulty should be resolved. He adds that he sees little difference between commission and the division of profits at the end of the year in what amounts to a retroactive commission. 'When the public realise that getting your financial planning right is more important than buying the right car, or the right house, it may be more willing to recognise there is a cost involved.'
Mr Denham is much less certain that the commission system can be defended, saying 'what makes it so damaging is that it's linked to an industry with poorly trained staff and sometimes insecure employment conditions.' He claims that in the late 1980s, when the going looked good, many companies had a very high staff turnover and in some instances actively encouraged unethical behaviour.
One corporate victim of misdemeanours was the Prudential, Britain's biggest pension and life insurance company, which last week admitted it had sacked 23 staff in 1993 after 'evidence of activity intended to deceive customers and the company'. The employees concerned, three of them branch managers, had falsified customers' personal finance records and forged their signatures on crucial documents including direct debit mandates.
However, the Pru is by no means the only life insurer to be implicated in the growing pensions scandal. Indeed, it is one of the few companies to have set an earnings threshold for contracting out of Serps, so in this respect at least it may be less exposed than some of its fellow insurers.
Barclays Life and Lloyds Abbey Life's two life insurance arms have now pulled out of the pension transfer business, while Legal & General has made unspecified provisions for compensation and indicated that the SIB's report will 'significantly inhibit' its activities in this area. A number of other companies, including Hill Samuel and Britannic Assurance, are also steeling themselves for a rush of claims.
But the question remains, who is responsible for the mess? 'It's wrong to say that the problem comes down to an unscrupulous sales force. It's the companies that encouraged them, the people who were employing them, that are to blame,' Mr Denham argues. He believes the finger should be pointed at senior management.
In fact, several of the industry's top figures have attracted criticism for their partin promoting the wonderful world of personal pensions. Sir Mark Weinberg, former head of Allied Dunbar, and Marshall Field, former general manager of Phoenix Assurance, were among the 'retirement' study group appointed to advise the Government. In other words, the industry was deeply involved in drafting the system of self-regulation under which it still operates.
Insult was added to injury recently when Joe Palmer was appointed to run the Personal Investment Authority, the newest regulatory body. Mr Palmer presided over Legal & General when it failed to comply with rules for which it was later fined pounds 180,000 by Lautro.
The evidence already suggests that 'the industry cannot police itself', Ms Eaglesham says. 'It has a clear conflict of interest between the rule to give best advice and the profits it is generating from the sale of these products.' But if the industry and its regulatory mechanisms are at fault, so too is the Government. Its 'enthusiasm for private pensions, unfettered by common sense or a sense of responsibility, has led to a situation where the interest of the consumer has taken second place to the interests of those selling personal pensions', Mr Denham says.
'From the initial decision to encourage opting out of Serps, the Government actively promoted the move to personal pension plans,' he argues. 'The Government was responsible for a whole broadside of publicity, without any discrimination, in an industry that had no effective regulation.'
Alistair Darling, MP for Edinburgh and Labour's City spokesman, points the finger more specifically: 'Pension transfers and self-regulation were part of the Tory dogma of the 1980s. It was John Major as a junior minister who helped steer through the pensions legislation that has led to many of today's difficulties.'
In fact, the triumvirate of ministers behind the promotion of personal pensions and contracting out - a policy designed largely to reduce the burgeoning state bill for pensions - comprised Norman Fowler, then secretary of state for social services, Anthony Newton, his minister of state, and Mr Major, then parliamentary undersecretary. Today, Mr Newton is Leader of the House, Sir Norman Fowler is chairman of the Conservative Party and Mr Major is Prime Minister.
Between them, they have contributed to what may yet turn into a financial disaster for the next generation. At the very least, it has cost consumers between pounds 200m and pounds 500m in early cancellations, and an unspecified sum in erroneous transfers and opt-outs. As Mr Denham notes, 'you're talking about more money than Robert Maxwell ran off with'.
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