While the arguments about the abolition of commission for auto-enrolment pensions (from April 2016) are clear-cut, the fate of policies which aren’t used for auto-enrolment – isn’t.
This is particularly the case for commission based occupational pension schemes.
This week, I spent time with colleagues from First Actuarial and the DWP, exploring four questions; with regard to occupational schemes
What parties were involved in commission agreements?
Which parties entered into contracts?
Who is aware of these commissions?
What different commission models are there out there?
The answer, as we found out, is that there is a chasm between the legal and practical answers to these questions.
Legally, the contract was between insurer and trustee, permitting a proportion of the policyholder’s funds to be used to pay for advice over the lifetime of the contract.
Practically, it was an agreement between a sponsoring employer and an adviser which got the adviser paid by the member. A form of risk transfer which typically worked at the expense of the member.
In exploring these two positions, it became clear that the chasm between them was the problem. Trustees may have signed off commission agreements as part of their contract with an employer, but they were often unaware of doing so – and almost certainly unaware of the long-term impact of the agreement.
As for members, well they hardly feature in the discussion, other than as the unwitting victims of commission paid. This is particularly awful for members of schemes where there was no employer contribution and the commission was calculated purely on the member contributions.
For here, members were being asked to make AVCs (voluntary personal contributions) or being contracted-out of the state pension and the benefits of doing so were being impaired by an agreement they knew nothing about, for a benefit they seldom received.
The benefit of commission is advice, advice not just at outset (the point of sale) but throughout the life of the contract. People who contracted out on a money purchase basis could find up to 60% of their first year’s contracting-out rebate paid to an adviser for doing- ABSOLUTELY NOTHING.
The diminished pot may have been invested in capital units for the past 30+ years. Many of these policies are maturing today, with nugatory pots. But there is a second sting in the tail. Because the member entered the scheme (of their own choice) , they have voluntarily given up rights to the state pension. You may have been a junior employee when you were contracted out, but if you’re retiring now, your state pension is being reduced because of that decision.
COMPs and CODs
The idea was that the value of your contracted-out money purchase pension (COMP) would have been enough to replace the amount of pension you lost from the COD – the contracted out deduction from your state pension. It would be a fascinating piece of academic research to compare the purchasable pension in 2015 from one of these COMP pots with the COD. If the COMP could cover 50% of the COD (even with a commission free policy).
Where commission was paid to an adviser, the value of the pot might be reduced by 50%. Again a piece of research that compared the impact of commission on pension pots would be helpful.
AVCs and EPPS
Many occupational pension schemes operated AVC arrangements run by insurance companies (Equitable Life, Prudential, Standard Life, Norwich Union and a long tail of others).
These arrangements were hugely popular with employers as they could generate huge commissions to advisers which could subsidise the running of the mains scheme. WIN- WIN for the employer and adviser – LOSE LOSE for the member.
Most of these AVC policies were set up on a non-commission basis and offered good value for money (by the standards of the day). But there were exceptions. One ruse invented to reward advisers, was to dispense with the AVC and use another kind of contract, an executive pension plan (EPP) which could be funded purely by the member but was governed by a separate master trust. These arrangements were hugely popular with employers as they could generate huge commissions to advisers which could subsidise the running of the mains scheme. WIN- WIN for the employer and adviser – LOSE LOSE for the member.
These EPP arrangements were often set up by the advisers under the auspices of an organisation to which the adviser was connected. Such an organisation was the International Association of London and Overseas Banks, which operated successfully in the City of London, seemingly offering economies of scale to small financial institutions.
In practice, it became a commission washing operation for the advisers who set it up. All this sounds pretty victimless, unless you were a member of one of these EPPs, where you’ll find your benefits are now sitting in the pockets of a few (mainly retired) advisers.
Insured defined benefit arrangements
Perhaps the most bizarre casualties of commission are the employers funding the defined benefit schemes set up decades ago as insurance policies. Many of these schemes paid huge amounts of commission to advisers. The impact of these commission payments is being felt today in the funding rates being demanded to meet the pensions now coming into payment.
Employers looking to move away from these legacy contracts with insurers are finding that there are enormous cessation charges to pay. These charges are to meet commission that has been paid to advisers who may not have been seen by the employers for years (if not decades)
Here’s a quote from an insurer
“As you may be aware , there have been large amounts of commission paid to advisors in the past for their services. Unfortunately due to the small fund size we have been unable to recoup these payment and our charges to any significant extent….on discontinuance of the policy there would be a charge of approx. £250,000 expressed as 20% of the fund value at this date”.
The victims of this state of affairs are ostensibly the company. But it the cost of meeting the liabilities of the pension scheme impact the capacity of the employer to compete, the policy could stunt growth or – in extremis- bankrupt the employer.
Commission is not the victimless payment it appeared to be when these legacy contracts were agreed many years ago. The impact of this commission is being felt today and it can be horrid.
What to do?
In April this year , a new kind of consumer champion emerged, the Independent Governance Committee and in particular its chair. Every insurance company must set up an IGC and (though this doesn’t appear to be easy), the Chairs of these IGCs should be accessible to receive representations from policyholders.
In addition, the ABI are laboriously working through what they are going to do about legacy policies which suffer the kind of problems I mention in the quote above.
It seems entirely reasonable for policyholders who feel they are being treated unfairly to take their grievance to the Chair of the IGC for consideration – where they can get no satisfaction from the employer. Escalation to the IGC is not something I’d recommend in every instance since the cost of fighting some battles might be better shared.
But if find you are in the chasm and that you are suffering from the impact of a commission decision you were not a party to, did not have explained and is severely damaging your retirement prospects, I’d be very careful .
The prospects for such policyholders (and for the members of policies arranged by third parties -trustees) appears to be getting better. With a consumer focussed pension minister and some regulations in place which have the potential to bite, my advice – if you have a grievance – is to watch this space.
For a light hearted (but very serious) sideways glance at commission, read Paul Lewis’ excellent blog on the subject here