Cicero Policy Briefer

Issue 5, October 2006

Pensions and profitability: business through the back door

By Malcolm Small

Recently, I’ve been doing some consumer research in pensions (more details at www.thepensionsreport.co.uk). It’s pretty clear that the results suggest that people view pension providers with very deep mistrust. They sometimes also regard their charges as expensive, although not as much as you might think, given the government’s focus on this area.

In this context, it may come as a surprise to know that the providers may not be making any money at all on this business—and may even be losing a packet!

How, you ask, can this be?

For as many years as I can remember, the single most important annual reporting figure for insurance companies and other pension providers has been “new business premium income”. In other words, the total of the new business that has walked in through the door, either direct or on the backs of intermediaries.

Very little attention has been paid to the business going out of the back door in the form of lapses or transfers to other providers, at least in part because there has never been a requirement to report this.

In the old days, this was not a particular problem. The generally accepted knowledge was that business sold direct was generally of poorer quality than intermediated business, which would tend to stay active and ‘on the books’ for eight to 10 years or more.

Recent work has suggested that this situation has effectively reversed, with intermediated business, in some cases, sticking on the books only three years on average before migrating to some other destination. This does not allow sufficient time for the ceding provider to recover its costs of business acquisition, resulting in a loss being made.

Why is this happening?

The first issue is the continuing obsession with ‘new business’, which roughly equates to ‘turnover’ in outside business terms, rather than ‘profit’. Especially as so many providers have become plcs rather than mutual organisations, CEOs feel under pressure to report a stream of ‘good news’—the simplest of which is increased sales.

The second is cannibalisation within the market. There is actually very little new money coming into the pensions market relative to its monetary size, so the money coming into a provider’s new business stream will generally have come from somewhere else, often a competitor. That’s OK if you can hang on to the money when it does get to you.

The third is that all too often, you can’t. Products improve, acquiring wider fund choice, more features and lower charges, all the time. And perhaps the ‘killer’ for some advisers is this. Some providers will allow you to take, say, five per cent commission (while they may charge just one per cent annually) without any mechanism to ‘claw back’ excess commission in the event of the plan being transferred early. In the example above, ‘early’ would mean earlier than at least year 6 if the commission costs alone were to be recovered—never mind other establishment costs. There is also usually no visible cost to the consumer in transferring; only the adviser wins financially, with the provider taking a heavy loss.

Now, this does not happen all the time, and there are perfectly legitimate reasons to move clients from one provider to another, and many advisers would abhor such practices. However, I have seen this practice too many times with my own eyes to dismiss the possibility.

The answer is in financially prudent commission claw back terms that are acted upon by providers in their relationships with advisers in the market, as well as better scrutiny by FSA and, perhaps, revised reporting rules.

But in the meantime, you might like to ask your provider if they claw back unearned commission.

Malcolm Small can be contacted on +44 (0)20 7665 9530 or click here to email.

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