The death of active member discounts

Scottish Life’s Jamie Clark explains why the case against AMDs is getting stronger the nearer we get to auto-enrolment.

It seems inevitable to me that auto-enrolment will kill off active member discounts (AMDs). No one is explicitly banning them and, with the exception of AMD models that result in substantial annual management charge increases designed to support higher initial commission, no-one is saying they are inherently bad.

But I put it to you that, like it or not, they are already on trial, and the case against them is getting stronger.

Exhibit A: DWP Qualifying Workplace Pension Schemes default fund guidance

“The default option should be appropriately and competitively priced for active and deferred members and charges should not be excessive, in relation to services being provided...”

Exhibit B: FSA Discussion Paper DP11/1 on product intervention

This paper discusses how the FSA could intervene at the early stages of product design to make sure it is suitable for the target market and to prevent future problems.

It specifically mentions “exploitation of consumer behavioural traits (risk appetite, inertia)” as a potential problem in product design.

One indicator of a problematic product feature is stated as being “products with a secondary charge (e.g. charges contingent on events throughout the life of the product)”.

It can clearly be argued AMDs exploit inertia and result in a secondary (increased) charge contingent on an individual no longer being an active member.

Exhibit C: The press

A recent Financial Times article named and shamed AMD structures that result in providers paying out more initial commission.

When millions of people are automatically enrolled into pension saving, the press will inevitably expose any detriment to members caused by higher charges when they happen to change (or lose) their job.

Exhibit D: Small pension pots

The DWP is deeply concerned about small pension pots under automatic enrolment: “We do not want to see a situation where individuals amass numerous small pension pots as they move from employer to employer, only to find these pots are stranded and they are unable to purchase a worthwhile annuity.”

Respondents to a recent DWP consultation said the government should look at helping individuals to amalgamate their pension pots, with suggested benefits being “reduced impact of charges, such as active member discounts, on total savings over the working life...”

Exhibit E: Government policy

As the Pensions Bill moves through parliament, the issue of AMDs has been raised. During the seventh sitting of the Public Bill Committee, Steve Webb said:

“We propose to publish in the autumn a document about transfers that will partly deal with the issue of deferred member penalties, because, as the Hon. Lady said, if we can do something about transfers, the issue of people becoming stuck with a previous employer and having their charges jacked up will be much less significant.”

This could mean the transfer rules may be changed to allow easier transfers of pension pots between employments. The commercials of AMD structures invariably rely on pension pots staying put.

High charges, whether real or perceived, could bring pensions into further disrepute and be deemed unacceptable in an auto-enrolment world.

If the issue of small pension pots is eased by the introduction of easier and/or automatic transfers, providers will be forced to reconsider AMD charging structures – and the higher commissions they may generate.

Providers may then choose to renegotiate directly with employers, taking the adviser out of the equation in an attempt to retain the business.

In the context of auto-enrolment, it is clear to me the pensions industry will need to develop workplace pension propositions that completely embrace the new vision. There is growing evidence that AMDs will not be part of that vision.

I rest my case.