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Pension exit fee cap could hit contract law hurdle

The regulator may come up against legal resistance when it attempts to cap pension exit charges.


by Michelle McGagh on Jan 20, 2016 at 13:33

Pension exit fee cap could hit contract law hurdle

The Treasury’s plan to cap pension exit fees could be scuppered by contract law and provoke insurers into a legal battle over charges.  

Chancellor George Osborne has given the City regulator, the Financial Conduct Authority (FCA), the task of placing a cap on exit fees faced by retirees accessing their savings early.

Osborne said ‘we will change the law to place a duty on the FCA to cap excessive early exit charges from pension savers’.

This means 670,000 over-55s could see their pension funds boosted as their fee for accessing their fund early under new freedom reforms will be reduced.

However, Martin Tilley, a pension expert at Dentons Pensions, questioned whether the regulator would be able to override contract law and force insurers to cap their charges.

‘I do not think they can do it,’ he said. ‘Osborne has opened his mouth without thinking about it beforehand.’

Tilley said the charges were put in contracts and ‘correctly disclosed’ to consumer sat the time pensions were taken out. When pension contracts were entered into an exit charge was typically levied to recoup the cost of setting it up and if the pension was terminated before the saver reached a certain age – typically 65 – then an exit charge was levied.

‘It is the individual who is breaking the contract by coming out [of the pension contract] early,’ said Tilley.

He likened the contract to those entered into with telecommunications companies, where a fee is levied if you change providers before the term of the contract is up.

‘I think some of the insurers will challenge [the decision] legally,’ said Tilley. ‘Depending on what the FCA comes up with the closed book providers [those who only service old contracts and do not take on new business] could be hit significantly.’

The FCA could get around the legality of changing contracts by implementing principle six of its treating customers fairly rules, said Hargreaves Lansdown head of retirement policy Tom McPhail.

The principle ensures: ‘Consumers do not face unreasonable post-sale barriers imposed by firms to change product, switch provider, submit a claim or make a complaint.’

‘[The FCA] can cover this under regulatory principles,’ said McPhail. ‘It does not want to get bogged down in a legal challenge. It will want to come up with something that sits in the regulatory framework.’

'Bold move'

McPhail said it was a ‘bold move’ by the Treasury to announce a cap and ‘they would do not go down this route unless they were happy that legally they could make this stick’.

The Association of British Insurers (ABI) would not say whether it was considering its legal position regarding the cap and a spokesman said it needed ‘to see further details’ from the FCA about ‘what [cap] will be set and how it will work in practice’.

However, the spokesman reiterated the ABI’s view that exit charges protect those who stay invested in the pension fund for the agreed amount of time.

‘The point is that the exit fees were designed to protect those who stay the course not penalise those who leave early,’ he said.

Insurers will, under the proposed changes, still be able to levy an exit fee but the extortionate charges – up to 10% - written into some pensions will no longer be justifiable.

McPhail said a fair exit charge would be ‘below £100’ as it was an administration charge to recoup the cost of setting up a pension contract.

While Tilley agreed excessive exit fees should be reduced, he believes it will be harder to judge what a fair cap will be as it depends on the type of pension contract and also on the size of the pension fund.

Rather than capping fees retrospectively, Tilley believes Osborne was wrong to announce pension freedom in the way he did.

‘There were promises made; freedom for all which implies everyone when it should have been freedom for most [without exit fees],’ he said.

3 comments so far. Why not have your say?

Law Man

Jan 20, 2016 at 16:07

Conditionally, I tend towards Mr Tilley's view. If genuinely the fund takes in money on the basis that:

(1) there are certain front end costs which are amortized over, say, 30 years, and

(2) it plans its business outgoings in advance (long term costs commitments such as a 25 year lease of premises)

- then it prices its annual fund charges over the 30 years reckoning to pay those expenses.

If the investor withdraws after, say, 5 years, then the fund loses future contractual income AND it is the other investors (who keep to the 30 years) who will pay that deficit.

Mr McPhail refers to Principle 6 of "UNREASONABLE post sale barriers". Indeed, the fund must show the exit charge is reasonable to cover the income foregone.

Otherwise, the contract term may be subject to Unfair Contract Terms legislation (I have not checked). Matters such as disclosure of the charge before the contract is made will be relevant. It is arguable that the amount of the exit charge is not subject to voidness under the UCT laws as being a core term relating to price.

The common sense view (which is not necessarily what the law says) would be that a proportional exit charge, calculated to recover costs, and reducing over the term, is more likely to be fair.

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Ivor Nestegg

Jan 20, 2016 at 17:38

Sounds like MVAs (Market Value Adjustments) on Endowment Policies all over again!

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Graham Proud

Jan 21, 2016 at 09:44

I remember the terms being 'correctly disclosed' and I also remember thinking 'how bl**?y much!!!!' but what choice did customers at the time have? For me it was accept and have a pension my employer would contribute into or have one without these handcuff charges but miss out on the contributions. That is not a real choice and it is something that has riled me for decades. The situation is a fair bit improved lately but still room for more.

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