AN UNERRING EYE
FOR THE VULNERABLE
John Plender uncovers a proletarian
version of the Lloyd's of London scandal.
It is, of course, much bigger
WHOM SHOULD we blame for the increasing numbers of nurses, miners and teachers fleeced by predatory insurance salesmen selling personal pensions?
If the insurance companies are to be believed, it is just a handful of rogue sales- men whose activities have been wildly exag- gerated by the media. Sir Norman Fowler, who gave the personal pensions bandwagon its first big push in the mid-1980s when he headed the Department of Health and Social Security, blames the industry, not the government. The Opposition, with its usual incompetence, has not thought this a point worth pressing, except in a desultory manner.
Yet this proletarian version of the scan- dal at Lloyd's of London has the potential to make political waves on a scale that the rich people's insurance club could never have generated. The number of victims and the sums involved are on a scale that might have made even the late Robert Maxwell gasp.
The insurance salesmen, it should be said at the outset, are too easy a target. Most are given, at best, a few weeks to grasp the complexities of actuarial science, taxation and accountancy before they start selling, or `mis-selling', in the industry's nicely judged euphemism for fleecing the cus- tomer.
Industry insiders admit (off the record, naturally) that they have to `mis-sell to live'. More than half all insurance salesmen fall out within two years, often having sold expensive and inappropriate policies to their unfortunate family and friends. And the reason why it has been so easy for the more sophisticated salesmen to gull their customers is that insurance and pension products are complex, and the salesmen have not, until now, been obliged by law to disclose the fat up-front commissions that the policy-holder is charged. Bewildered customers, worried about saving for retire- ment and ignorant of the arcana of person- al finance and investment, blithely assume that the salesman is there to help.
They are not to know that the economics of the industry are pure Alice in Wonder- land, and not simply because the number of life assurance companies would shrink beyond recognition if their salesmen really did provide decent advice to their clients. The point is that the life assurance business has lost most of its raison d'etre, but cannot bring itself to recognise the fact. It can only survive in anything like its present form if the British public continues unwittingly to subsidise it on a huge scale and the regula- tors fail to call a halt to an astonishingly cynical scam.
The life assurance industry's problem is that it derives only a small part of its profits from selling socially desirable, and relative- ly cheap, forms of protection to deal with death, misfortune, unemployment and the rest. The big profits of the business now come from competing with banks, building societies, unit trusts and others in selling saving and investment products.
The industry suffers a competitive disad- vantage here, in that it has to keep an expensive army of nearly 200,000 salesmen in the field, whereas the banks and building societies are merely selling investments and insurance policies through an existing branch network that was set up to provide a banking service. Yet the life companies are able to overcome this handicap thanks to a lax regulatory regime which does not require them to disclose the big commis- sions they charge to remunerate the sales- men. In effect, they have carte blanche to misguide the public, while selling poor- quality investments that most people would shun if they had the remotest idea what they were being sold. Consider their best-selling line, which is the endowment policy. This combines the desirable protection of life cover with a conventional investment product from which the outstanding principal of a mort- gage can be repaid. Because the insurance companies have to maintain their army of salesmen, who are rewarded with big com- missions when the sale is made, the cost of the investment product will be higher than many other conventional forms of invest- ment. More important, since the initial premiums on the policy are absorbed by the up-front commission payments, the insurers impose heavy penalties for early surrender — a huge disadvantage com- pared with, say, a unit trust or personal equity plan.
That disadvantage was sometimes worth putting up with in the days when the Gov- ernment provided a subsidy in the form of tax relief on the premiums paid. But the industry's life-support system was switched off by Nigel (now Lord) Lawson when he abolished the tax relief in his first budget in 1984. Since then endowment policies have been an exceptionally poor invest- ment for most home-owners.
Yet despite the fact that most would now be better off taking out a repayment mortgage or paying separately for the pro- tection while investing in a less costly and more tax-efficient way elsewhere, endow- ments in 1990 accounted for 75 per cent of the mortgage market compared with a mere 7 per cent in 1970. That aberration arises because the salesman receives little or no reward for suggesting the more sen- sible alternative, while the commission on endowments remain generous. Research carried out for the Securities and Investments Board (SIB), the financial services industry watchdog, suggests that between a quarter and a third of all such policies lapse in the first two years, an astonishing rate of attrition which points to poor-quality advice from the salesmen. Most policy-holders incur a substantial penalty for early surrender; some get no money back at all. In effect, the whole endowment system is based on the princi- ple of robbing Peter to pay Paul. Were it not for the high lapse rates, the returns to surviving policy-holders would be much less.
When the tax relief was abolished, it would have been logical for the industry to contract. It was spared that pain by the privilege of non-disclosure, which worked against the consumer's interest, and by the Government's enthusiasm for personal pensions, which are now the second most important line in the insurers' product portfolio. They owe a huge debt to Sir Norman Fowler — all the more so since personal pensions are, so to speak, the short straw of the investment world. No sane person would want one if he or she had an alternative available. This is because the ultimate return on a personal pension plan is uncertain: it depends on the state of the stock markets, not a com- pany's promise to pay a fixed amount in relation to final salary. The return will also be depressed by the high cost of the sales- men's commissions: independent actuaries estimate that expenses absorb between 20 to 30 per cent of an individual's pension contributions over a working lifetime. And there is usually no contribution from the company.
While personal pensions may not be the most tempting of options to the consumer, they have obvious advantages for a govern- ment that has been discreetly running down the state pension system and regards company schemes as paternalistic. There are around 11 million people who are not in occupational pension schemes and for whom the state will provide a retirement income that is very low compared with pre- retirement pay. There is thus a problem with inadequate pension provisions for a large chunk of the population. For Sir Norman Fowler and his succes- sors, including the present incumbent, Mr Peter Lilley, privatisation was an ideologi- cally appealing answer. When a lobby headed by Lord Vinson and the late Philip Chappell came to bend Sir Norman's ear about the joys of personal pensions, he gave it a wildly enthusiastic and wholly uncritical welcome. This despite the fact that the basic arithmetic of private pension provision means that it is impossible for personal pensions to make more than a modest contribution to the nation's pen- sion arrangements. The cost of administering small pension contracts with low premiums is high, so most insurers make a disproportionately high fixed charge for them. If they are rep- utable, they are usually reluctant to sell personal pensions to people earning much under £10,000 a year. As the consulting actuary Bryn Davies points out, two thirds of the 11 million people in employment who are not members of occupational pen- sion schemes are earning less than that; and the average earning of such non-mem- bers is £8,750. In short, most of the people who need additional pension provision cannot find it on an economic basis in the personal pensions sector. This might suggest that personal pen- sions were no more a bonanza for the insurance industry than a panacea for the Government. But the loss of its fiscal privi- leges meant that the insurance industry desperately needed a new bonanza. So it created one regardless, by selling personal pensions to all the wrong people. First, there were those who accepted Sir Nor- man Fowler's fiscal bribe to leave the state earnings-related pension scheme (Serps). That was, broadly, a sensible option for the very young or for high earners, but not for most others — least of all the lowest paid, because of the high charges on small con- tracts. Despite these caveats the Department of Social Security has discovered that around 60 per cent of the nearly 5 million people who have opted out of Serps have invested no more than their National Insurance rebates, worth a few hundred pounds a year, in a personal pension. The returns will thus be eaten up by charges. In some cases the policy-holders will probably dis- cover that the whole pension has been whittled away. The sales effort appears to have been astonishingly indiscriminate. DSS figures now show that at the height of the pen- sions boom in 1988-89 personal pensions were sold to 63,000 women who had no earnings during the period and so did not even qualify to take out personal pensions. It is just about conceivable that a personal pension might have been suitable for a handful of these women in occasional employment, but most were unquestion- ably sold a very expensive pup.
So, too, were most of those who opted out of public sector pension funds into a personal pension. These funds offer cer- tain returns on retirement, with complete inflation-proofing. The circumstances in which personal pensions can match the benefits available to someone who leaves such a scheme are likely to be rare. There are hardly any circumstances in which it would be sensible for someone still work- ing for these industries to opt out of an occupational pension scheme, since it would involve forfeiting all the employers' contributions. But this was no constraint on the companies and their salesmen.
With an unerring eye for the vulnerable, they have picked on miners, because they are being made redundant and have an understandable, emotionally charged desire to be shot of British Coal, and thus the mineworkers' pension fund. Nurses are widely regarded as a soft touch because they are more preoccupied with life and death than money. The teachers have been vulnerable because their pen- sion scheme, despite other merits, does not offer a pension to spouses — a clear sales opening.
A standard insurance company tech- nique is to hire an ex-employee to approach former colleagues. Trust is the key to sales and thus to a fat commission income. Some salesmen have been known to pay up to £1,000 to obtain the internal telephone directory of a big firm, because the most cost-effective killing comes from extracting maximum sales from a single workplace. It makes a good investment: the commission on a single £10,000 pen- sion transfer can be as much as £500, so by the third sale there is a 50 per cent return on the investment — all in a matter of days or weeks. The result of these high- pressure tactics are that 67,000 miners are reckoned to have been wrongly but suc- cessfully advised to transfer from the British Coal pension fund. The compara- It'll be all right in the end. It always is!' ble figure for teachers has been put at 27,000.
The lapse rates on personal pensions are even higher than on endowment policies. And a by now notorious report from the accountants KPMG Peat Marwick carried out for the SIB, the industry's top watch- dog, has revealed gaping regulatory short- comings. In order to satisfy the requirements of the 1986 Financial Ser- vices Act, the salesmen have to know enough about the circumstances of each potential purchaser to be able to offer appropriate advice. Yet in 83 per cent of the client files in KPMG's sample there was insufficient information to demon- strate that the salesmen could have met these 'know your customer' requirements.
Estimates of the cost to consumers of lapses of life assurance and pensions poli- cies in the first year alone range from £300 million to £800 million, while estimates of the compensation that may be required to compensate the victims of the personal pensions fiasco reach as high as £3 billion.
In the face of overwhelming evidence that they have been conducting a ruthless smash and grab raid on the British public, the insurance companies are curiously unabashed. They question the methodology of the experts who make estimates of lapse rates, while refusing to make relevant information available from their own records. And hard-liners within the indus- try rail at the SIB for trying to introduce independent outsiders to look after the public interest in monitoring their affairs.
Yet their best excuse for this dismal per- formance remains unstated — to wit, that the Government fixed the rules of the game in such a way as to encourage the original rape of the consumer and cheered the industry on while giving the whistle to the wrong referee. Sir Mark Weinberg, the man who could reasonably claim to have introduced high-pressure selling to the British insurance industry, was the chief author of the SIB's initial rules.
From January next year, at the behest of the Office of Fair Trading and the Trea- sury, the insurance companies will finally be required to disclose their commissions and clarify the risks to the consumer in allowing a policy to lapse. This will be the start of a long overdue contraction in the industry, as the British public begins to find out the high price of treating with the insurance industry. But it will come too late for the countless people who have unwit- tingly provided the insurers with a multi- million-pound subsidy.
The irony is that the Government scrapped the tax relief on life assurance and promoted personal pensions with a view to encouraging individual responsibili- ty and unshackling employees from pater- nalistic employers. Instead we have a vast amount of misery, two thirds of all stock exchange investment still in monolithic institutional hands and a vacuum in lieu of a government pensions policy.