Yesterday I was kind to insurance companies; this was a PR mistake.
My inbox received a number of reproofs reminding me of the shoddiness of insurance company practice – in particular their reliance on “embedded value”.
Fortunately these did not include a broadside from Con Keating but I live in fear of the great man’s vitriol when he discovers I was shedding a tear for the life actuary who wrote
Henry, the Embedded Value write offs if the cap comes in at 0.5% will be in the £bns
“Embedded value” is the insurance industry‘s preferred metric to value itself. What happens is they look at their present income streams, project these forward over a number of years and then settle on a nominal valuation based on agreed assumptions.
Sounds familiar? Well of course this is the way we used to value occupational pension schemes until we decided we couldn’t take a view on the future and had to assume the world stopped tomorrow.
Capping the maximum an insurance can take in revenues from its existing book of business has a terrible impact on its value as the valuation is based on this never happening.
Deep inside insurance companies there are of course actuaries who stress test worse case scenarios and capping future income streams sits pretty high up on the list.
It is so scary because , unlike the charging structures of the thirty years preceding stakeholder (where insurers protected themselves through a massive charge on “initial units” purchased in a policy) the pension plans sold by insurers since the introduction of stakeholder pensions need the future contributions to be delivering a healthy margin.
And because the margin increases over time (as the cost of the sale falls away and the value of the management charge increases with the value of the assets) , the whole edifice is dependent on a non-interventionist approach from Government.
Until recently, Steve Webb has been very consoling towards life companies, he has explained to his adoring public that so long as pension plans are like cans of baked beans, we can decide on the price we are going to pay for them by looking along the supermarket shelves and working out the pence per 100g.
I don’t think those who ran the corporate propositions of the life companies were very flattered by the analogy (I don’t suppose the suppliers of superior baked beans were either) but no-one got very worried because the net result was that insurance company’s embedded value was not affected. The warehouses full of baked beans still to be sold would not be marked down.
But then along came Gregg McClymont and Ed Milliband and Ed Balls and their favoured Rottweiler – the OFT – was unleashed. And along came a consultation on a charge cap on the default fund of qualifying workplace pensions.
Which brings me back on topic.
The imposition of a charges cap which impacts on the existing book is analogous to the behaviour of the DWP when it changed the rules for the revaluation of pension scheme liabilities (RPI to CPI). The change fundamentally changes the rules, not just for the future but for the past and it is the retrospective impact of a charging cap on the unprotected pension books of the insurers which is getting them so worked up.
So does this matter. Well yes it does. Any analyst working in the City with an eye on the share-price of an insurer who has written large amounts of unit-linked pension business over the past fifteen years should be getting excited. The analysts should be looking at the embedded value calculations and be working out just how much of the projected future profit is based on income streams of more than 100, 90, 80 ,70 ,60 and 50 basis points.
Because the haircut that they will have to apply to the share price will be based on anything from a number 4 to a number 1 set of clippers accordingly.
And this is the “sins of the fathers” bit. Much of the AMC above 50bps attained by the insurance companies was not retained by the insurance companies, it went straight through the system like a late-night curry and the money is now sitting in the bank accounts of the golf-clubs and the car salesrooms frequented by their distribution teams.
Horrible though it is to contemplate, those who devised, implemented and profited from these strategies are mostly gone, those left to face the consequences are of another generation. Which is why I had some sympathy yesterday.
But the fact remains that the “embedded value” calculations were inflated by some insurers who bought business through the AMC and now face a reduction in the embedded value unless they can argue that the “advisers” are still advising.
There are literally tens of thousands of company pension schemes which have commissions in payment or have AMCs based on commissions already paid, which are now orphaned.
The IFAs have flown the nest, finding RDR too tough either because of the exams or the disclosures or because the “easy money” tap from the insurers had been turned off. And the end of Consultancy Charging is no more than a second lock being put on the door.
There are life companies who did not pay commissions on pensions and those who offered the bulk of their book at prices well below 1% pa. They have little to fear by a pricing cap.
But for those with high historic pricing there is a job of work to do and there will either be compliance or a very good explanation going forward.
But in the meantime, the life companies with large numbers of schemes with highly charged default funds need to be taking immediate remedial action. The going is getting a lot tougher and don’t be surprised to hear some very awkward (public) conversations over the summer.
- What a charge cap would mean for insurers (henrytapper.com)
- Pensions for nothing and advice for free (henrytapper.com)
- Ten sexy stats that drive pension firms wild! (henrytapper.com)
- Making hard easy. (henrytapper.com)
- Those Dutch Pensions – a Civil Servant writes (henrytapper.com)
- Pot noodles member (henrytapper.com)
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