25th September 2013
As an investor, have you ever had an encounter with a closed insurance company? It is not closed like a high street shop, not the financial equivalent of an empty shuttered building. Closed funds are not taking in any new money but they still manage billions of pounds worth of investors’ cash.
Now there is a chance these funds could be opened up as a result of the OFT inquiry into defined contribution workplace pensions. On Mindful Money we have already written a considerable amount about this review. The regulator found that many old schemes were charging a lot more than current market norms. And some of this money is with closed book insurers. The OFT is primarily concerned with making sure the UK’s pensions are fit to take the money of many millions of employees (and their employer’s money) in the new auto-enrolment workplace reforms. But as a bonus, it could represent the first real shake up closed funds have faced in years and that has to be good news.
Many millions will have money invested in these closed funds, and it isn’t always the most pleasant experience. You may have had your pension or one of several pensions, a with profits bond or even an endowment policy invested with such a firm, perhaps on the recommendation of a financial adviser many years ago. Of course at the time when you invested the company and the fund would have been open for business.
Yet a look at the trouble shooting pages of the personal finance pages will show that many policyholders are unhappy. Financial planners today tell Mindful Money that their clients have, generally, had a bad time from these firms. It is difficult to get a valuation for what is invested which can make financial and investment planning all that more difficult. If it’s a pension, when it comes to purchasing an annuity, some closed offices are slow to transfer the cash and in the very worst examples they can risk the investor/annuitant missing out on a better rate. That could amount to a permanent cut in someone’s pension.
What is also alarming is the signals these funds send to the City and institutional investors. Sometimes City journalists claim these businesses ‘throw off cash’. This can benefit shareholders but what about policyholders who are also ironically indirectly investing in equities themselves through these funds. It is instructive that those City journalists’ colleagues in the personal finance pages dub them zombie funds.
Now briefly, here is a little bit of history, to put all this in context. In the 1990s and early 2000s lots of insurance companies were faced with huge business challenges. The government forced down pension charges. There were several scandals and fiascos such as that involving endowment mortgages. Equitable Life nearly collapsed around the turn of the Millennium trapping many investors in an underperforming fund. The financial watchdog, then called the Financial Services Authority also brought in new rules making sure that the insurance firms followed a relatively conservative investment strategy – effectively by not holding too much in equity – so that there was no risk that any would collapse as Equitable nearly did– and which would have been just about the worst of all worlds.
One unforeseen consequence was that many insurance businesses that were open decided to close. They would no longer pay commissions and could scrap the advertising and marketing budget. They could also cut back dramatically on staff. They would not have to bear the strain of taking on new business by setting aside more capital. They could devise a new lower cost investment strategy.
All this may well have made sense. But there is a downside. Big insurance funds whether they are open or shut are collective undertakings. The funds were and are run to meet all sorts of different goals and promises. Sometimes they provide life insurance. Sometimes they promise smoothed investment returns either inside or outside a pension. Sometimes those pensions are workplace schemes sometimes individual. These days, using a big life fund for such different purposes is very much out of fashion. But as we say, they are still very much a feature of today’s investment landscape.
The directors and the actuaries have to make sure that there cannot be a run on the fund. They can levy penalties if you withdraw cash early to defend the interests of other policyholders. They have to report all this to the regulators – these days the Financial Conduct Authority and the Prudential Regulatory Authority.
All this may be necessary, yet to our mind, they haven’t had to justify these policies. As much as penalties may make sense, it is their actuaries that determine how high they are. How can we be sure they are being fair? It is the company that decides what fund management and administrative charges to levy. These will inevitably come out of investors’ pots of money. And as we noted earlier some financial journalists believe these businesses throw off cash. Remind us. Whose cash is that?
Now transferring isn’t always a no-brainer. Some of the guarantees policyholders bought into perhaps a couple decades ago or more can be very valuable today. Essentially these insurers mispriced a lot of things, and a guaranteed inflation proofed pension may be incredibly valuable at today’s prices.
Yet we also know that millions would probably have transferred their money somewhere else without those penalties. We think it is time they funds were sense checked. And this OFT inquiry may provide the opportunity. Closed funds should have to justify publicly and transparently, what they charge and whether the penalties they levy are really protecting other policyholders. And if the OFT doesn’t open these firms up, the other financial watchdogs need to do so.