Personal finance: The second great pensions scandal - the charges' cut

Regulators are failing to address the basic flaws in an exploitative industry, warns John Chapman

Saving through a personal pension plan should be very straightforward. You pass your premiums over to a company which invests them to achieve a lump sum to buy you an annuity. But the real world is full of horrors.

Pensions companies indulged themselves for years under the noses of the whole shebang of financial watchdogs. That mess is finally being cleared up, but there is a real danger the regulators will now sit back and do little to tackle the basic flaws in this largely expensive and exploitative industry.

Do you know which are the companies with low-charge products offering the best prospect of good returns? I doubt it. In 1993, the Office of Fair Trading (OFT) had a purple patch under Sir Bryan Carsberg and forced through the principle of disclosure of charges, with the help of the Treasury. Sadly, regulators have since failed dismally in putting that principle into practice.

First, they have made a cock-up on what should be disclosed. The "Key Features Document", which should provide clients with the information they need to make their choice, focuses on transfer values - the value of their pension fund if it were transferred to another provider after a given period.

But, in reality, most people do not transfer their funds.Instead, they stop paying premiums and leave their accumulated investments, misleadingly called "paid-up values", in their old fund. These paid-up values can dwindle to nothing, eaten up by mild-looking charges like capital levies and policy fees.

As was pointed out in The Independent last year, it is astonishing it has taken so long to recognise this. In its January 1998 report, the Personal Investment Authority (PIA), the frontline regulator, refers to hidden profit-making on paid-up values, and pledges to extend disclosure to cover them.

Most damagingly, regulators have failed to deliver the true objective of disclosure: comparisons in the financial press of charges in different products, which would filter down to consumers through the general media.

The 1993 OFT report concluded by calling for comparisons of projected (that is to say, assumed) returns after all charges at the early, intermediate and maturity stages of policies. In 1995 I suggested an ABC rating system at these three stages, which features occasionally in the financial press.

But the crucial step of getting the national press to recommend the AAA plans and warn people to steer clear of CCC plans has not been taken by the regulators. As a result, sales of the worst products are still increasing at much the same rates as the best products.

Thirdly, the regulators are behaving shamefully about the high numbers of pension plans that lapse early. The PIA does publish the persistency rates of different companies. These show that, on average, 34 per cent of plans sold by direct sales forces, and 22 per cent of those sold by IFAs, lapse within the first three years. There is tut-tutting about the quality of selling but, much to its discredit, the PIA makes no attempt to bring together the effects of the front-end loading of the often heavy charges and the effects of early lapses.

Analyses I have done for The Independent, the specialist magazine Money Management and World in Action, have shown that on average about a third of people taking out pension plans actually make losses on their transfers or very poor returns on their paid-up values. With some companies I have put the proportions much higher. How can any self-respecting regulator allow these widespread and harmful practices? How can ministers allow such ostrich-like regulators to continue in post? We are dealing here with people saving for their pensions, not buying lottery tickets.

Next week's article will look at the best and worst-performing companies in terms of their charges, together with some proposals on how the overall issue could be improved.

John Chapman, a former OFT official, was closely involved in the debate over disclosure of charges. He is now a freelance writer and consultant.