Intermediaries need to recognise stakeholder-style pricing models are unsustainable and rethink how their business operates or risk serious financial damage, warns Scottish Life.
Using analysis from a report by Cazalet Consulting, Scottish Life is highlighting what it says are the inevitable consequences of the “stakeholder pricing model”, which operates with only an annual management charge (AMC), and which allows the policyholder to stop contributions or switch to another provider at any time without penalties.
The stakeholder model only works if policyholders keep their plan going for most of its intended lifetime, but Alasdair Buchanan, group head of communications at Scottish Life, says the charging structure means there will almost always be an incentive for the policyholder and adviser to switch to another provider before the “break-even” date.
According to the report from Cazalet Consulting, the financial “break-even” point for typical plans is well over half way through the plan term, with 16 years for a 25 year regular premium plan and 14 years for a 15 year single premium plan.
But, the research shows that barely 50% of plans remain in full force after four years, which has resulted in a hidden decline in “earned premiums” and negative overall cashflow for the life and pensions industry.
Cazalet Consulting describes the commission-based life model as recycling, adding: “so-called new business for the most part is simply pre-existing business that is being switched from one provider to another at a cost of around £4bn a year in acquisition costs”.
It goes on to claim life offices have been pandering to IFAs in a desperate scramble for pension market share, but to do this, providers have been using pricing features, such as very limited commission clawback, which degrades the quality of pension business cashflows.
The worry for intermediaries is, as many have taken advantage of the generosity of life offices with regard to commission levels and contract terms, they have also, to some extent, “come to rely on these unsustainable revenue sources to bolster their businesses”.
The report also claims it is inevitable life offices will have to face reality and when they do, “the consequences could be severe for the revenue flows of some IFAs. So the sooner intermediaries realise the current gravy train is due to hit the buffers and readjust their business models accordingly, the better”.
But the report warns some advisers will not be able to make the transition away from the current commission based model, which will lead to a reduction in their numbers.
Scottish Life says providers will have to move to a sustainable pricing model, or risk serious financial damage.
Buchanan says despite some brave talk about a large market share being the answer, the reality is stark, as the greater the sales of such business, the greater the potential losses for the provider.
The company says it lobbied against the stakeholder charging structure before it was introduced in April 2001 and has consistently voiced concerns about the practical consequences.
“We argued against the increased AMC charges which have been introduced for the ‘Sandler’ stakeholder products, because it’s the shape of the charges, rather than their level, that is the real problem,” says Buchanan.
Scottish Life claims it was the first provider to come up with an alternative to the AMC-only charged products with the launch of their Financial Adviser’s Fee (FAF) commission option in 2003.
Buchanan says: “Some companies have now started to follow our lead, but there are others who seem to believe they can defy financial gravity. The Cazalet Consulting report demonstrates clearly how short-sighted such attitudes are.”
But should other providers take the advice of Scottish Life and move away from stakeholder-style pricing, it could be some IFAs that will suffer.
“One of the unfortunate side-effects of stakeholder-style pricing is that some IFAs haven’t yet recognised that the model is totally unsustainable. It’s essential for these IFAs to understand this point and to urgently rethink the way their business operates,” says Buchanan.
“If they don’t act now, they are likely to be left high and dry when the remaining providers see sense and move to product pricing methods which aren’t going to lose them tens or hundreds of millions of pounds.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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First mentioned in Cridland Report