June 2008

Protect your rights

It may have escaped your notice but April 2008 was the twentieth anniversary of the launch of personal pensions. Without question the arrival of personal pensions changed the course of pension provision in the UK. Whether for better or worse is a continuing debate.

However, one consequence of the introduction of personal pensions was the extension of contracting out to individuals with a defined contribution pension - including personal pensions. This in turn led to the creation of the "protected rights" market - which was encouraged by the availability of a 2% incentive added to the National insurance rebate for five years up until 1993.

Given the time that has elapsed since then it is hardly surprising that the protected rights market has mushroomed to the point where estimates have suggested that the total accumulated funds may now exceed £100billion. I recently conducted a straw poll of around 150 advisers attending an industry event and was not surprised to discover that about 60% of the audience had some protected rights funds. What was a little more surprising was that a number of the audience were unsure of the size of the funds - and even more worryingly quite a few were unsure where the funds were invested. If that is the case with advisers then one can assume that the position is likely to be even worse for the population at large.

Historically it would appear that the investment of protected rights has often been ignored. This may be because many protected rights funds are quite small in size - typically under £50,000 and often less than £20,000. However. there are circumstances - particularly where the protected rights have accrued in an occupational defined benefit scheme - when the value can easily exceed £100,000. Once invested the protected rights can tend to disappear off the investor's - and their adviser's - radar leading to infrequent reviews and potentially sterile investment performance.

Investment options

Obtaining accurate information on where protected rights funds are invested is difficult because there are no published statistics. Many of the protected rights will be residing in funds - both unit linked and with-profits - run by life assurance companies that are closed to new business. Not only may they be off the radar of investors but the management of the funds will often now be in the hands of very different fund managers from those chosen at the outset.

The investment options available for protected rights have also been constrained by the DWP restrictions on the type of organisation able to establish what is known as an "appropriate scheme" - a personal pension scheme which can hold protected rights. Historically SIPPs have been prohibited from holding protected rights on the grounds that the protected rights should not be subject to the degree of risk that can arise from self-investment. Life assurance companies have dominated this market and have tended to make only their own funds available for investment. A few life assurance companies have made a "private" or "self managed" fund option available which allows a wider range of investments to be held.

However, this may be set to change. The DWP is currently considering responses to its consultation paper on self investment of protected rights and some other minor changes. It will publish its conclusions by the end of May and it is widely expected that it will allow "self investment" of protected rights from October. Indeed one or two SIPP operators have already announced that they will accept protected rights transfers in cash now - in anticipation of the change. That may prove to be premature.

Now that SIPPs are regulated and treated in much the same way as personal pensions insurance based specialist SIPP operators are likely to have a much greater financial resources requirement - partly as a result of the ICA provisions - as compared with trust based SIPP operators.

Consequently not only will the solvency levels differ depending on the operator and scheme structure but importantly insurance based SIPPs will usually offer a higher level of investor protection.

It seems entirely reasonable for there to be consistent treatment in respect of the compensation requirements for protected rights funds. Consequently in our view any SIPP operator prepared to accept such funds should be expected to have a capital requirement in respect of those funds at the same level as that expected of life insurers and pay comparable fees to the FSA. This point was overlooked by the DWP in its proposals.

Level playing field

The DWP and others have suggested that proposed changes would "level the playing field" for trust based SIPP schemes. In reality if implemented the rules would tilt the balance the other way putting life insurance SIPP providers at a disadvantage - although perversely under current HMRC rules the charges levied by trust based schemes would be subject to VAT whereas those levied by life company based SIPPs would not!

So advisers need to watch for the outcome of the DWP consultation. If the above arguments are accepted then it could be that the introduction of the changes may be delayed. There is also of course the whole issue of suitability - particularly given the average size of protected rights funds. We expect to hear the outcome of the FSA's thematic review into the suitability of advice given on SIPPs - and particularly transfers into SIPPs - at the end of June. Any subsequent guidance will clearly be relevant to any protected rights transfers.

In the meantime advisers should think carefully when reviewing a client's protected rights investments. Where the client already has a SIPP for other non-protected rights investments with a life company based SIPP provider moving the protected rights onto a self invested basis may make sense.

However. for the foreseeable future the protected rights will need to continue to be accounted for and reported on separately - the DWP proposals did not go as far as allowing a consolidated approach. In other circumstances the adviser may wish to wait until at the very least the timing and detail of any new regime is confirmed - including the regulatory framework and investor compensation arrangements. As ever nothing is simple in the world of pensions.

John Moret
Director of Sales and Marketing
Suffolk Life