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SERPS mis-selling


Patrick Kelliher

In recent weeks, ads for a SERPS misselling claims company have popped up frequently on my Facebook page [1]. Not content with mortgage endowment and PPI misselling, ambulance chasers are also looking at contacting-out sales as a source of claims and fee income. Just how serious a threat is this ?

At the heart of the misselling claims are appropriate personal pensions (APPs) used to contract out of SERPS [2]. The government paid National Insurance rebates into the APP but in return, a deduction would be made from SERPS benefits in respect of the period contracted out. When contracting out through APPs was introduced in 1988, the rebate did not vary by age, whereas the value of SERPS benefits foregone increases with age, so contracting out was generally expected to be beneficial for younger people below a “pivotal age”. Although rebates were then changed to be age related, the expectation, based on assumptions for investment returns and life expectancy, remained that contracting out would still be beneficial for younger people. Life insurers assessed pivotal ages every year and wrote out to APP policyholders over this age encouraging them to contract back in to SERPS.

The FSA looked at SERPS misselling 10 years ago, commissioning a report into those contracting out of SERPS through APPs in 2005. This report by Oxford Actuaries and Consultants (OAC) found significant shortfalls in APP funds relative to the value of SERPS benefits foregone, depending amongst other things on whether customers had contracted back in to SERPS [3]. However the OAC report did not assume any change to SERPS benefits whereas we now know that SERPS is going to be phased out in favour of a higher state pension of ca.£151 per week.

Still those who have contracted out will see a deduction from this in relation to the period they were contracted out [4]. Furthermore, while OAC generally valued benefits at retirement using a real yield of 2% p.a., current real yields are ca.0% p.a., which would increase the value of any state pension foregone relative to APP funds built up from contracting out. These funds would also have suffered from poor returns during the financial crisis. It is likely that shortfalls persist on many of the 8m APPs used to contract out of SERPS.

As to whether these policies were missold, the FSA’s conclusion in 2007 after it had finished its investigation was that there was no evidence of widespread mis-selling [5]. No doubt this was based on the fact that contracting out was presumed to be beneficial for those below pivotal ages. The FSA did identify 120,000 policies (1.5% of the total) which were sold to people over pivotal ages but noted there may have been legitimate reasons for this.

The following year, the Financial Ombudsman Service (FOS) highlighted a claim for SERPS misselling which it had rejected in part because the complainant was below the pivotal age [6]. FOS have generally rejected SERPS misselling claims, upholding only 2% of these in 2014/15 [7].

So does that mean SERPS misselling is insignificant? Well there has been a slight uptick in FOS uphold rates and some of the awards are significant - £71,000 in one instance. Some low level of SERPS misselling losses may be expected to persist.

However this could change if FOS and/or the FCA change their view of SERPS sales. After all, many of those who contracted out may have lost out due to low bond yields brought about by QE, poor investment returns and rising life expectancies. I am sceptical as to whether these risks were explained properly to those contracting out. I also doubt if advisers, let alone customers, fully understood the SERPS benefits being given up. Even if the customer was below the pivotal age, the advice to contract out could still have been flawed. Given the number of APPs, any such change in view could be very expensive for advisers and for insurers responsible for appointed representative sales.

As well as the potential scale of SERPS misselling, another issue is the latent nature of exposure, which may take many years to emerge. Few people will realise they have lost out from contracting out before they come to retire. Unlike mortgage endowments, where time-bars have been triggered by issuing warning letters of shortfalls and where the scope for future claims is limited, I could see SERPS misselling claims continuing to be a potential threat for some time [8].

Finally, even if there is no issue with contracting out sales, there could be an issue for life insurers in terms of post-sale advice and information given to customers. I have written in previous blogs about FSA PS07/11 on “Responsibilities of providers and distributors for the fair treatment of customers” [9] and the potential implications for providers such as insurers. This includes post-sale responsibilities (see pgh1.21 of PS07/11 regulations) including “…to check whether the product is continuing to meet the general needs of the target audience that it was designed for, or whether the product's performance will be significantly different from what the provider originally expected and communicated to the distributor or customer at the time of the sale”. Contracted out policies could be said to be significantly under-performing against original expectations that contacting out would be beneficial given the reality is that many have lost out.

If this occurs “…the provider should consider what action to take, such as whether and how to inform the customer of this (to the extent the customer could not reasonably have been aware), and of their option to seek advice, and whether to cease selling the product”. Insurers have generally been proactive in encouraging customers to contract back into SERPS but there is a risk that the FCA may feel that some insurers have not done enough to make customers aware of under-performance. In extremis, insurers could be asked to contribute to shortfalls in APP benefits relative to state pension benefits foregone.

To conclude, notwithstanding the efforts of ambulance chasers, exposure to SERPS mis-selling losses is likely to be modest, but there are tail risks in terms of the regulators view on how contracting out policies were sold and the adequacy of post-sale communications.

[2] SERPS was replaced by the State Second Pension in 2002 but I shall use SERPS to refer to both.
[4] For more details on the new state pension, see with details of how contracting out affects this set out in:   
[8] Though not if FCA allows a15 year “long-stop” limitation on claims consistent with the Statute of Limitations for torts.

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