WALL STREET JOURNAL - August 10, 1998 Britain's Social Security Debacle May Send Warning Signals to U.S.
By STEVE STECKLOW and SARA CALIAN Staff Reporters of THE WALL STREET JOURNAL LONDON -- Anyone suggesting Americans should get a say in how their Social Security contributions are invested might look at the British system. A little scrutiny might help avert a big disaster. Britain's pension industry is reeling from the financial fallout of a decade-old, government-backed program that led millions of Britons to opt out of their public and company-sponsored pension plans and invest the money themselves.
Dubbed the "pension misselling" scandal, it is expected to cost British insurers an estimated $18 billion in compensation payments to nurses, miners, schoolteachers and other workers who were hurt by bad advice. Regulators here have fined insurers and financial advisers more than $7 million for allegedly deceptive sales practices and delays in making settlements. And Scotland Yard is conducting a criminal inquiry to determine whether insurance-company directors bear any responsibility. Final resolution of the mess will take years.
PROTECTIONS NEEDED The debacle suggests that if Americans eventually are allowed to manage part of their Social Security savings, as some people have proposed, the system will "have to be structured in a way to protect people against themselves," says Roberta S. Karmel, a New York securities lawyer. How did Britain slip into such a mess? It all began with a debate over retirement benefits that partly parallels the one now going on in Washington. In the early 1980s, the British became concerned that their own Social Security program would go bust when the bulging population of baby boomers retired. Many also contended that people could earn better returns on their Social Security contributions and might save more if they could invest in equities and other instruments. In addition, the government wanted to encourage labor mobility by correcting a glaring inequity: Many people who switched jobs had their retirement benefits reduced or frozen by their former employers.
The solution -- enacted by Britain's Conservative government in 1986 and put into effect two years later -- was the "personal pension." All workers still would pay into a basic, government-run pension plan, but higher-income workers, who previously also contributed to a supplementary pension program, could opt out of it and manage their own contributions. Employees also could get out of employer-sponsored pensions -- or transfer funds from them -- and invest the money in new personal-pension policies.
PROMOTED HEAVILY Hoping to lure a lot of people out of the costly supplementary plan, the government heavily promoted personal pensions, offering financial inducements and staging an extensive media campaign. One television commercial featured a Houdini-like character tied up in chains and ropes and stuffed inside a sack. "Hello. I've been asked to tell you about the new pension arrangements," the man says, emerging from the sack. As he busts out of his shackles, he proclaims, "At the moment, millions of you are bound by the existing system. But soon you'll have the freedom to choose your own personal pension."
Insurance companies, banks and financial advisers all began pushing personal-pension policies. The insurers were especially aggressive; increasing competition and declining sales of mortgage insurance (because of a crash in the housing market) made them hungry for new sources of revenue. David Hitchcock, a former salesman at the Pearl Assurance unit of AMP Ltd., says the companies viewed the new policies as "a bonanza," thanks to the government endorsement. "All we were doing as salespeople was chasing around selling pensions."
Mr. Hitchcock, a veteran life-insurance salesman who sold pension policies between 1988 and 1991, says his typical sales pitch began with a suggestion that the prospective customer opt out of the government's supplementary pension plan -- a move that actuaries even now say was usually wise. But then, he says, he would ask, "Are you going to stay in your job forever?" If the prospect said no, as was usually the case, Mr. Hitchcock would suggest the client also opt out of his or her company-sponsored pension plan. "The sales pitch was, 'You need a portable pension. You need to take the pension with you from one place to another,' " he says. Then he would offer a personal pension.
OFTEN A BAD DEAL The trouble, actuaries and regulators now say, was that personal pensions usually were a bad deal compared with company plans. Customers often paid hefty upfront commissions and management fees for personal pensions. (Mr. Hitchcock estimates that he once earned nearly $16,000 in commissions in one week.) Even worse, most companies that matched or topped employee contributions in workplace plans contributed nothing to personal pensions. So, a policyholder either would have to make up the difference or get giant rates of return.
Mr. Hitchcock says he and other salespeople, coached by their managers, had a ready answer if customers questioned this: "The returns will be so much higher that it doesn't matter."
That proved to be wrong. Regulators, who failed to realize the scope of the problem until about four years ago, now say many of the more than two million people who quit or didn't join a company plan and bought a personal pension shouldn't have done so, and suffered losses. Pearl Assurance said in June it had set aside nearly $1 billion to compensate thousands of personal-pension buyers. "We were one of the first, if not the first, of the companies to actually admit that we missold pensions, to publicly apologize," a spokesman says. "We accept responsibility." Pearl isn't alone. Joyce Douglas, a Durham schoolteacher, says she quit the teachers' plan in 1990 and purchased a personal pension after an insurer told her the switch would enable her to retire four years early. The company, Abbey Life Assurance Co., is now owned by Lloyds TSB Group PLC, a London-based bank and financial-services company.
FAST-FADING PROMISE "They told me they were investing the money and it would be worth much more than if I stayed in the teachers' plan," she says. "I assumed they were the experts." The promise of early retirement quickly vanished; after all, her employer no longer was contributing 9% of her salary into her pension plan each year. In the end, she says, Abbey paid her $19,000 so she could rejoin her old plan and recoup the money she lost over six years by not remaining in it. An Abbey spokeswoman confirms the settlement, saying, "We take the whole situation very seriously. If anyone has been missold a personal-pension plan, they have been compensated."
But many victims still are waiting. Regulators have forced personal-pension sellers to review more than two million cases to determine whether compensation is merited. Many companies have been slow to act; regulators have fined dozens of them for failing to meet compensation deadlines.
Many insurers were hoping to argue that their personal-pension policies weren't "missold" and that customers, in fact, got sound advice and were responsible for any losses. Under rules that took effect about the same time personal pensions became available, pension sellers were required to "know" their customers by obtaining detailed information from them and provide an adequate comparison between the client's existing plan and a personal one. "It's actually a very difficult actuarial calculation to work out," says Julia Black, a lecturer at the London School of Economics.
Many companies found that their customer records were in disarray or nonexistent, says David Addison, a partner with Watson Wyatt Worldwide, a British actuarial and benefit consulting firm. "That audit trail simply isn't there," he adds. "So, they couldn't produce positive evidence that the sale was compliant even if in practice it had been."
CRITICAL STUDY Indeed, a study that KPMG Peat Marwick prepared for regulators in 1993 found that 91% of 735 personal-pension policy files reviewed were "unsatisfactory" or "suspect" in terms of giving clients appropriate advice. In 35% of the cases, salespeople apparently hadn't even asked at what age the client planned to retire.
Lacking adequate documentation, most large companies bowed to intense pressure from government officials and regulators who fined and publicly humiliated companies that were slow to review cases and make compensation; they decided to pay up and move on. Mr. Addison says many companies now simply assume most of their personal pensions were missold and "go straight into determining loss."
That has been costly, Dr. Black notes. The educator says pension sellers have had to hire teams of consultants and actuaries to calculate compensation. And if an employer refuses to let the policyholder back into a company pension, as some have, the pension seller must promise to pay out, when the client retires, the same benefits the employer plan would have provided. The result, she says, is that some companies will be paying compensation for decades.
In recent weeks, banks and insurers have reported huge charges related to pension misselling, on some days rocking the London stock market. On July 31, Lloyds TSB said its first-half pretax profit fell 11% from a year earlier to $2.09 billion, partly because its provisions for missold pensions totaled $653 million, far more than the $490 million most analysts expected. Its stock fell 7.4% that day.
Regulators and personal-pension sellers have encountered another obstacle in untangling the mess: public apathy. Despite widespread publicity in Britain, about 40% of policyholders haven't bothered to answer letters from life insurers seeking information that could bring them compensation. One reason, surmises Ron Devlin, who is directing Britain's pension review, is that "pensions are absolutely boring" and people pay little attention to them. Another problem, he says, is that, given their past experience, "they don't trust the life-insurance industry and think they're trying to sell them something."
REGULATORY MOVES To help combat such problems, Mr. Devlin's agency, the Financial Services Authority, recently began running a public-service TV ad urging personal-pension policyholders to take action to get their cases reviewed. The ad shows an ostrich that sticks its head in the sand. Mr. Devlin says regulators have moved to prevent misselling in the future by, among other things, requiring salespeople to undergo rigorous training and licensing and clarifying the information they should provide prospective buyers.
Meanwhile, some of the politicians responsible for introducing the personal pensions aren't talking. Former Prime Minister John Major, who served as a Social Security undersecretary in the mid-1980s, declines to comment, "due to the many other pressures on his time," a spokeswoman says. A spokesman for former Prime Minister Margaret Thatcher, after learning the subject matter, declined to pass a message to her and said she was on holiday. And an assistant to Norman Fowler, who as secretary of state claimed credit for the legislation that permitted personal pensions, responded by sending a chapter on pension reform from his 1991 memoir, "Ministers Decide."
The book, which appeared before the misselling scandal broke, declared personal pensions "in many ways the most spectacular success" of the welfare reforms of the 1980s. "The public have been provided with more choices, and have shown that they want a pension which is theirs by right," he wrote.