Are stakeholder pensions properly protected?

Your stakeholder pension may not be as well protected as you might think.

I've uncovered a worrying flaw in the compensation scheme underpinning the stakeholder pensions industry. I think it has worrying implications for the many readers with stakeholder pensions. In the weeks ahead, I'm going to try and see if the government can't be prompted to sort out this rather messy situation.

Stakeholder pensions were introduced by the present government in 2001 and have proved to be a popular innovation. Simply put, the 'stakeholder' badge shows that the scheme meets certain minimum criteria in terms of fees and transferability. And -- just to stress this point again -- this is a change brought about by the present government.

I suspect that many holders of stakeholder pensions have never thought about what might happen if the pension provider went bust, but if they were concerned, they might be reassured by the fact that the Financial Services Compensation Scheme (FSCS) covers stakeholder pensions.

For years, the FSCS laboured in a quiet backwater.  It existed, but no one knew or cared much about what it did. That was  until banks and building societies like Northern Rock, Bradford & Bingley, Icesave and Kaupthing Edge started collapsing.

Then many people cared very deeply, and the FSCS helped hundreds of thousands of people get their money back.

Should a provider of a stakeholder pension collapse, then it's the job of the FSCS to organise compensation for those policyholders, too. Such a collapse is unlikely, but so -- arguably -- was the collapse of Northern Rock et al.

How much?

So how much compensation for a pension will the FSCS provide?  I telephoned the press office, and was told the answer: 100% of the first £30,000, and 90% of the next £20,000 -- and that's it.  If you had any more than £50,000 in a collapsed provider's stakeholder pension scheme, and FSCS compensation was required, you've lost it.  In other words, if you've £100,000 in your stakeholder pension, you'll get £48,000 back from the FSCS, should it need to intervene.

That's because stakeholder pensions are regarded as 'investments', I was told, and so are treated differently from older-style pre-2001 'insurance-based' pension products.  These have a different compensation rule: 100% of the first £2,000, and 90% of the remainder -- with no upper limit.  So if you had £100,000 in one of those products, you'd get £90,200 back from the FSCS.

There's a huge difference between £90,200 and £48,000 -- and to labour the point -- this is in a product that has been actively promoted by the present government.  I think it's a scandal.  But wait, it gets worse.

Disbelief

I put the examples above to the very helpful press office at Legal & General.  They're a huge provider of pension products, and nowadays all the pension plans that they sell are stakeholders.  The initial reaction was disbelief, then surprise.  It can't be, they said: our compliance people have checked all this out very carefully.

Phone the FSCS, I said.  Talk to them.  They did, and phoned me back.  And a murky situation became even murkier.

Crucially, a stakeholder pension with Legal & General -- and other insurance-based providers, it seems -- isn't regarded as an investment-based product by the FSCS.  It's an insurance-based product, so is covered by the other compensation rule -- the one that pays out £90,200 if you have a pot of £100,000 with a collapsed provider, and the scale of collapse is such that the FSCS has to get involved.

Nevertheless, said the Legal & General press office, the insurance giant is so worried about the anomaly that I described that its lawyers will be writing to the FSCS to clarify the position.  (As with other providers, Legal & General invests its stakeholder pension savers' money in unit trust-style investment funds -- hence the ambiguity that it realises it needs to clarify.)

So who does get caught out by the FSCS's 'investment-based' stakeholder compensation scheme?  In short, anyone who is saving for their pension with a provider that isn't an insurance company, or offering an insurance-based stakeholder, it seems.

Bank or building society

Bought your stakeholder from a bank, or building society?  I'd be worried if you thought there was any possibility that provider might collapse, with pension liabilities greater than the assets in its fund.

And here's the crucial point.  Imagine two different people, each buying a stakeholder pension at exactly the same time -- one from a bank, and one from an insurance company.  Their investments grow to £100,000.  One is entitled to FSCS compensation of £48,000, and the other to £90,200.  Madness?  I think so.  Especially in seemingly-identical products that have been -- you guessed it -- heavily promoted by the government.

Industry experts are -- frankly -- surprised.  Mark Dampier, head of research at pension provider Hargreaves Lansdown, describes it as "extremely odd."  "An awful lot of people are worried about the security of their money nowadays," he says.  "And if the government doesn't believe that, they're welcome to come and listen to the calls to our help desk."

Now, should you lose any sleep this Easter weekend?  Should you rush out and move your stakeholder pension on Tuesday morning?  No.  Despite plummeting share prices, Britain's banking and insurance giants are in no danger of immediate collapse -- and, as Legal & General stress, its savers' money is securely ring-fenced, all £252 billion of it.

But longer term, the situation needs rectifying.  Nine years after the collapse of Equitable Life, its savers are still battling for recompense.

In short, having promoted stakeholder pension schemes, the government must regulate them properly, making sure that the money is kept securely ring-fenced -- and compensate victims of collapse where that regulation has failed.

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