Memorandum submitted by Which?
SUMMARY OF WHICH? VIEWS ON PENSION REFORM
THE NPSS
1. Which? welcomed the Pensions Commission
report. In particular, we believe the proposal for a National
Pension Savings Scheme (NPSS) represents the best model for reforming
the private pensions market to create a cost-effective and trusted
pension system which provides consumers with the security and
opportunity to save with confidence for the future.
2. In relation to reforming second tier
pensions, we developed a number of key features and criteria we
think are critical to successful reform. These are: cost and affordability;
coverage; security and legal protection; regulation; governance,
accountability and representation; choice; advice, communication
and information; competition; investment risk; investment performance;
consumer confidence and trust; and political risk and sustainability.
We have used these criteria to develop our own version of the
NPSS outlined in the Pensions Commission Second Report and to
assess and compare the models proposed by the IMA, NAPF and ABI.
3. The Treasury Select Committee rightly
has chosen to look at operational costs as one of the key issues
in its inquiry. The cost of providing second tier pensions will
determine the affordability and sustainability of pension reform.
So far, most of the public debate on operational costs seems to
have focused on the costs of administering and collecting contributions.
This is important of course but is important to recognise that
the total costs associated with the various proposed solutions
will depend on more than just collection costs (see below). We
think it is sensible at this stage to identify the crucial factors
or components of the operational charges.
4. Moreover, each of the proposed models
face a number of common challenges. It is too difficult to say
at this stage as some have claimed that the administration systems
associated with one particular model offers a killer advantage
over the others.
5. Our conclusion is that, assessed against
those consumer-focused criteria, an NPSS style pension scheme
is by far the best solution to the pensions challenge the UK faces.
HOW WHICH?
SEES THE
NPSS WORKING
6. Contributions would be directed to NPSS,
and held in individual consumer retirement accounts. Consumers
would have property rights over their assets and would have choice
from a managed range of funds (see below) to suit their attitude
to risk.
7. NPSS would bulk buy investment management
skills from the institutional investment industry—with a
target annual management charge of 0.3% a year—based on
the US Federal Thrift Savings Plan model.
8. NPSS would be governed by group of independent
trustees or board members, consumer, employee, and employer representatives,
legal duty to look after interests of scheme members similar to
the legal responsibilities associated with the US Federal Thrift
Savings Plan.
9. Consumers would receive regular statements
on how their pension was doing.
10. The evidence we have gathered suggests
that the NPSS model would provide access to decent pensions at
a fraction of the cost of other models. For example, we believe
that it would be two to three times more cost-effective than,
say, the model proposed by the Association of British Insurers.
The NPSS concept levels the playing field between the consumer
and the powerful financial services industry. The use of competitive
tendering and bulk buying of investment services makes the market
work in the consumer interest unlike the current system or the
proposed ABI model which is designed to support the business models
of insurance firms.
11. The NPSS model removes many of the conflicts
of interest which have plagued the sales of personal pensions.
The ABI's proposals would still require the use of commission
style incentives, and large marketing and promotional spend if
firms are to compete for market share. In effect, we think the
ABI model is contracted-out personal pensions by another name.
This particular business model leads to long term upward pressure
on distribution costs rather than downward pressure as we have
seen in other countries such as the USA which have adopted NPSS
style schemes.
12. Business practices such as the use of
commission style incentives are the root cause of much of the
misselling seen in the UK over the past two decades. Yet we understand
that the ABI proposals would mean that the sales process would
be unregulated. This would clearly create opportunities for contracted-out
personal pension style misselling which would undermine confidence
and therefore sustainability of pension reform in the long-term.
13. NPSS provides better opportunities for
sharing risk for consumers. It also provides a sensible level
of choice rather than creating the illusion of choice.
14. It is much more secure in legal and
governance terms as the assets would be ring fenced, and overseen
by independent trustees unlike insurance company personal pension
schemes where the firm legally owns the assets, not the consumer.
15. Our research shows that an NPSS type
model is preferred by consumers, whereas the insurance company
model suffers from low levels of consumer trust and confidence.
Indeed, one of the key causes of the pensions crisis in the UK
is this low trust and confidence in pensions. Therefore, strong
independent governance is crucial to restoring confidence. Requiring
consumers to save with the same insurance sector which was responsible
for some of the largest misselling scandals of the past two decades
will be rejected by consumers and would self-evidently undermine
the sustainability of any pension reform.
16. Each of the main models being discussed
face challenges over administration or collection of contributions.
No single scheme has a clear advantage on this score. However,
the main issue is that we get the reform of the pension system
right rather than adopt the proposal which may appear at first
glance to be the "path of least resistance".
17. The ABI model represents major political
risk for the Government in our view not just because of the unsustainability
of the insurance company model. Ceding control to the insurance
industry to run pensions creates a hostage to fortune. The industry
may come in with a low bid to run pensions. But the sector would
then be in a powerful position to raise charges significantly
over time. By that time, it would be difficult for the government
to negotiate with the industry or start again with alternative
reforms such as the NPSS model.
18. We do not see how the existence of an
economic regulator would protect the long-term interests of consumers
and taxpayers. We have been here before with stakeholder pensions.
When first mooted in 1997, the original concept of stakeholder
pensions was closer to the Pensions Commissions recommendations
but the powerful insurance lobby undermined this and we ended
up with a retail personal pension product which the industry couldn't
sell to the governments target market as shareholder expectations
wouldn't allow it. However, the industry still lobbied for an
increase in the stakeholder charges and indeed was successful
in persuading HMT to raise the price cap from 1% per annum to
1.5% for the first ten years (with 1% thereafter). Yet that still
wasn't enough and the industry has been lobbying the FSA to remove
the RU64 rule which would allow charges on personal pensions to
rise above the new stakeholder price cap.
19. The retail pensions industry already
controls the financial futures of millions of consumers. We do
not think it prudent or wise for the government to auto-enrol
yet more millions of consumers into insurance company schemes.
The NPSS represents an ideal opportunity to create a viable and
sustainable mixed economy of pension provision consisting of state,
employers, personal and collective schemes (NPSS).
PART I: FACTORS
AFFECTING THE
OPERATIONAL COSTS
OF NPSS AND
TIMING OF
ANY GOVERNMENT
OR REGULATORY
DECISIONS RELATING
TO SUCH
COSTS
Overview
20. A number of proposals have been put
forward by various parties which claim to meet the objectives
and principles underpinning pension reforms set out by the Pensions
Commission - namely, affordability and economic efficiency, simplicity,
consumer confidence, sustainability, and coverage. The key alternative
proposals being considered include models from the Investment
Managers Association (IMA); National Association of Pension Funds
(NAPF); and the Association of British Insurers (ABI).
21. We are of the view that the model proposed
by the IMA (with some modifications) is the one which provides
the best opportunity for the meeting the key objectives for the
NPSS set out in the Pensions Commission report and for meeting
the principles for reform we have developed (see below).
22. Conversely, we are of the view that
the ABI proposals do not represent the fair, cost-effective, and
secure pensions which are needed if consumers are to have the
confidence necessary for ensuring sustainable pension savings
(see below for details). Measured against those critical criteria
of affordability and economic efficiency, simplicity, consumer
confidence, sustainability, and coverage the ABI model is clearly
not fit for purpose.
23. There are a number of clearly identifiable
component factors to the costs and risks of implementing the Pensions
Commission's proposals—regardless of which model is finally
chosen by the Government. The key cost components are:
— Collection and administration costs.
— Distribution and competition costs.
— Investment management costs.
— Advice, communication and information.
24. We have assessed the NPSS/ IMA and ABI
models against each of these main component charges, below. We
have not reproduced the same analysis for the NAPF model. However,
we believe the NAPF model would sit somewhere between the NPSS
and ABI models at each of those component stages. Therefore, Using
this modular approach we conclude that overall in terms of cost-effectiveness
the main models would rank as follows:
— ABI insurance company open-market
model.
Collection and administration costs
25. We believe that compulsion is the fairest
and most cost effective method of ensuring that enough money goes
into pensions. Soft compulsion (auto-enrolment with an employee
opt-out) has been proposed by the Pensions Commission. Under a
system of auto-enrolment there are a number of identifiable stages
in the collection and administration process. These will not be
exactly the same for each of the key models being proposed but
they are broadly similar.
26. The main stages are:
i. deduction and collection of contributions
from employers and individuals;
ii. maintenance and administration of individual
accounts;
iii. allocation of contributions to chosen
fund/provider and dealing with transfers;
iv. verifying/reconciliation of contributions
(to ensure compliance with contribution requirements and if tax
relief is involved);
v. communication and information to employers/individuals
including regular statements (including liaising with DWP on combined
statements).
27. There are a number of potential mechanisms
for operating each of these stages—in some cases these are
interchangeable. However, in our response we focus on the two
major models proposed—the NPSS model and the ABI open-market
model.
28. In the NPSS model it is envisaged that
stage i) could be carried out by either using the existing PAYE/
NIC system to collect and transfer contributions to the NPSS or
by setting up a new dedicated Pension Payment System. The NPSS
"board" would be responsible for "appointing"
the investment managers to run the pension schemes (which is where
the main cost savings arise, see below). In addition, the NPSS
would be responsible for the administration of stages ii) to v)
but in practice this would almost certainly be outsourced to a
third party. This is how the US Federal Thrift Savings Plan Board
operates the Thrift Plan—it outsources administration to
the Department of Agriculture (check). Closer to home, the National
Savings and Investment Board outsources the administration of
NS&I savings accounts to Siemens. Concerns have been raised
about using the existing PAYE/ NIC system given the time lag between
deductions from payroll and allocation to individual accounts.
However, this can be dealt with using smoothing accounts with
the NPSS collection agency acting as nominee. [45]
29. In the ABI open market model the proposal
is to make use of the existing BACS system to collect and transfer
contributions to individual insurance firms (what the ABI have
termed a "BACS Plus" system). Stages ii) to v) would
be undertaken by individual insurance firms.
30. Much has been made of the supposed benefits
and drawbacks of the different models when it comes to collection
and administration with critics arguing that any centralised "quango"
system would be too risky, costly and slow to implement and that
it makes sense to utilise existing infrastructure. We take the
view that it is very difficult to say with certainty which would
be the best model in terms of efficiency or risk.
31. However, we would make a few points.
We think the efficiency of the open market model is probably exaggerated.
Deconstructing each of the five stages outlined above it is difficult
to see exactly where the open market model is advantageous. At
stage i) it is not clear why a BACS Plus system would be necessarily
more efficient than a modified PAYE/ NIC system. But more to the
point if the BACS system was more efficient then there would seem
to be no reason why this could not be used in conjunction with
the NPSS—after all the objective is to collect and transfer
contributions to funds/providers.
32. With regards to stages ii) to v) we
find it difficult to see how administering the proliferation of
relationships between millions of individual consumers, employers
and individual providers could be less onerous than having some
form of centralised clearing house mechanism—especially
when it comes to dealing with switches and transfers between funds
and employers.
33. One argument for the efficiency of the
open market model is that it makes use of insurers existing administrative
systems. This assumes that insurers are efficient administrators.
It is not clear what the evidence is on this. However, we would
make the point that many insurers have to deal with huge legacy
problems due to closed funds and older life insurance business.
34. In addition, the idea that the insurance
company model avoids the need to deal with a "quango"
to perform centralised administrative functions is simply wrong.
Reconciliation and verification of contributions would still be
required to ensure that employers/individuals are contributing
to the required level and to ensure tax-relief is administered
correctly.
35. Overall, we conclude that it is too
difficult to undertake a precise cost comparison at this stage
between the various models. However, we feel quite confident that
using this modular approach which breaks down the collection and
administration function into different stages the NPSS/IMA model
with its centralised functions and crucially a limited number
of administrative "pathways" between employers, individuals
and providers would in all probability offer possibility for significant
efficiency gains over the open market model.
36. Even if the open market model was able
to provide a more cost-effective delivery model we cannot foresee
a situation where it would be so efficient as to outweigh the
major disadvantage associated with the insurance company proposals,
ie. unnecessary distribution and competition costs (see below).
Distribution and competition costs
37. This is a crucial factor and represents
a key difference between the NPSS/ IMA model which uses bulk-buying
and competitive tendering and the ABI proposals which remains
at heart an open-market competition model where individual insurance
firms will have to compete to attract the custom of individual
employers and employees, consumers.
38. The NPSS/IMA model cuts out unnecessary
marketing and distribution costs. It also removes the "negative"
competition costs associated with the open market model. Even
the existence of auto-enrolment does not get round this major
obstacle to cost-efficiency in the open-market model. It is difficult
to see what would be different under the ABI's proposals—individual
firms would have no option but to use sales incentives for sales
staff (or advisers), and significant marketing and distribution
spending to allow them to compete for business.
39. It is the nature of the open-market
model which leads us to conclude that the ABI would be much more
expensive in terms of distribution and competition costs. We argue
that in essence the ABI model is not much different to the existing
contracted-out personal pensions market.
40. A combination of evidence from the contracted-out
personal pensions market, the Australian market (where the open
market model is used with "full" compulsion, and the
recent experience with stakeholder pensions and child trust funds
leads us to conclude that it is very unlikely that the ABI model
could deliver charges at below 1% a year. Indeed, we think it
is reasonable to expect that charges in time would increase to
over 1% a year. Whereas, we believe the NPSS target of 0.3% is
achievable if the experience of the US Federal Thrift Savings
Plan is anything to go by. The USFTP uses a similar bulk-buying/IMA
model.
41. An economic regulator would not be effective
in maintaining downward pressure on costs in the open-market model
as we have seen from the stakeholder pension experience.
Choice of funds
42. The choice of funds available to employers
and consumers will affect costs. A greater degree of choice will
cost more in terms of administration and distribution. There will
be significant additional costs as employer and consumer choices
and decisions would have to be supported by advice, communication
and information.
43. As with much in financial services the
concept of choice is illusory with proliferation of products and
duplication of choices benefiting product manufacturers and distributors
rather than the end-user. Reduced choice should be cheaper but
the counter to this is that it would limit the choices available
to consumers and employers. We think the challenge is to get the
balance right by offering consumers a sensible, manageable choice
of funds which meets their broad needs without any of the cost
or complexity disadvantages inherent in the open-market model.
The NPSS model achieves this balance (see Annex).
Investment management costs
44. Whichever model is adopted, ultimately
contributions have to be managed by investment professionals.
Again, we see the NPSS/IMA model as being the most cost-effective
model as it uses bulk-buying and competitive tendering to purchase
investment services from institutional fund managers who are used
to operating on efficient margins. This model is the most direct
route to the capital markets unlike the ABI model which involves
a number of layers which carry additional costs.
Advice, communication and information
45. Whichever model is adopted, consumers
will need regular information and communication and in some cases
financial advice to help with decision making. But there are major
differences between the need for regulated financial advice because
of the conflicts of interest involved in the different models.
46. Questions have been raised about how
advice, communication and information would be provided under
the NPSS/IMA model. We believe the need for comprehensive advice
would be very much reduced because of the comparative simplicity
of choices. The advice and communication received would be closer
to that available with employers schemes.
47. Moreover, critically, the NPSS model
does not prevent consumers getting independent advice if they
need it. The difference being that the choices and therefore the
need for expensive comprehensive advice is much reduced. Therefore,
we envisage that the NPSS/ IMA model would have significant spin-off
benefits for the general advice market.
48. We take the view that advice under the
industry open-market model would simply become a euphemism for
selling opportunities. Moreover, the very nature of the open market
model proposed by the ABI introduces conflicts of interest into
the selling process which in turn introduces the need for financial
advice and would require additional consumer protection measures
to control the risk of massive misselling. These conflicts of
interest do not exist to the same degree with the NPSS model.
49. So, overall, we believe that the total
costs of advice, communication and information provision would
be much lower with the NPSS/IMA model.
Regulatory regime
50. We have set out below in answer to the
Committee's second question the key elements of regulation and
consumer protection we think should govern the running of an NPSS/IMA
type scheme. However, the nature and therefore the costs associated
with regulating second tier pensions could differ considerably
depending on which model is adopted. Looking at the three broad
areas of: security and legal protection; regulation (conduct of
business/sales process/promotions); and governance, accountability
and representation we are confident that the NPSS/IMA again offers
considerable cost advantages in addition to superior consumer
protection and governance in the first place.
51. The key cost disadvantages in the ABI
model lie in the need for additional legal and regulatory protection
to compensate for the fact that the ultimate legal ownership of
insurance company assets resides with the firm not the consumer.
This is a fundamental flaw in the insurance company model.
52. It is not wise or prudent to cede control
of the long term financial futures of millions of consumers to
life firms under such a legal structure. We do not believe that
consumers would be willing to invest their long-term futures with
insurance companies on those terms given the litany of misselling
and other scandals which have plagued the industry. This would
ultimately threaten the sustainability of pension reform. Whereas
the NPSS/IMA model would see consumers assets ring-fenced and
held in trust.
53. Moreover, although we understand the
ABI model proposes that in its model the sales process would be
unregulated, we do not think this would be acceptable to the consumer
public. Allowing unregulated sales would undoubtedly undermine
consumer confidence. The same conflicts of interest which were
at the root cause of misselling in the past would remain and would
require regulation of the sales process to avoid contracted-out
personal pension style misselling in the workplace and to promote
consumer confidence. This would further add to regulatory costs
in the ABI model.
PART II AND III: REGULATION
AND POSSIBLE
ROLE OF
THE FINANCIAL
SERVICES AUTHORITY,
ROLES PLAYED
BY FSA AND
HMT IN TAKING
FORWARD PENSIONS
MEASURES
54. There are a number of complex legislative
and regulatory issues to consider in relation to pension reform.
The nature and the extent of regulation very much depends on the
model chosen for delivering the Pensions Commissions proposals
for cost-effective second tier pensions. For example, the FSA
would retain a significant role if the open-market insurance company
model proposes by the ABI was adopted.
55. We are focusing on the following key
issues:
— Legal security and ownership of assets.
— Governance, accountability and consumer
representation.
— General consumer protection measures,
including financial promotions and where applicable regulation
of the sales process.
— Regulation of investment managers.
Legal security and ownership of assets
56. Pension security is crucial in its own
right and if we are to create a sustainable long-term pensions
settlement. Importantly pensions have to be seen to be secure
to maintain confidence in the system. The legal structure of pension
schemes is critical to long-term consumer protection. This in
turn will affect the degree of consumer confidence in reforms
and through this, sustainability of the reforms. As mentioned
above, we envisage the NPSS/IMA model would offer a much better
legal structure either through the use of trust law (as in occupational
pension schemes) or by using established collective scheme provisions
(where assets are held separately by depositaries or trustees
who would have legal duty to act on behalf of consumer. The key
point here is that the assets are ring-fenced and held separately
from financial institutions.
57. In contrast, the existing insurance
company personal pension model leaves consumers vulnerable to
manipulation in the future. What is not often realised is that
when consumers invest in an insurance company product, then the
legal ownership of the assets resides with the firm not the consumer—in
other words consumers don't even own their own assets anymore.
This leaves funds vulnerable.
Competition issues
58. The ABI model envisages a new economic
regulator created to regulate prices on insurance company "Partnership
Pensions". We think this is unnecessary as the competitive
pressures created by the NPSS model would be much more effective
at maintaining competitive pressures on costs.
59. However, it does raise interesting issues
for the non-NPSS personal pension market. If the ABI accepts there
is a need for economic regulation of personal pension prices then
there may well be a case for the FSA to accept this principle
for existing personal pensions.
Governance, accountability and consumer representation
60. Governance is all about ensuring that
interests of all stakeholders are represented and people in position
of power are held to account if they abuse that position. We are
in no doubt as to the significant advantages in terms of governance
offered by the NPSS model which uses collective buying power to
put power in the hands of consumers.
61. In relation to governance, we envisage
that the NPSS would be an independent body run by a governing
board or board of trustees. There are a number of alternative
ways of constituting this body. The first would be to create a
body similar to the National Savings and Investment Board or the
US Federal Retirement Thrift Investment Board which administers
the Federal Thrift Savings Plan. Another alternative would be
a non-Departmental Public Body such as the Pensions Protection
Fund or the Student Loan Company as suggested in the Pensions
Commission Second Report. The third option would be to use a not-for-profit
organisation which the government would effectively outsource
the running of the NPSS.
62. As outlined above, the NPSS would be
managed by independent board consisting of consumer, employee,
employer representatives with an explicit legal duty to look after
the interests of scheme members (along the lines of the US Federal
Thrift Plan Board), and legally accountable to the public. The
precise form of accountability would depend on which option was
chosen.
63. Vested interests are scaremongering
that the NPSS would be vulnerable to government raids in future.
This is nonsense as the NPSS assets would be ring fenced and held
in trust, overseen by independent trustees with a legal duty to
scheme members, consumers would have property rights over their
assets, and would receive regular statements telling them how
their pension was doing.
64. The retail pensions model has very weak
systems of governance and major conflicts of interest. Under UK
company law, directors of firms have a primary legal duty to shareholders
balanced with what we think is a fairly weak regulatory duty to
"treat customers fairly". Shareholders also have legal
rights of access to information which affects their decisions—whereas
ordinary consumers don't.
65. Moreover, as mentioned above, there
are major concerns about the legal ownership structures of insurance
funds. All in all, the major conflicts of interest and ownership
issues mean that it would be reckless in our view to allow firms
who owe a primary duty of care to their shareholders to control
the financial futures of so many millions of consumers—especially
insurance firms.
General consumer protection measures, including
financial promotions and where applicable regulation of the sales
process
66. Whichever model is adopted for investing
contributions, regulation will be needed to ensure consumers are
protected - primarily in relation to financial promotions. It
is difficult to say what precise form this will take at the moment.
But the key difference is that the NPSS is likely to be closer
to occupational pension regulation with the retail model regulation
more or less same as it is.
67. Statutory regulation of the sales process
would still be needed. One of the main reasons regulation is needed
are the conflicts of interest sales people face between the firms
who pay their wages and consumers. These conflicts just do not
exist with the NPSS model.
Regulation of investment managers
68. It is envisaged that regardless of the
model chosen, the investment managers would ultimately be authorised
by the FSA under the current regime.
Role of HMT and FSA
69. The extent of HMT and FSA roles depends
on the nature of the model chosen to implement the NPSS. Our preference
is that due to the advantages presented by the NPSS, the FSA would
have a relatively limited role. The main role being maintaining
the current authorisation and prudential supervision of the investment
managers who would ultimately manage the pension funds.
70. We would imagine HMT retaining a significant
role because of its responsibility as the lead government department
overseeing the operation of the UK financial services industry.
71. A NPSS would have significant effects
on the operation of the UK's financial markets—primarily
investment markets and firms. Therefore, issues such as the competitiveness
and productivity of the UK's investment markets would remain the
primary responsibility of HMT. We are of the view that the introduction
of the NPSS would be hugely beneficial to the functioning of the
UK's investment markets by introducing significant competitive
forces.
72. The FSA may also retain a significant
role in relation to financial capability—but this depends
on how the wider financial capability is taken forward.
73. However, the key roles for HMT/FSA in
relation to NPSS are to:
— prevent detrimental behaviour occurring
in the run-up to the introduction of NPSS. The Committee will
be aware of our serious concerns about the removal of RU64. We
think this will create opportunities for misselling of expensive
personal pensions unless the FSA retains RU64; and
— managing the legacy problems in the
life insurance sector. Regardless of which model is adopted there
are major concerns about the long-term sustainability of the life
insurance personal pension model. The growing number of closed
funds is evidence of that. The introduction of competition into
the pensions market through the NPSS will challenge the business
models of life firms and this will need to be managed by the FSA.
In effect, we are increasingly of the view that a managed, orderly
decline of the sector will be necessary.
Lessons from Stakeholder Pensions
74. There are a number of lessons to be
learned from the experience with stakeholder pensions in the UK—in
terms of choosing the most appropriate pensions model for consumers
and for regulating in the consumer interest.
75. The ABI model represents major political
risk for the Government in our view not just because of the unsustainability
of the insurance company model. Ceding control to the insurance
industry to run pensions creates a hostage to fortune. The industry
may come in with a low bid to run pensions. But the sector would
then be in a powerful position to raise charges significantly
over time. By that time, it would be difficult for the government
to negotiate with the industry or start again with alternative
reforms such as the NPSS model.
76. We do not see how the existence of an
economic regulator would protect the long-term interests of consumers
and taxpayers. We have been here before with stakeholder pensions.
77. When first mooted in 1997, the original
concept of stakeholder pensions was closer to the Pensions Commissions
recommendations but the powerful insurance lobby undermined this
and we ended up with a retail personal pension product which the
industry couldn't sell to the governments target market as shareholder
expectations wouldn't allow it.
78. However, the industry still lobbied
for an increase in the stakeholder charges and indeed was successful
in persuading HMT to raise the price cap from 1% per annum to
1.5% for the first ten years (with 1% thereafter). Yet that still
wasn't enough and the industry has been lobbying the FSA to remove
the RU64 rule which would allow charges on personal pensions to
rise above the new stakeholder price cap.
79. The retail pensions industry already
controls the financial futures of millions of consumers. We do
not think it prudent or wise for the government to auto-enrol
yet more millions of consumers into insurance company schemes.
The NPSS represents an ideal opportunity to create a viable and
sustainable mixed economy of pension provision consisting of state,
employers, personal and collective schemes (NPSS).
March 2006
APPENDIX A
PRINCIPLES FOR REFORM
In our policy report "Blueprint for a National
Pensions Policy" and in our submissions to the Pensions Commission
we set out a number of key principles which we believe need to
inform pensions reform. Any decent pension system should:
— Be universal in its coverage and
provide an adequate retirement income for all.
— Be affordable and sustainable in
the long-term, and have the confidence and trust of consumers.
— Be flexible enough to accommodate
changes in labour-market patterns and lifestyles.
— Be designed to meet consumer needs
rather than let the market determine needs.
— Be efficient, cost-effective and
offer value-for-money.
— Minimise and control risk within
generations and between generations, reform should provide the
security and opportunity to plan for the future.
— Be simple so that consumers can play
an active role in planning for retirement.
— Give consumers a sense of ownership
of their pensions arrangements.
— Promote accountability and responsibility
in government, consumers and industry.
— Be based on a supportive political
framework for long-term pension provision and protect pensions
policy from short-term political intervention.
We note that there seems to be a degree of consensus
developing around the necessary principles for reform. This is
to be welcomed of course. However, we should stress that the choice
of model for reforming second tier private pensions will very
much determine whether these principles are met.
For example, we are convinced that if the Government
chose the model proposed by the ABI, then this would not deliver
the necessary value-for-money for consumers or taxpayers; would
not have the confidence or trust of consumers, and therefore would
not be sustainable.
APPENDIX B
REFORMING SECOND TIER PENSIONS
In relation to reforming second tier pensions,
we have set out a number of key features and criteria we think
are critical to successful reform. These are: cost; coverage;
security and legal protection; regulation; governance, accountability
and representation; choice; advice, communication and information;
competition; investment risk; investment performance; consumer
confidence and trust; and political risk and sustainability.
We have used these criteria to develop our own
version of the NPSS outlined in the Pensions Commission Second
Report and to assess and compare the models proposed by the IMA,
NAPF and ABI.
The Pensions Commission Proposals
— All employees automatically enrolled
into funded pensions with right to opt out. Combined 8% contribution
rate[46]
shared between employer and employee.
— Contributions into either high quality
employers schemes or newly created National Pension Savings Scheme
(NPSS).
— Contributions would be collected
via PAYE or new Pensions Payment System.
Assessing various models for delivering second
tier pensions
It is our view that the IMA model represents
the closest match to the concept set out in the Pensions Commission
Report and developed by Which? In relation to the NAPF model,
we are of the view that this much preferable to the ABI model.
It scores much better than the ABI model on the features and criteria
set out above but does not quite match the benefits of the NPSS/
IMA model.
We have included a summary of this assessment
below which compares Which?'s model of NPSS compared directly
against the ABI's model. We would be happy to submit a similar
summary of our analysis of the NAPF model if it was helpful to
the Committee.
Therefore, in rank order we would argue that
the models which offer the best opportunity for creating sustainable
reform are:
The ABI model in our view is fundamentally unsuited
to the challenge of providing value for money, secure pensions
that consumers have trust in. Based on UK and international evidence
we think that the ABI model would be two to three times as expensive
to manage and operate as the NPSS/ IMA model (and this is before
the additional legal and regulatory costs that would be needed
if the ABI model was to be anywhere near trusted by consumers—see
below).
As the table in Annexe A shows, our recent survey
found only 11% of consumers would trust financial services firms
such as insurance companies most vis a vis other options
to manage their pensions. This is perhaps not surprising given
the litany of misselling scandals the insurance industry has been
responsible for.
However, we understand from the ABI's proposals
that the model envisages that the sales process would be unregulated.
This concerns us as the ABI model involves selling at the workplace
to employers and employees and to individuals. This raises the
spectre of the contracting out episode where insurance sales staff
persuaded employers/ employees to contract out into personal pensions.
At least in the case of contracting-out, consumers who have a
legitimate claim for misselling (if they were missold) can claim
redress. Under the ABI's proposals it is likely that consumers
rights to redress would be severely curtailed if the sales process
was unregulated. This is in itself would be unacceptable but the
critical point is that the absence of a regulatory deterrent (in
the form of redress) would encourage more unscrupulous firms to
make unsuitable sales. This is in turn would encourage the rest
of industry to follow suit for fear of losing market share to
more aggressive firms.
One of the major weaknesses in the ABI's proposals
is that the very concept introduces the need for regulated advice
(and indeed unnecessary distribution costs). Competition for business
and market share in this open-market model will by its nature
require significant incentives for sales staff, promotion and
marketing spend if individual firms are to attract the custom
of employers and individuals. The use of incentives by definition
introduces conflicts of interest into the sales process between
the interests of the firm (and the sales representative) and the
consumer. Conflicts of interest in our view are the root cause
of much of the misselling we have seen in the UK over the past
two decades. This in turn requires regulation of some form to
try to ensure that the consumer interest is not overridden by
the commercial interest of the firm/ sales person.
This conflict does not exist in the NPSS/ IMA
model as it fundamentally changes the nature of competition and
distribution for business. Using bulk-buying introduces huge economies
of scale and, critically, institutional investment managers would
be competing directly to the NPSS thereby cutting out the "middle
man".
We do not believe that the introduction of auto-enrolment
would be sufficient to allow the insurance sector to reduce costs
to anywhere near the level possible under the NPSS/ IMA model.
As mentioned above, the ABI model will still require substantial
incentives, marketing, and promotional costs if individual firms
are to compete successfully in what will be a very lucrative market.
Sustainability and long-term risk
This lack of trust and confidence must call
into question the sustainability of the ABI proposals. The ABI
model poses significant long-term risks for consumers (and society
in general) as the legal structure of insurance based pension
schemes means that the ultimate ownership of assets resides with
the firm not with the consumer. The insurance industry already
controls the assets of millions of consumers. We do not think
it is prudent or wise for the Government to allow the insurance
sector to control the long-term financial futures of yet more
millions of consumers.
Moreover, once consumers are made aware of the
ownership implications of being auto-enrolled into insurance company
based pensions then this would exacerbate the trust and confidence
problems. It is perhaps not sensible for the Government to try
to soft-compel consumers into insurance company pension schemes
which would further undermine sustainability.
It would of course be possible to address these
legal ownership/ structural issues by introducing major additional
legislation and regulation. However, this would involve significant
additional expense to add to the cost inefficiencies built into
the ABI model.
Political risks
Much has been made of the political risks attached
to the various proposals for second-tier pensions. Indeed, each
of the models proposed do present risks and challenges in relation
to set up costs and implementation.
However, we see no particular advantage or disadvantage
in any particular model in respect of these issues. Each of the
main proposals will involve some set up costs and will take some
time to implement. It is not possible to quantify with absolute
accuracy what those costs are or the time taken to implement reform.
The Pensions Commission report contains the best independent estimate
of set up costs based on international experience. Moreover, we
are persuaded by the IMA's proposals for a centralised clearing
house.
The ABI's contention that its proposals build
on existing systems and therefore represent least risk for government
are exaggerated in our view. Even if it was possible to create
a BACs Plus system to collect and administer contributions it
would still require some form of centralised administration to
verify contributions.
The critical point is that the necessary time
should be taken to implement the necessary administration reforms
properly.
However, we believe that the greatest political
risk comes not from implementation or administration but from
allowing the insurance industry to gain control of long-term pensions
assets. The ABI is arguing that it can deliver low-cost pensions.
Our research and other independent reports suggest that insurance
firms are unable to deliver pensions on low-cost basis. So, even
it was able to drastically reduce total costs from the existing
level at the outset, this is likely to be on a loss leader basis.
The sector would then be in a powerful position to raise charges
significantly over time. By that time, it would be difficult for
the government to negotiate with the industry or start again with
alternative reforms such as the NPSS model. In effect, the government
would be creating a hostage to fortune.
We do not see how the existence of an economic
regulator would protect the long-term interests of consumers and
taxpayers. We have been here before with stakeholder pensions.
When first mooted in 1997, the original concept of stakeholder
pensions was closer to the Pensions Commissions recommendations
but the powerful insurance lobby undermined this and we ended
up with a retail personal pension product which the industry
couldn't sell to the governments target market as shareholder expectations
wouldn't allow it.
However, the industry still lobbied for an increase
in the stakeholder charges and indeed was successful in persuading
HMT to raise the price cap from 1% per annum to 1.5% for the first
ten years (with 1% thereafter). Yet that still wasn't enough and
the industry has been lobbying the FSA to remove the RU64 rule
which would allow charges on personal pensions to rise above the
new stakeholder price cap.
46 Employer 3%, employee 4%, 1% from state making
8% of earnings above the Primary Threshold.
APPENDIX C
Table 1
TRUST IN PENSION SCHEMES
Organisation most trusted to manage pension savings
(base: 1,104 adults 15+ working/seeking work)
Organisation
| Percentage of respondents |
EITHER an independently-run financial organisation
OR A non-profit making independent body
| 40% |
| A non-profit making independent body | 26%
|
| The Government | 20% |
| An independently-run financial organisation like National Savings and Investments
| 14% |
| The Financial Services Industry (eg an insurance company)
| 11% |
| Would trust them all equally | 6%
|
| None—I wouldn't trust any of them |
13% |
| Don't know | 11% |
| |
APPENDIX D
Table 2
COMPARISON OF FEATURES OF NPSS STYLE PENSION SCHEME AND
ABI/OPEN MARKET MODEL
Features |
NPSS
| Open market personal pensions model
|
| Cost | |
|
Access costs are crucial in pensions. If consumers are to provide for the future then the Government needs to look objectively at which model provides the most efficient and cost-effective access. Unnecessary costs reduce the final value of people's pension funds.
Choosing the right pension vehicle is important for the taxpayer as well as the consumer given the amount of tax relief we spend in the UK encouraging provision.
Even under auto-enrolment, the government will retain tax-relief. Higher cost pensions would waste this tax relief.
| The Pensions Commission estimates that with bulk buying and economies of scale costs will be in region of 0.3% a year. The NPSS model, with a co-ordinating independent body appointing the fund managers using bulk buying and competitive tendering, provides huge economies of scale and removes the need for marketing and promotional costs.
In addition, the NPSS model allows for centralised administration of contributions.
| More likely to be in region of 1.3% a year. This would have effect of reducing value of individual pension fund by 30% (all things being equal). Even with auto-enrolment the retail model is too expensive due to the huge marketing and promotional costs hundreds of financial firms would spend competing to persuade millions of individual consumers to choose their particular employers and products and funds. Retail firms would still need to pay high commission to advisers to get them to recommend their products. The retail model would be fragmented and would not achieve the necessary economies of scale. And statutory regulation of the sales process would still be needed.
|
| Security and legal protection |
| |
Pension security is crucial in its own right and if we are to create a sustainable long-term pensions settlement. Importantly pensions have to be seen to be secure to maintain confidence in the system.
| Vested interests are scaremongering that the NPSS would be vulnerable to government raids in future. This is nonsense as the NPSS assets would be ring fenced and held in trust, overseen by independent trustees with a legal duty to scheme members, consumers would have property rights over their assets, and would receive regular statements telling them how their pension was doing.
| In contrast, the existing insurance company personal pension model leaves consumers vulnerable to manipulation in the future. What is not often realised is that when consumers invest in an insurance company product, then the legal ownership of the assets resides with the firm not the consumer—in other words consumers don't even own their own assets anymore. This leaves funds vulnerable.
|
| Regulation | |
|
| Whichever model is adopted for investing contributions, regulation will be needed to ensure consumers are protected. It is difficult to say what precise form this will take at the moment. But the key difference is that the NPSS is likely to be closer to occupational pension regulation with the retail model regulation more or less same as it is.
| Under this model, there would need to be some form of regulation of the NPSS but it would remove the need for regulating the sales process we currently have. It would be closer to the regime we have for the workplace and employers schemes.
| Statutory regulation of the sales process would still be needed. One of the main reasons regulation is needed are the conflicts of interest sales people face between the firms who pay their wages and consumers. These conflicts just do not exist with the NPSS model.
|
| Governance, accountability and representation
| | |
Governance is all about ensuring that interests of all stakeholders are represented and people in position of power are held to account if they abuse that position.
We are in no doubt as to the significant advantages in terms of governance offered by the NPSS model which uses collective force to put power in the hands of consumers.
| As outlined above, the NPSS would be managed by independent board consisting of consumer, employee, employer representatives with an explicit legal duty to look after the interests of scheme members, and legally accountable to the public.
| The retail pensions model has very weak systems of governance and major conflicts of interest. Under UK company law, directors of firms have a primary legal duty to shareholders balanced with what we think is a fairly weak regulatory duty to "treat customers fairly". Shareholders also have legal rights of access to information which affects their decisions—whereas ordinary consumers don't.
Moreover, as mentioned above, there are major concerns about the legal ownership structures of insurance funds. All in all, the major conflicts of interest and ownership issues mean that it would be reckless in our view to allow firms who owe a primary duty of care to their shareholders to control the financial futures of so many millions of consumers—especially insurance firms.
|
| Choice | |
|
There are two main stages in the "decision making process" when selecting a pension scheme[47]. First, is choosing type of assets/fund(s) which suit attitude to risk, trade off between risk/ return. Second, the actual investment manager must be chosen.
Evidence strongly suggests that too much choice is as detrimental as too little choice in undermining effective decision making by consumers in complex areas such as pensions[48].
| Consumers would have a choice of a default fund[49], guaranteed fund[50], managed fund[51] and higher risk fund[52]. However, the NPSS would appoint the investment managers to run these funds using bulk buying and a competitive tendering process—so individual consumers wouldn't have to choose the managers themselves.
We think that the NPSS model offers consumers a sensible, managed choice—providing security and opportunity to maximise the potential of pension contributions.
| The main difference between the NPSS and retail model appears to be that individual consumers would have a wider range of fund and provider choices. But this choice is an illusion in our view.
The actual decision making process is still more or less the same—the difference being that under the NPSS scheme the choice is intermediated while in the retail model consumers have to choose from a wide range of individual funds and providers, and will probably need financial advice so adding to costs. The crucial point is that this wider choice comes at a much higher cost because funds are fragmented, economies of scale are lost, and consumers end up paying for marketing and distribution costs out of charges levied on the funds. But the higher costs do not provide consumers with any advantage in return through higher performance (see below).
|
| Advice, communication and information
| | |
Whichever model is adopted, consumers will need regular information and communication.
But there are major differences between the need for regulated financial advice because of the conflicts of interest involved in the different models.
| Questions have been raised about how advice, communication and information would be provided under the NPSS model. We believe the need for comprehensive advice would be very much reduced because of the comparative simplicity of choices. The advice and communication received would be closer to that available with employers schemes. Moreover, critically, the NPSS model does not prevent consumers getting independent advice if they need. The difference being that the choices and therefore the need for expensive advice is much reduced.
| We take the view that advice under the industry open-market model would simply become a euphemism for selling opportunities. Moreover, the very nature of the open market model proposed by the ABI introduces conflicts of interest into the selling process which would require additional consumer protection measures to control the risk of massive misselling.
These conflicts of interest do not exist to the same degree with the NPSS model.
|
| Competition | |
|
| The investment markets in the UK are huge but there is a world of difference in terms of competition between the institutional and retail investment management sectors. In the institutional sector competition works to make charges competitive while in the retail market more choice and competition puts upwards pressure on costs.
| The NPSS model would have beneficial effect on competition in the financial services industry. In the USA, the use of a coordinating body awarding the tenders for large scale investment management contracts forced large institutional investment firms to compete fiercely for business which drives costs down.
The essence of the NPSS is collective consumer power making markets work in the consumer interest.
| The UK retail model has been heavily criticised for ineffective competition. What competition there is, is for distribution, not the consumer which pushes up costs. Even with auto-enrolment, having large numbers of individual firms competing to attract the custom of millions of consumers requires huge sales commissions, advertising and marketing budgets. Most people now accept consumers have very weak influence in retail pension markets.
|
Investment risk |
| |
One of the major causes of the lack of trust and confidence in the pension system has been the volatility of stockmarket based pension schemes. Consumers risk seeing their income in retirement reduced if they retire at the "wrong time"[53].The demise of the final salary scheme transfers risk to consumers—new ways of sharing risk are needed to restore confidence and trust.
Our consumer research shows that consumers want a high degree of certainty about their pension returns.
| There is no real difference between the basic investment strategies (or asset allocations) the NPSS and retail model could offer consumers—lifestyle/smoothed managed, guaranteed, adventurous and so on. The question is: which model is most efficient at managing the risk?
Advocates of the retail model argue that advisers and sales staff would be able to advise consumers on choice of investment strategy. This is true—but this comes at a huge cost and there is no evidence that these advisers are more effective at choosing appropriate long-term investment strategies. Moreover, one of the key reasons the retail sales process needs to be regulated is to try to minimise the risk of advisers recommending products which don't suit the consumers risk profile.
Finally, we think the NPSS model allows more cost-effective bulk buying of risk management techniques from the institutional fund manager sector so that consumers can have the greater degree of certainty they want.
|
Investment performance |
| |
| As well as depending on the amount contributed, the value of pension funds depends on three main factors—the asset allocation, charges and investment performance of the fund managers.
| It is not possible to say with certainty that one particular model on average will deliver superior investment performance—past performance is no guarantee of future performance etc. It may well be that given the wider range of individual retail funds, a small number of consumers from time to time will get a higher return than the "average" NPSS saver. However, it is more likely that the majority of savers would do worse than they would do under the NPSS model due to the effect of charges.
All things being equal the NPSS should provide better net returns for consumer due to the lower charges (see above).
Moreover, we think that even though past performance is no guide to the future, the NPSS approach has a better change of delivering superior returns than the retail model—primarily because the competition to win the contracts for the assets will be so fierce that major institutional investment firms will want to put their best fund managers on the job. As well as economies of scale, this is another advantage we see in the collective approach to pension provision. It makes the markets work in the consumer interest.
|
|
| |
45
See IMA working paper, Individual Retirement Accounts: a discussion
of technical issues, Appendix 1 para 6. Back
46
Employer 3%, employee 4%, 1% from state making 8% of earnings
above the Primary Threshold. Back
47
see Pensions Commission Second Report, p68-69. Back
48
probably an equity fund. Back
49
There is the decision on how much to contribute of course but
we ignore this for now in an auto-enrolment system. Back
50
This would be either a lifestyle fund where investors are switched
from equities to government bonds and cash the closer they get
to retirement, or a smoothed managed fund (a modern version of
with-profits funds without any of the disadvantages). Individuals
could choose whichever type of fund suited them but if they didn't
make a choice, their contributions would go into the default fund. Back
51
this would be invested in cash and government bonds. Back
52
a mix of UK and international equities, bonds and cash. Back
53
figure from the Pensions Commission. Back
| 
