Examination of Witnesses (Questions 20
to 39)
MR MICK
MCATEER
AND MR
NED CAZALET
25 APRIL 2006
Q20 Mr Newmark: Do you honestly believe
that? Do you think 99% of people in this country really understand
the difference between debt and equity?
Mr McAteer: Yes, I do. It depends
on how it is explained to them. When we surveyed consumers and
we asked them which they preferred, this safe fund or this riskier
fund investing in equities, people did understand the difference.
Q21 Mr Newmark: That is the concept
of safe and risky. Do they understand the concept of debt and
equity or the concept of risk and return?
Mr McAteer: I think ordinary consumers
understand the concept of saving for the future.
Q22 Mr Newmark: There is a big difference
between saving for the future and deciding on asset allocation
choices.
Mr McAteer: The main purpose of
the NPSS is to filter the choices and present consumers with a
simple means of asset classes. No system is perfect. If the alternative
is to go with the ABI model or the NAPF model where consumers
still have to face even more complex choices—
Q23 Mr Newmark: I am still not clear
on what are the advantages and disadvantages as you see it of
giving consumers a wide range of choice.
Mr McAteer: Whenever a consumer
makes an investment decision there are two core decisions they
have to make: they have to choose the particular asset class in
the round and then choose the provider or the investment management
company to implement that decision. If you look at the way stakeholder
pensions are on the up, typically they may have 20 different options
for each provider. They will not do that under the NPSS, they
may have ten different options. There already you see that consumers
are faced with about 500 different options to choose from under
an open market model. If you do that, that means you definitely
need regulated financial advice.
Q24 Mr Newmark: That costs money.
Mr McAteer: That costs a lot of
money in opportunity cost. The point is, it does not add any value
for consumers, actually it destroys value. There has been quite
a sea change over the past few years in the understanding of consumer
psychology around choice. It used to be automatically assumed
that the more choice you had the more effective competition was.
That understanding is now changing when it comes to complex markets
like financial services. If you look at the evidence in America
and Australia and the evidence in Sweden, it shows you that the
more choices you have the less effective the decision-making on
the part of the consumer is.
Q25 Mr Newmark: How can we help consumers
make the choice? Should we load the language with "This is
a safe product" and "This is a risky product"?
Who is making those judgment calls?
Mr McAteer: It would have to be
the regulator. At the moment we have the worst of both worlds,
ie we have a proliferation of options without any clear signals
from the regulator or the Government as to what the inherent risks
are in those different asset classes. With an NPSS scheme, regardless
of which particular model is adopted, we would need to improve
the language, communication and the information provided to consumers
to help them make those choices. When it comes to the basic decisions,
I do not accept that consumers cannot make the distinction between
a risky product over the long term and a safer product. If you
filter down the choices, I think consumers are well capable of
making those decisions on their own. There is a straw man being
created whereby the NPSS means you cannot get financial advice,
but that is nonsense. If you had the NPSS system and people were
not confident about making their own choices on their own initiative,
they could still go and get financial advice. The NPSS is so much
more cost effective than any other model. You could give people
a voucher for £200 each year for the rest of their lives
and it would still be cheaper to run the NPSS.
Q26 Mr Newmark: Do you feel that
the NPSS should be offering more choice or less choice?
Mr McAteer: Less choice.
Q27 Mr Newmark: So less is good in
your view?
Mr McAteer: In this case, yes.
Q28 Mr Newmark: Ned, just comment
quickly on the things we have been talking about.
Mr Cazalet: When you come out
of the Tube at Westminster you walk past Tesco's. Go in there
and ask the people who work there what they think about the relative
merits and de-merits of debt and equity and the fund management
styles around that. Unless you are expecting people to engage
seriously with this then you need a very heavily facilitated or
guided approach to asset management and what that means. I think
to say to people in a sort of no advice world to go out and spend
money in an advice world, here is a choice of 1,000 funds, you
work it out, could well result in opportunities for people running
television programmes on What Fund? monthly. To say that
the consumer is happy grappling with that on day one does not
sound right to me. You will need to guide them and steer them.
Q29 Mr Newmark: Do you think having
some active management funds within NPSS is the best route to
go or not?
Mr McAteer: I think for the core
funds in practical terms you would end up using passive funds
anyway because there is simply no evidence that active managers
can ever deliver persistent out-performance anyway. If you are
appointing the managers on a competitive tendering basis then
my guess is, in the same way as many of the big employers' pension
schemes are now doing, you will use passive management for the
core investment strategy, but you may well appoint active managers
to add a bit of value. I would imagine at the core of the portfolios
would be passive management.
Q30 Mr Newmark: In order to drive
up returns, do you see an active management route as a better
route to go, and should the consumer be paying fees for that?
Mr McAteer: When it comes to UK
equities as an asset class, there is just no evidence that active
management adds any value for consumers. In fact, you could make
a fairly strong statement and say that active management destroys
value in that sense because of the higher level of charges. Active
managers have not been able to outperform the benchmark and this
is a consistent fashion. Therefore, by default, if you have higher
charges that will lead to a lower investment return. If you wanted
to have a core portfolio consisting of UK equities and then modify
that by using active management, I think that would be perfectly
feasible.
Chairman: We have to remember the financial
capability aspect. The FSA sent us information a couple of weeks
ago showing that 40% of people with equity ISAs were unaware that
its value would fluctuate with stock market performance. We have
got a big hill to climb here.
Q31 Angela Eagle: What does choice
mean in this context? We have got the financial services industryand
this Committee has looked at this in the pastwhich is only interested
in the top level of income generated and not the other 90%. Turner
tries to create a circumstance where pension savings for the rest
would be viable, and what we have now seen is a massive scramble
by the same industry, which has completely let down 90% of people
in this country, to try to turn the Turner model into something
else they can leach off for the rest of their lives which will
not create any value.
Mr McAteer: I would absolutely
agree with that. There is an old saying that if it has got four
legs and it looks like a dog and it barks like a dog then it is
a dog. You can dress it up as a cat and call it Tabby or give
it a name like "Partnership Pensions" but all it is
is contracted out personal pensions by a different name. That
is really what the ABI's proposal is all about. You have your
money deducted from your salary and then you have a range of retail
insurance companies competing for you or your employer's business.
That is the thing that leads to mis-selling. That is the thing
that leads to charges being pushed up and then more people being
excluded from the market. I really do believe this is a once in
a decade opportunity to create a pensions system that is designed
from the consumer perspective rather than from the industry's
perspective. In America it has been shown that it can work. The
Federal Thrift Savings Plan disproportionately deals with people
on lower incomes anyway. It shows you that if you gather people's
money together and use that collective principle you can force
the big Wall Street fund managers to act in your interest. That
is what Lord Turner is trying to do here. He is trying to create
a system that makes the City work for consumers rather than expecting
consumers to build their lives around the business models of the
financial services industry. That is the secret of Lord Turner's
proposal.
Q32 Angela Eagle: What is the prospect
of this kind of an approach getting through the morass of lobbying
and slagging off that has happened since Turner was published
and coming to some kind of fruition?
Mr McAteer: You can see from the
reaction of the vested interests that it scares the life out of
them because it fundamentally exposes how inefficient and how
unviable their business model is for delivering value for money,
affordable, decent pensions. They know they cannot do it, which
is why they are trying to damage the NPSS with straw men like
quangos and Stalinist states and what have you. That is what they
are trying to do. They recognise that the NPSS is the best solution
and they are doing everything they can to challenge that. We have
been here before with stakeholder pensions.
Q33 Angela Eagle: Which they did
successfully damage.
Mr McAteer: One of the first reports
I worked on when I joined Which? was looking at personal
pensions and we exposed the value of personal pensions and they
were appalling value. We like to think that that led in some part
to the creation of stakeholder pensions. The original stakeholder
pensions was not the model we have now, it was actually much closer
to the NPSS model or maybe a bit like the NAPF "Super Trust"
model, which is a big collective stakeholder pension scheme, but
the industry lobby got in there and forced the Government to turn
it into a retail product. That is why we are where we are at the
moment. It is not because the prices are too high or too low or
whatever, it is just that the insurance guys were never going
to be able to sell products to people on lower to medium incomes.
Q34 Angela Eagle: Can you take us
through not only the retail aspects of the ABI model but the fact
that they are associated with much larger brand advertising costs
and costs for endless financial advice that goes round and round
in circles and puts costs up? Can you say a little bit more about
what has happened in Australia where this model appears to have
triumphed?
Mr McAteer: In Australia they
have a full-scale compulsory pension system, not the auto-enrolment
that we are proposing here, so in theory the full-scale compulsion
should be even more efficient than auto-enrolment for the reasons
that Ned mentioned earlier on, persistency and so on. We got Watson
Wyatt, the consultancy firm, to look at the costs in Australia
and we found that the ABI version of pensions in Australia cost
about 1.4% a year even with full-scale compulsion. My understanding
is that about 0.5% of that cost alone is down to the marketing
and distribution costs. Even if you have compulsion or auto-enrolment,
the fundamental reality is that you still need all these different
insurance companies competing ferociously to attract your custom
or your employer's custom and the only way they know to attract
that custom is by spending billions of pounds on advertising promotion
or else on commissions and other incentive schemes.
Q35 Angela Eagle: So they try to
get the distribution network to give them the business or they
have to advertise to consumers to give them the business and there
is no value added with all the money spent, that is the basic
point.
Mr McAteer: Yes. As far as I understand
it, the ABI has said there will not be commission paid to independent
advisers and so on. They will still have to offer other types
of incentives to incentivise their staff to try and grab market
share. It does not change the fundamental distribution of pensions.
I think you have hit the nail on the head there. That is the essential
difference between the NPSS and the ABI's model. In fairness to
the NAPF, under their model it puts the consumer in the driving
seat because you are forcing the City to compete with you and
actually drive charges down, whereas under the ABI model as it
is now you still have different individual insurance companies
competing for business and, as we know from history, that drives
up costs.
Q36 Angela Eagle: Ned, you have been
a vocal critic of the current structures of the insurance industry
and how it does its business. What model do you think would most
effectively deliver what Turner wanted? It certainly is not the
retail one.
Mr Cazalet: Let me give you some
hard numbers on the life assurance sector. We do not have the
2005 numbers yet, but if you take the years 2001 to 2004 inclusive,
life companies in the UK spent almost £30 billion on seeking
to acquire new business and that is commission to intermediaries,
it is other upfront costs. This is not to do with administering
the in force business, this is money spent on acquiring new business.
Those numbers are just crazy. The spend runs at about £7
billion a year-on-year-on-year. We expect the 2005 numbers to
be pretty much the same. You have to work out how much that is
for every household in the land. It is about £1,000 or more
for every household in the land. There is something not quite
right here. These are vast amounts of money being doled out to
sustain a model that is quite clearly crumbling away at the edges.
To a great extent this is an industry that is very internalised
with the life companies looking to the intermediaries and the
customer is somewhere over the hedge or in another field altogether.
I think you can take it that this model is economically defunct,
it is crazy. The money is sloshing around the system and people
are chasing each other's tails. I am reminded of the Benny Hill
programme back in the Sixties and Seventies where they all run
round in a circle at high speed. I guess Benny Hill was slightly
funnier than this. One has got a lot of sympathy with the Turner
concept of breaking the mould and saying that competing for distribution
leads you to be bid up in your costs because you have to pay for
distribution. That is not competing for customers, it is competing
for distribution. How can you turn the tables on that? We still
think fundamentally that the Turner model is a nice idea, but
the problem—because we modelled the numbers and remodelled
them—is can you get a private or an infrastructure provider,
whether that is one of the names that Mick mentioned, or even
an insurance company that did nothing else to run that and that
is without the intermediation and so forth? We do not think the
numbers stack up. We have not been challenged back on Turner,
but clearly there is a lower number and clearly it is desirable
from the consumer point of view. We have talked about stakeholder
charges as well being 1%, but they have been jacked up again to
1.5%. Look at what has happened to that half. You have seen one
or two players say now that the charge levels have gone up to
1.5% the great news is we can pay more commission to intermediaries.
Q37 Angela Eagle: That is why we
have to break the mould as it were. How do we break the mould?
Surely we have got to establish some kind of fund like this and
be absolutely resolute about the structure.
Mr McAteer: I think that is absolutely
right. It is at that point where the NPSS offers the real advantage
over the retail model or the ABI's model. In fairness to the NAPF
model, that does deliver some of that bulk buying and competitive
tendering as well.
Mr Cazalet: It is almost pathetic
to say something must be done. I am not sure where the model is
going to emerge from because one of the big key things is infrastructure
and customer connection. If you force a Turner-style approach,
you can argue about the changes, then that will be the way of
breaking it. I do not think you can expect this industry to give
this silly game up quickly. It has been silly for a long time
and I think it is going to be silly for some time yet. A lot of
this stuff is palpably uneconomic. People know the numbers. People
run their models in the life companies. They can see this stuff
does not make money on the existing model but still they do it.
I think it may come down to suppliers of capital in the City.
You would be surprised at how little people know about the internal
workings of life companies. They do not product the sort of charts
which look at how much money companies lost last year. There is
a lot of smoke and mirrors that goes on in terms of financial
presentations and maybe that is something that we can work on
on day one, to say what really is going on here within these large
and important organisations.
Q38 Peter Viggers: I have to declare
an interest as a chairman of a pension fund. I see this as another
chapter in the search for the Holy Grail of a generous, cheap
pension which, of course, does not exist. Have you addressed your
minds to the issue of whether bulk transfers will be allowed in
and out of the scheme?
Mr McAteer: I must confess, we
have not looked in any specific detail at that at the moment,
but our general view is that the NPSS, if it is created around
Lord Turner's proposals, should be as flexible as possible. I
would quite like to see people being able to transfer more money
into the NPSS from existing provision. Is that what you mean?
Q39 Peter Viggers: In bulk transfers
the normal arrangement is for the actuary from whom the fund is
being transferred to discuss with the actuary of the fund which
is being transferred what the bulk transfer value should be and
that is agreed. The pension regulator has been coming forward
with some really vicious valuations on pensions recently. I just
wonder whether, if there is available a public fund like the one
we are discussing and if bulk transfers are allowed in and out,
there is a risk here of a major mis-selling scandal.
Mr McAteer: Speaking as a trustee
of a pension fund as well, I can understand the very complexities
that you are talking about. I would imagine that if the NPSS is
created in the way Lord Turner imagines then it is unlikely to
be a defined benefit scheme anyway. I do not think the complexity
that you are talking about would relate to transfers out of the
NPSS. I expect that the NPSS would be structured in such a way
that would allow transfers in to the NPSS. I think the calculation
of the transfer out from existing benefit schemes is a separate
matter because that really depends on the pensions regulator ensuring
that people who are leaving schemes are being treated fairly and
that the trustees are administering their duty to all beneficiaries
and all members in a fair and equitable manner.
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