1. The choice of funds
The Second Report of the Pensions Commission recommends a new National Pension Savings Scheme. This is progress because it is a recognition that a new national scheme is needed. The problem is that the particular scheme proposed is a market-based saving scheme, rather than a non-market pension scheme.
The existing financial industry, that is the industry regulated by the FSA, should have as little to do with the new scheme as possible. The Report refers to: "The range of investment fund choices made available." (page 402).
"NPSS to bulk negotiate a range of 6-10 funds and to allow access to a wider range of funds." (page 37)
To include:
"three to five bulk-bought indexed funds similar to those offered by the Federal Thrift Savings Plan" (page 103)
However on page 376 it is not so sure whether there will be access to the other funds beyond the "range of 6-10 funds"
"These funds could either be the totality of the NPSS system, or could be combined with the ability to offer other funds at non-negotiated fees."
There should arguably not be a choice of funds:
"However the National Pension Savings Scheme is set up ,there will be serious difficulties in ensuring a cost-effective system for funneling money from members - employed or not - into the right funds at the right time." x
Funds should all be internal rather than external. This means that the organisation running the scheme has its name on the share and bond certificates of the investments of the scheme and receives the dividends and interest.
Figure 10.7 explaining NPSS shows flows of money to external "fund managers" on the right. I refer to them on this website as "fund management companies". They not only manage but also control investment funds. The term "fund manager" is not defined in the Glossary of the Second Report. NPSS seems to be a recipe for handing over control of pension funds to fund management companies.
2. Criteria for choosing between funds
The First Report said:
"The retail financial services industry has lost the trust of customers as the result of a series of scandals and mis-selling problems (such as pension mis-selling, endowment mis-selling, Equitable Life, spilt capital trusts)." (page 214)
The Second Report says:
"Many do not trust the financial services industry to sell good value products." (page 27)
It is more serious than "loss of trust". Many people consider that they have been defrauded. x
The fund management industry cannot be trusted not to impose hidden charges. An example discussed on this website is the non-declaration of stockbrokers' commission in the accounts of unit trusts and OEICS. x
Yet even though the Pensions Commission says that the industry is not trusted, it wants the funds to be managed by the industry!
The Second Report discusses the Swedish Premium Pension scheme (PPM). Most of the funds in this scheme are not managed by private sector fund management companies, but by the public sector Seventh Swedish National Pension Fund. This is invested 82 per cent in global equities, 10 per cent in Swedish index-linked bonds, 8 per cent in alternative investments. An advantage of such in-house funds, rather than the funds being located with external fund management companies, is that it is possible to avoid implicit costs. The Second Report says that "over 90%" of new PPM members are joining the default fund (page 374).
It has a low fund management charge of 0.15% and a better than average investment performance, or perhaps the best: "the default fund has received the highest five-star ranking from the fund-rating service Morningstar". x The lesson from PPM is therefore surely that a choice of funds, that is the market, is a waste of time and money and should not be proposed for the UK.
In this respect there are analogies with Child Trust Funds. One article asks: "Are child trust funds a costly flop?" x
The Second Report does not seem to discuss what happens on retirement for the PPM scheme, which provides a pension, and does not require members to buy an annuity when they retire as proposed for NPSS. (page 37)
A PPM guide for choosing funds between the approximately 700 funds in the scheme asks: "What is your risk-tolerance?", "What type of fund suits you?" These do not seem very meaningful questions, since 90% of new members are joining the default fund.
What criteria will there be for choosing between the funds? "What is your risk-tolerance?" - does not seem suitable for younger people. "Do you trust the industry?" - is not much use if only industry funds are on offer and most people would in any case answer "no".
It mentions the six funds of the Thrift Savings Plan for Federal employees in the US, which it prefers as a model to the Swedish PPM scheme, as a way of reducing charges (page 373). They do not seem to be comparable since the TSP funds are all index-trackers. It also discusses KiwiSaver in NewZealand. This is a market-based saving scheme, which is not operational until 2007, and therefore has no track record.
A general problem with NPSS as proposed, seems to be that it is minimalist. It is doing as little as possible. I would like to see instead a new financial institution which is in control of investment funds and provides pensions. This presents various problems. It will need capital to set up. There is the question of accountability. But these problems seem preferable to those of NPSS, such as annuities.
There are extensive discussion about tracker funds on the web, including the topic of hidden charges. Such as:
"A tracker's likely true costs will be around 1% best case." x "The case for tracker funds HAS NOT been made - except by marketing departments." x
I personally believe in long-term-buy-and-hold. In spite of the dislike that many people have for tracker funds, the Second Report recommends the NPSS should offer:
"three to five bulk-bought indexed funds similar to those offered by the Federal Thrift Savings Plan"
But they might turn out to be similar to trackers in the UK, which have much higher charges.
3. Annuities
NPSS requires people to buy annuities when they retire. It describes annuities as "transparently priced" (page 384). What does that mean? The cost of annuities is invisible, as discussed on this website. x
A further problem with annuities is that they are based on bonds. A contributor to a discussion said:
"Adair Turner glosses over falling gilt yields and their effect on annuity rates.
The Government controls the bulk of gilt issues so pension income from NPSS pots will also be under their control and is unlikely to be generous.
You only need to look at National Savings rates." x
4. A bonanza for fund managers
The Second Report (page 106) says that the annual management costs obtainable by large occupational pension schemes is 0.1 - 0.3 % of capital. This pays for the cost of administration including providing pensions, and fund management. For example the 2005 accounts of the Universities Superannuation Scheme x gives: administration costs £9.1 m, investment expenses £15.9 m, assets at start of year £19,446.1 m, assets at the end of the year £21,739.7 m. Therefore the expense ratio is 100 x 2 x (9.1 + 15.9)/(19,446.1+21,739.7) = 0.12%.
The funds of USS are mainly invested in-house rather than using external fund managers. A problem with the "target Annual Charge of 0.3% or below" for NPSS (page 20) is that each fund has a separate management charge. If the 0.3% is an average some people may be paying more.
The possibility of a new scheme was discussed, before publication of the Report, in an article Will fund managers pinch the spoils? by John Chapman in the November 2005 issue of Money Management, where he says that a new scheme could be "a bonanza" for fund managers. He reports that:
"Saunders of the IMA John Chapman is confident that the UK fund management industry could deliver the low charges envisaged."
Pity they are not doing so for Child Trust Funds, or stakeholder pensions. Yet here we go again with a scheme that is claimed to be not only "low-cost" but also "cost-efficient"! John Chapman says:
"With compulsion, distribution and marketing costs would disappear."
They have not disappeared in the case of Child Trust Funds which are compulsory. The Second Report only recommends "soft" compulsion, that is automatic enrolment with the ability to opt out.
What is being negotiated? This presumably includes the AMC. Should there not be negotiations with all the funds? "Bulk negotiate a range of funds" seems weaker than "purchases fund management services in bulk" (page 106) for the Swedish and Danish schemes. Which "fund management services"?
Any funds should be in-house. That is NPSS has its name on share certificates and dividends are paid to NPSS, which could buy-in investment expertise if necessary.
The First Report on the Pensions Commmission discussed "explicit costs" and "implicit costs", which are not mentioned in the Second Report. Is the AMC the same as the TER? What will be done about implicit costs? There also seems to be no discussion of the cost of annuities, although I recommended that this should be studied in my submission to the Commission.
So having started off with a 0.3% AMC target, we already have:
0.3% + increase (probable) + implicit costs (certain)
+ cost of annuities (certain)
A bonanza indeed!
Much of the Second Report discusses topics which are outside the remit of the Pensions Commission, such as state pensions, demography and the state retirement age. It says in the Foreword:
"Our terms of reference asked us to review the evolution of the UK's system of pension provision."
No it did not! It asked the commission only to review the private sector. x But then not doing what was agreed, such as provide a pension, is a large part of the problem in this area. The Commission is reported to have cost £1.5 million. It seems a profligate use of taxpayers' money to request someone to do a task costing £1.5 million, and then allow them to do something other than what was specified.
A general problem in this area is that so many people have hidden agendas. Therefore if a committee does not do what was requested, this raises the possibility of a hidden agenda. Perhaps the Commission has included the public sector to distract attention away from the private sector. Perhaps the real objective of the Second Report is to produce a bonanza for fund managers.
5. Paved with good intentions
They promised that stakeholder pensions would be low-cost, and "be provided by affinity groups, with trustees", x and have "a simple and transparent charging structure". x The Second Report says that NPSS is going to "bulk negotiate" funds and perhaps annuities. We have been here before. The green paper Partnership in Pensions (1998) said that stakeholder schemes would:
"use a collective structure, like occupational schemes, to get the best value-for-money for scheme members" (chapter 7, paragraph 15)
"As collective schemes with bargaining power, we would expect stakeholder pension schemes to be able to offer good value access to other arrangements, such as life insurance cover" (chapter 7, paragraph 70)
The Pensions Commission is now saying that stakeholder schemes are unacceptably expensive, since 20-30% of premiums is absorbed by the annual management charge. Hardly any are provided by affinity groups with trustees. The TUC stakeholder scheme has trustees, but is provided by the Prudential. They do not have a collective structure since anyone can join. As discussed on this website the charging structure is not "simple and transparent", unless you ignore charges outside the cap on charges.
Like the proverbial road to hell, stakeholder schemes started off with good intentions, and for this reason, at least initially, met with the approval of many busy people working with a checklist such as: low-cost, trustees, affinity groups, collective structures, simple and transparent charging structure, bargaining power.
When first proposed stakeholder schemes seemed similar to occupational pension schemes, but ended as a new kind of personal pension. The Financial Times says (17th November) the "low charges" of the proposed new NPSS scheme are "similar to large final salary schemes". Here we go again starting with comparisons with occupational pension schemes! But occupational pension schemes do not form a market competing for members. People cannot chose which scheme to join. They have to join the scheme of their employer. The Second Report says:
"There are for instance many aspects of the design of the NPSS which will need to be agreed following consultation and detailed implementation planning." (page 301)
Such consultations tend to be industry-dominated with most responses from the industry. Or the government sets up an advisory group like the Stakeholder Pensions Advisory Group, with most members from the industry.
6. NPSS promotion
The Financial Times leader Turner's elegant compromise says:
"But if these benefits are to be enjoyed, the Pension Commissioner's recommendations cannot be partially implemented." (3rd December 2005)
This is the "integrated approach" (page 133). The advantage for the industry of NPSS being part of a package, is that it can then claim the moral high ground such as a better deal for women, manual workers and ethnic minorities.
Another technique being used to promote NPSS is to say that the insurance industry may not be involved - only fund managers. This is fictitious because they are largely the same people. An organisation XYZ commonly consists of XYZ Unit Trust Managers Ltd, XYZ Life Assurance Ltd, XYZ Marketing Ltd and so on.
Techniques being used by the industry to promote NPSS are:
- Do not explain charges properly.
- Do not discuss non-market schemes.
- Claim the moral high ground.
- Claim that current problems are the fault of the insurance industry and fund managers are different.
The proposals in the Second Report seem to me to be more of a dog's dinner than an "elegant compromise". They are largely not even within the remit of the Pensions Commission, and seem to be intended to promote NPSS.
7. Conclusion
NPSS is described as "cost-efficient" because of the proposal to gather contributions through the PAYE system, or a new Pension Payment System. A contributor to a discussion said:
"It's the IFA/salesmen based distribution system and its associated commission/compliance/ misselling/FOS costs which make the whole pension system so expensive.
If this distribution system could be replaced then the providers should be able to produce cost-effective products." x
This could be an exaggeration. What percentage of costs are caused by the "IFA/salesman based distribution system"? I have not so far found this in either the First Report or the Second Report. John Chapman in his article mentioned above, estimates that up to half of the charges in the retail sector are for distribution and marketing.
There is a need for a new national pension scheme, that is a scheme which provides pensions, like PPM. Another difference between NPSS and PPM is that the latter has a default fund run by a department of government. To set up something similar in the UK will require capital. As proposed, NPSS is more like a government-owned clearing-house than a new mutual financial institution. In the Second Report the NPSS has:
- not kept to its remit,
- underestimated the cost of NPSS to investors, missing out the cost of annuities entirely,
- not discussed the topics which I requested in my submission: x the Danish ATP scheme, the cost of annuities, the investment performance of personal pensions.
December 2005