The Pensions Meltdown
by Stephen Wynn

1. Self-administered pension schemes are declining in relative importance.

Table 1 shows that the assets of (self-administered occupational) pension schemes has been declining relative to those of insurance companies and unit trusts.

Table 1

Assets of institutions (£ billion)

year (end)	unit trusts	investment trusts	insurance companies	pension funds	% pension funds
1993	88	29	434	480	46.6
1998	163	47	776	699	41.5
2000	223	60	933	765	38.6
2002	190	38	854	610	36.1

This has resulted from:

- the introduction of personal and stakeholder pensions,

- general government policy of promoting choice especially "informed choice",

- the trend from DB to DC pension schemes,

- decline in membership of occupational pension schemes ( at least for men ^x ).

Pensions run and provided by insurance companies rather than being self-administered, have high charges. Charges divide into:

a) the annual management charge,

b) other management charges,

c) expenses,

d) dealing costs,

e) the charges of annuities.

The more income to investors is paid out of capital rather than investment income, the more charges are hidden. In the case of annuities the income is almost entirely paid out of capital and charges are entirely hidden.

The stakeholder cap on charges combines a) - c), at least in theory. But dealing costs d) are not included in the cap. The FSA says that personal pensions have "high hidden charges". The stakeholder cap only includes the explicit charges. Dealing costs are highly dependent on portfolio turnover because the more dealing the more charges. In the US portfolio turnover is specified as a percentage in the accounts of mutual funds.

There is a general problem with contract law in comparison with trust law. A contract is an agreement. Individuals are in no position to negotiate charges. More generally in practice there are endless arguments about what was agreed. For example:

"By introducing a negative final bonus, the Society has changed the basis for future bonus calculation in a manner which is neither explicitly described in, or could be reasonably deduced from, my contract." ^x

There is a similar trend from DB to DC schemes in the US with the development of 401(k) plans. There have been numerous problems with complaints about charges. ^x Whenever there is a scandal with mutual funds, this has an implact on 401(k) plans.

The Myners Report Review of Institutional Investment in the United Kingdom recommended that the trustees of occupational pension schemes should interest themselves in dealing costs. This was endorsed by the Treasury. Personal pensions and most stakeholder pensions do not have trustees.

Stakeholder pensions have lower charges than personal pensions. To some extent there has been a trend towards stakeholder pensions, away from personal pensions. But stakeholder pensions are more expensive than self-administered occupational pension schemes. The trend away from self-administered schemes are funds moving to where they can be more easily syphoned off by both explicit and hidden charges. The topic of pensions is complicated. There are endless arguments. The bottom line is: How much is it all costing? There is a diagram in the First Report of the Pensions Commission showing the lower cost of running large occupational pension schemes:

Diagram 1

An Estimate of the Overall Cost Curve Reduction in Yield

Annuities are not included on this diagram, but are a particularly serious problem.

3. Moving towards a crisis

The First Report of the Pensions Commission refers to "implicit costs". This is those costs which are hidden. It does not recommend that they should be disclosed. So that in this respect the First Report is on the side of the smoke-and-mirrors brigade. It does not discuss the duties of trustees, or the cost of annuities. The Second Report will hopefully discuss these topics.

The problem of hidden costs and annuities can almost be described as a crisis. This has various further components:

1. Mis-selling (and mis-buying)

There are continual mis-selling stories in the press such as recently Eurolife's Secured Bond ISA, ^x and Guaranteed Minimum Pensions, which are neither minimum nor guaranteed. Ros Altmann ^x says:

"These people paid for a guaranteed pension for years. They were promised a guaranteed pension. I can’t understand how the government can now refuse to pay them." ^x

2. Insolvent financial advisers

Financial advisers or subsidiaries of financial advisers sometimes become insolvent in order to avoid mis-selling claims. For example Whitechurch Investment Services Ltd has been wound-up:

"This allows them to wash their hands of their involvement in precipice bond selling. The bill for compensation will instead be picked up by the FSCS, which in turn takes the cash off the rest of the financial services industry." ^x

3. Increasing complaints

The March 2004 Annual Review of the Financial Services Ombudsman reported 97 thousand new complaints for the year of which 51 thousand were mortgage endowments. It says:

"This year alone, the number of new complaints reaching the financial ombudsman service increasd by 57% on the previous year. (which itself saw a 44% increase)." ^x

If the claim is against a company which is no longer in business such as Whitechurch Investment Services Ltd mentioned above, then this goes directly to the Financial Services Compensation Scheme rather than the FOS. There must be a considerable number of such complaints as many IFAs have gone out of business. They are additional to FOS complaints.

4. Equitable Life Scandal

The Parliamentary Ombudsman is currently investigating possible maladministration. EMAG has a petition to the European Parliament. There is the saga of Equitable complaints with the FOS.

5. Closed funds

In one large survey of the closed funds of life assurance companies, 40% refused to say who are the fund managers. Closed funds "trap their investors with chunky exit penalties." ^x

6. Insolvent occupational pension schemes ^x

The latest example at the time of writing of an insolvent pension scheme is Allders.

Problems 1-5 relate to the financial industry. That is the firms regulated by the FSA. However I do not think that the industry is entirely to blame.

A succinct summary of problems is:

"Equitable Life alone is now on about its fourth inquiry and won't go away, the windup problems are getting worse (Rover) the Pension Protect Fund is already under threat, there's constant hassle from the unions over deficits in company schemes, there's no co-operation at all from the insurers on stakeholders or Sandler products or any other Government initiative to improve savings. He's had to order an investigation into the actuaries and the mutuals. The Ombudsman system is falling apart, the misselling problems just go on and on and there's constant bitching about the FSA." ^x

4. The FSA is controlled by the industry.

The FSA cannot be sued unlike for example the regulator (APRA) in Australia. It does not come under the Parliamentary Ombudsman. It appoints the Consumer and Practitioner Panels, its own Complaints Commissioner, the board of the FOS.

It is answerable to the Treasury and Treasury Select Committee. But there may be problems. Robert Shrimsley writing in the Financial Times (2nd February 2005, page 16, Notebook), to John McFall the chairman:

"Because it is dominated by MPs trying to keep up with Gordon Brown, you habitually treat the department with kid gloves."

The actions of the FSA can be criticised in many ways. I have been concerned that it decided not to request funds to disclose portfolio turnover. High profile is for example the takeover of orphan funds by Axa. Behind the scenes it has changed regulations to permit charges to be taken out of capital, rather than investment income. This is part of the wider topic of taking income out of capital, and the actions of the FSA in this area. This is a problem with high income bonds. ^x There has been a considable amount of discussion of this topic by Equitable Life policyholders, describing with-profits annuities as a "precipice product":

"The annuitant's income is paid out of the capital in his guaranteed fund, not out of the earnings his investment has made. .. This transfer of money from the 'ownership' of the annuitant to the 'ownership' of the company mounts up until eventually all his capital has gone." ^x

"Your guaranteed money was converted monthly into income withdrawals so that even if the fund performed well after say 10 years it became totally non-guaranteed making it a highly dangerous product." ^x

The FSA's recommendations on equity release or home reversion schemes, should include the advice to consult relations.

5. Who is running the country?

When stakeholder pensions were being devised, they started out looking like occupational pensions, with trustees and collective structures, but have ended looking like personal pensions. They were lobbied to pieces by the financial services industry. Government policy in this area is decided by the financial services industry. We have practically reached the stage where we can ask: Who is running the country - the government or the financial services industry? Except that the savings industry is more concerned with selling "products" than providing a service. It has to be concerned with selling "products" in the first instance because no "products" no industry.

This domination of policy by the industry started when New Labour came to power in 1997, with the formation of the FSA, which is the takeover of the regulators by the industry, or a continuation of self-regulation.

Committees of enquiry of particular interest, in the area of pensions and savings are: 1) Paul Myners Institutional Investment in the United Kingdom (2001), 2) Paul Myners Review of the governance of life mutuals (2004), 3) Adair Turner First Report of the Pensions Commission (2004), 4) Sir Peter Davies Report of the Employer Task Force on Pensions (2005). Paul Myners, Adair Turner, Sir Peter Davies are all from the industry - Gartmore, Merrill Lynch and the Prudential. We can expect their recommendations to therefore be largely from the point of view of the industry.

In particular the First Report of the Pensions Commission seems to contain a cover-up of personal pensions, by not giving details of investment performance and by combining personal pensions with stakeholder pensions or occupational pensions. It has a look-to-the-future approach. There is a once bitten twice shy problem.

Also for example the Davies report recommends 401(k) plans in the US, which if imported into this country would tend to favour the industry in comparison to alternatives. The Turner report says that annuities are only provided by insurance companies, which is untrue. It gives the investment performance of shares but not of "products".

The industry can afford to spend large amounts on lobbying. Savers and investors have UKSA, The Consumers Association, the Investors Association, EMAG. The Consumers Association had a seminar on the topic of pensions policy, which I attended representing the Investors Association. There are also various think tanks. The Centre for Policy Studies dreamt up personal pensions. Recently we have the proposal for the Citizens Pension from the Pension Policy Institute. This is a non-starter. It would be based on residency. But how do you prove residency? It is no use consulting the Home Office which does not seem to know where anyone is and to be a general shambles, to the extent that a Minister and the Home Secretary recently resigned.

A fundamental problem in this area is individuals doing business with organisations, amateurs with professions. The market is too one-sided. The only solution is to set up new organisations.

6. New organisations

Three connected concepts in this area are that of a) affinity groups, b) compulsion, c) trustees. If there is compulsion there needs to be an associated group of people who are being compelled. Similary where there are trustees there is, or at least should be, an affinity group. Occupational pension schemes have trustees and the affinity group is the group of employees. The role of trustees in unit trusts is debatable.

I am not necessarily in favour of compulsion and think it is unnecessary if there is a sufficiently high incentive to join or remain a member, and if it is necessary to opt out rather than to opt in. There are examples showing large differences in membership according to whether it is necessary to opt in or opt out.

In my submission to the Treasury Committee, I recommended that Child Trust Funds (CTFs) should be run by a new organisation. They are instead becoming tangled with charges. For example they were intended to encourage saving by parents and grandparents. According to the Daily Mail, the Liverpool and Victoria Friendly Society CTFs have extra charges for such additional contributions. Their website says that the Bonus Builder CTF has: "One off set up charge £90. Annual charge 1.24% of the fund." ^x An article in the Daily Mail (9th February) says that the £90 applies to additional lump sums in addition to the set up:

"The whole £90 will be deducted from lump sums of over £300. If the lump sum is less than £300, then 30% of it will be taken in charges. The balance of the £90 will be taken out of any further gifts. These charges can seriously damage your child's wealth." ^x

I telephoned the Liverpool and Victoria who say this is untrue. Perhaps it was true but has now changed! There are other examples of Child Trust Funds with excessive charges, for example:

"It is 'ridiculous' that stakeholder CTFs from providers offering computer-run index-tracking funds, including Halifax and Nationwide, cost 1.5 per cent. This is five times more than what investors would pay for the same type of funds outside a CTF." ^x

"Many equity CTFs levy higher-than-average charges than identical index-tracking funds, which are outside the CTF wrapper." ^x

A Central Discontinuence Fund has been suggested. This takes over pension schemes which are wound-up. A Pension Protection Fund has been established. ^x I like the Danish ATP scheme. In my opinion we will eventually have some such scheme in this country. The alternative is to have a series of "products" like CTFs, stakeholder and Sandler products which suffer from high charges.