Tuesday 24 June 2003

Report for the Investors' Association by Stephen Wynn

1. The purpose of the seminar

A seminar was held to launch proposals of the Consumers' Association for a reform of pensions. On their website there is a Press Release, Press Briefing, Executive Summary (15 pages). A report (64 pages) Blueprint for a national pension policy, Restoring confidence and trust in pensions (1) was introduced at the seminar by Sheila McKechnie, Director of the Consumers' Association.

A report Alternative thinking on pension investment and access to pension products (2), was commissioned from the firm of actuaries Watson Wyatt, by the Consumers' Association. It is concerned with alternatives to the current retail pensions model in the UK:

"Our new research also looked at various collective pensions models around the world and has found that there are more cost-effective ways of delivering pensions than the model promoted by the UK insurance and investment industry." (page 10)

It was introduced by Alan Pickering, a partner of Watson Wyatt. It describes Industry Funds in Australia, industry-wide schemes in the Netherlands, the Thrift Saving Plan for Federal employees in the US.

2. Who attended?

There were 77 people at the seminar: the chairman, 4 speakers, 12 Consumers' Association staff and 60 delegates.

3. Speaker topics

	James Purnell MP	Work and Pensions Committee member Political challenges facing consumers and the role of Government
	Sheila McKechnie	Director, Consumers' Association Consumers' Association report Blueprint for a national pensions Policy, Restoring trust and confidence in pensions
	Allan Pickering	Partner, Watson Wyatt LLP Watson Wyatt report, commissioned by the Consumers' Association Aternative thinking on pension investment and access to pension products
	Susan Anderson	Director of Human Resources Policy, CBI The employer and UK pensions policy

4. "A flawed and high risk strategy"

The Consumers' Association states that the provision of pensions using the "retail model" is wrong in principle. Reporting the seminar in the Guardian, Rupert Jones says:

"The CA claimed the "retail model" - where millions of people are left to negotiate individually with pension companies - simply did not work."

Members of the Investors' Association know that investors have to individually negotiate the terms for other "products" in addition to pensions, and that this also does not work very well, as for example in the case of endowment policies for mortgage protection. The Press Release states:

"As the state and employers retreat, consumers are shouldering greater risk and responsibility and forced to rely on stockmarkets and financial services to fund their pensions. But this is a flawed and high-risk strategy on the part of the Government. ... The root cause of the problem is that the retail financial services industry is just not fit for the purpose of delivering a secure and sustainable retirement package for consumers."

Various "inefficiencies" are listed in the first of the "Key conclusions" in the Watson Wyatt report (page 47):

The voluntary, retail pensions model has some obvious 'inefficiencies' relative to some of the other schemes approaches examined:

Higher distribution costs.

Smaller scale (and therefore higher unit costs) fund management operations.

Difficulties in reaching some groups:

The self employed

Employees of small and medium sized companies

Those on medium to low incomes

Women

Minority groups

These inefficiencies which are not restricted to pensions, relate to distribution costs, economies of scale, coverage. Members of the Investors' Association will be familiar with further problems relating for example to: stability, regulation, negotiating power, selling:

Providers may be taken over by other providers.

They are sometimes not properly regulated.

"Retail" means individuals, as opposed to organisations which have more negotiating power.

The companies in the financial services industry have to promote themselves in the market to survive by "shifting product" ^* - referred to as "distribution" in the report of the Sandler Review. This produces an incentive for mis-selling.

5. Charges

5.1 Explicit charges

Total expense ratios for the funds of the Thrift Savings Plan are below 0.1%, - less than a tenth of the stakeholder 1%. The Watson Wyatt report also discusses 401(k) plans which it says are "comparatively expensive for individual consumers". The Thrift Savings Plan is not competing in the market like the providers of 401(k) plans.

The Watson Wyatt report mentions the low cost ( 0.1% after 5 years ) of the Retail Employees Superannuation Trust, "Australia’s largest industry fund with over one million members". A recent study by Chant West Financial Services and the Association of Superannuation Funds of Australia finds that the fees for large industry funds are substantially less than those for retail personal funds (see page 2 (g) and (l)).

An Australian correspondent wrote that there is: "a debate going on here at present about the excessive charges (and results) of Managed Funds vs LIC's (Listed Investment Companies)." with reference to Argo Investments:

"Our costs represent less than 0.2% per annum of average assets at market value and there are no management fees. That’s 20 cents for every $100 managed.

Some of our competitors charge their investors management fees that are ten times our costs of administration. But then, they are owned by financial institutions whose major objective is to maximise the profit they make from the fund. The higher the management costs - the better for them - because the profitability of the manager depends upon it."

"a combination of dividend income and capital growth averaging 17.2% compound per year for the 20 years to 30 September 2001, assuming reinvestment of all dividends and entitlements. This compares with 13.3% for the All Ordinaries Accumulation Index."

The Consumers' Association prefers "the Netherlands model" for industry-wide schemes. They are certainly nearer and apparently less expensive: "We estimate on average that total costs as a percentage of total assets is 0.25%." (2, page 6) This is a quarter of the stakeholder 1%.

5.2 Hidden charges

I asked about hidden charges additional to the stakeholder 1%, and suggested the Consumers' Association should campaign on this topic. These hidden charges are not mentioned in (1) and (2).

6. Compulsion

Sheila McKechnie said "Compulsion is the only answer to take the cost out of marketing." She says in the Foreword to the Watson Wyatt report: "The case for compulsion is overwhelming."

James Purnell said that in some pension schemes employees are automatically members, unless they make a request to leave. This is a very mild form of compulsion.

Susan Anderson was not in favour of compulsion. She said there could instead be incentives, with a combination of employer, employee and government contributions. (For members of the Federal Employees Retirement System but not apparently the Civil Service Retirement System) the Thrift Savings Plan has a 1 per cent employer contribution. There are then optional employee contributions matched by employer contributions. This provides a strong incentive to save (for members of FERS).

Compulsion is discussed in Chapter 7 in of the Watson Wyatt report entitled "Compulsion - grasping the 'thorny nettle'". This reports that: "Countries like Australia, Chile and Switzerland have all legislated for compulsory contributions to be made into second pillar retirement accounts." Most of the Dutch industry-wide schemes have compulsory contributions.

7. Layering

It was pointed out at the seminar that over £ 100 thousand is required to buy an annuity which provides a pension equivalent to the state basic pension. Perhaps another £ 100 thousand is required to provide the SERPS/State Second Pension (depending on contributions made).

James Purnell said that other pensions are becoming increasingly layered. On the first layer are the civil service and MP's schemes, financed by taxpayers. On the second layer are occupational pension schemes which are defined benefit, followed by those that are defined contribution. At the bottom are personal and stakeholder pensions. Here people are out in the cold in comparison to the higher layers. They are subject to the chilling motto caveat emptor.

The choice between thousands of funds and "products" in the retail market is overwhelming and worrying for investors. In the case of the Thrift Savings Plan employees are presented with only five funds of increasing levels of risk illustrated by a table showing how they have performed in the past. The Watson Wyatt report says:

"The experience of TSPs with their limited fund choice demonstrates that this feature also helps reduce costs to the plan member." (2, page 47)

The Construction Industry Scheme was referred to more than once at the seminar. I do not understand this, because it is apparently not a pension scheme. The nearest pension scheme is the Building and Civil Engineering scheme. This also has a table showing unit prices ( click on "unit prices" ). But they are given (fortnightly) only back to January 2002. It is a stakeholder scheme, so that it is only possible to give data back to when stakeholder pensions were introduced in April 2001.

8. Independence from government

The Consumers' Association proposes "a range of new pension schemes.": a) "a National Pension Scheme (based on the US Federal Thrift Savings Plan) ", b) industry-wide collective schemes similar to the Netherlands model, c) "for the retail market, approved licensed stakeholder schemes sharing a common platform similar to the banking system." (1, page 13)

Various organisations - such as the trade union Unison - have advocated the development of a new National Pension Scheme. .

Sheila McKechnie said that such a new pension system should be independent of government. James Purnell said that independence from government is perhaps not such a good idea in view of the recent pension demonstrations in France. The Consumers' Association favours more independence of pensions from government in general, such as: "A political framework which allows tough decisions to be taken free from undue political influence" (1, page 5) "Be based on a supportive political framework for long-term pension provision and protect pension policy from short-term political intervention." (1, page 17)

More independence would surely result if a new National Pension Scheme were outside government, like the Danish ATP scheme, which is a funded national pension scheme. It has a board composed mainly of employer and employee representatives. This is similar to the composition of the board of the French state basic pension ( click on Conseil d'administration ). But the Consumers' Association proposes that a National Pension Scheme "would be government-run and - administered" (1, page 42).

The proposal of the Consumers' Association for a National Financial Advice Network (1, page 47). is a new organisation but is only giving advice. The Pension Protection Fund proposed in the recent government publication Action on Pensions is another new organisation. A discussion started about this at the seminar, concluding that more details are needed.

9. Summary

The Consumers' Association makes a considerable number of recommendations for action by the government, which largely follow from:

"The collective approach to providing pensions provides the opportunity for major economies of scale and significant cost savings for consumers and taxpayers." (1, page 13)

If the Consumers' Association brought the attention of its members and investors to the existence of hidden charges, this might encourage the government to adopt the collective approach, as an alternative to helping the financial services industry to "shift product". Hidden charges are mainly dealing charges - closely associated with portfolio turnover because the more dealing the more charges. The Treasury has recommended that the trustees of occupational pension scheme should be concerned about dealing costs such as broking commissions. But few, if any, retail savings "products" have such trustees.

Fitzrovia have published a 234 page report about the portfolio turnover of unit trusts and OEICS. This shows that there is a wide range of average values between the portfolio turnover levels of these funds between asset management companies. A Google search on "portfolio turnover" brings up about 300 thousand websites - often recommending that investors should choose funds with low turnover. All this enormous literature concerns charges which are outside the 1% cap.