Restoring Confidence in Long-Term
Savings
The Advantage of Saving Collectively
in Comparison to the
Retail Market Model
Submission to the Treasury Committee
Stephen
Wynn
Summary
The FSA report Towards a national strategy for financial capability (2003) says:
"The ageing population and changing employment trends combine with changes to state provision to increase the need for individuals to take responsibility for planning their own retirement." x
This implies a greater reliance on the retail market model for providing pensions. People will need to accumulate capital to provide a pension. But most people find looking after capital a worry and nuisance. The report says that consumers have an:
"inadequate understanding of financial concepts and products, and this at a time when consumers are increasingly being asked to take on more responsibility for their long-term financial planning." x
Paragraphs 1 - 48 below discuss the disadvantages of the retail market model. Paragraphs 49 - 69 discuss the advantage of the alternative collective model.
Individual Saving
The high cost of the retail model
1. The regulation of the financial industry seems like fire fighting. The flames are quelled in one area and they break out in another. The problems are systemic, and result largely from competition for customers. In evidence to your Committee (11th November 2003), referring to the life assurance industry, Ned Cazalet asked:
"Is an industry that costs each household £570 a year in aggregate and an industry that spends over £300 per household per year in trying to procure new business, is it a business model that actually makes an awful lot of sense?" x
2. It is a wrong business model for promoting saving. Encouraging people to save with a choice of many organisations results in competition between the organisations saying "choose me". The Sandler Review states:
"The Review therefore recommends the introduction of a suite of simple and comprehensible products ... a consumer could be sold these products without regulated advice." (10.12)
3. All financial advice given as a business is regulated. Advice is largely a euphemism for selling, and is a major way of selling "products". The industry is therefore arguing that Sandler stakeholder products need to be recommended by advisers, and that a 1% charge is inadequate to pay their commissions. The Sandler Review says:
"The advice itself is often compromised by the incentive effects of commission paid by product providers." (page iii)
4. The industry is even lobbying to raise the proposed 1% charge limit on Child Trust Funds (CTF), which should not have sales costs since purchase is obligatory. A list of costs of the industry is given in the memorandum of the Association of British Insurers (ABI) on CTFs starting with distribution costs and marketing costs:
"ABI work shows an annual fund charge of 1% is needed on a monthly premium of around £ 50 - or 2% if the premium were only £ 80 pcm - simply to meet those costs." (14)
5. The ABI discusses "one minor example" of a cost - the proposed vouchers for CTFs:
"This negates the possibility of providers keeping costs to an absolute minimum by enabling parents to open CTF accounts by more cost-effective and customer-friendly means - eg over the telephone or on the internet. The requirement to collect the vouchers means that even if such methods are used to register an account, it cannot be authorised unless the voucher is physically sent to the provider. This, in turn, creates additional administrative complexities (and associated costs) for providers who must make sure that the voucher has been received ... " (16)
6. The Green Paper on pensions Simplicity, security and choice: Working and saving for retirement (2002) x gives the cost of administration of occupational pension schemes:
"For the largest schemes (those with over 40,000 members), the average administration cost is around £ 28 per member a year. For smaller schemes (those with fewer than 500 members), the cost is around £ 80 per member a year." (page 129, paragraph 10)
This is far cheaper than the stakeholder 1% of capital per annum.
The Green Paper x states that participation rates for defined contribution pension schemes are 90 per cent of employees if new employees are made members and may opt out, but only 50 per cent if they are not made members and may opt in.
"participation rates among newly eligible employees are around 90 per cent compared to around 50 per cent among those using the opt-in approach." (page 16) x
7. Of those people who should take action when they start to work for a company with a defined contribution pension scheme - namely either to opt in or opt out of the scheme - 40 per cent do nothing (see below). (Another example where it is to everyone's advantage to act by 53% do nothing. x) But the Green Paper says:
"The Government believes that give the right opportunities, people will plan ahead sensibly." (para 9, page 6)
Forty per cent of people may not "plan ahead sensibly" but do nothing. Even if they decide to do something they may make a wrong decision. For example high lapse rates suggest that people often regret having bought policies. They made wrong choices:
"We estimate that the average contribution period on a 25 year regular premium personal pension is probably in the region of 10 years." (page 14)x
8. Saving on an individual basis requires people to make choices. The first of the recommendations on page one of the Working and saving for retirement Green Paper is to:
"help people make better informed choices about their retirement" x
9. This help is to be provided by a simpler system, education and clear information tailored to individual circumstances. The Green Paper says the Government believes that those who seem to be saving too little will save more if:
"there is a simpler framework to help people understand their choices; and individuals are equipped to understand financial choices and receive clear information tailored to their individual circumstances." (page 4)
10. The Select Committee on Work and Pensions in its report The Future of UK Pensions (2003) complained about the excessive complexity of pensions:
"One dominant theme throughout the evidence submitted to our inquiry was the excessive complexity of pensions." (43)
The Green Paper on pensions says:
"There are currently eight different tax regimes for pensions . . . To reduce this complexity we will radically simplify the pensions tax regimes." (page 6)
11. But in addition to the tax regimes for pensions savers have to cope with income tax, capital gains tax, stamp duty, inheritance tax. There are more abstruse topics such as the tax liability of life assurance companies and trusts. There are also interactions with the welfare system, such as those recently discussed by your Committee in the case of CTFs. x and the Minimum Income Guarantee for pensions.
In the Green Paper the expression "informed choice" refers to both a choice of pension "product", and for example retirement age. Where there is a choice of "product", there is a market. Thus the expression is pro-market. But it is argued on this website in the Introduction Section, that this is a "massive strategic policy error". x
The government's "informed choice" policy is intended to promote saving Chapter 3: Informed choice in pensions - choices for individuals of the Green Paper starts:
"There is a range of barriers to personal saving which need to be addressed."
Education
12. Consumer education is a central part of Government policy. The DWP set up a "pension education group" in 1997. The minister John Denham MP said:
"Developing greater financial literacy and economic awareness is crucial in order to give everybody - men and women, young and old - the confidence to make informed choices about pensions and take control of their financial future." x
13. The FSA has an extensive Consumer Help section x on financial planning throughout life and the financial consequences of life's changes such as expecting a baby. x Education is of course beneficial but, as the Sandler Review admits, education "can have only a limited effect" (10.90). An article on US pension schemes known as "401(k)s", The Silent Scandal: 401(k)s and the Failure of Responsibility, in the journal of the Financial Planning Association (December 1998) says:
"Can we disenthrall ourselves from the myth of self-reliance long enough to change course before we run aground? ... Calls for 'more' and 'better' education are the mutual fund industry's version of President Johnson's 'War on Poverty.' Enormous resources have been and will be expended. The goal is so noble, so self-evidently positive, that we are willing to ignore the fact that there is little evidence that force-fed information translates into better performance for investors." x x
14. This article refers to various "realities". Attempts to "promote confidence in long-term savings" and "reform the financial services industry" often seem to ignore underlying realities or home truths. One reality is that amateurs are negotiating and doing business with professional organisations. This is very one-sided. There is an amateurs versus professionals problem, and an individuals versus organisations problem. The Sandler Review states:
"The root cause of the problems in the retail savings industry is consumer weakness." (10.89)
15. The above article on 401(k)s says:
"Survey after survey confirms that the shortage Americans feel most is not information, not education, but time! ... All efforts to empower, educate and expand choice ultimately fail when confronted with this reality." x
Awareness
16. "Public awareness" is one of the objectives of the FSA under the Financial Services and Markets Act (2000). The Green Paper on pensions says that the Government will "encourage simple and flexible savings products". But savers are not being given the full picture about these "products". Good news always comes first. The fact that there are charges additional to the up to 1% cap on charges for stakeholder pensions appeared for the first time in the booklet of the DWP Stakeholder pensions: Your guide in April 2001, when stakeholder pensions were introduced.
17. Many websites and publications say that stakeholder pensions have no hidden charges (e.g. "Stakeholder must guarantee a charge of no more that 1% per annum with no hidden charges." x). Other websites say that there are additional charges (e.g. "Pension providers can recover other costs and charges they have to pay for e.g. stamp duty or other charges for buying and selling investments for your fund." x ).
18. Hidden charges are discussed on my website www.comparativetables.com. This website is especially concerned with the topic of portfolio turnover, referred to as "buying and selling investments for your fund" in the DWP booklet (30), and as "trading and churning" by Howard Davies to your Committee on 7th November 2000 (115). Dealing costs are not disclosed to savers or investors. Kevin James was mentioned at this hearing. In his occasional paper for the FSA (OP 6) he says:
"Furthermore, disclosed charges alone provide a misleading impression of the price of investing, as they do not include dealing costs (the costs of trading assets in a fund's portfolio). . . Consequently, retail investors now lack the information and knowledge they need to evaluate the investment funds they must choose between." (page 6-7)
19. The Sandler Review recommends that dealing costs should not be disclosed but continue to be "netted off investment return". Discussing "stakeholder with profits" it says:
"There would be clear regulatory prescription on the treatment of costs, to ensure consistency across providers and products. In principle, this should say that all costs should be shown, rather than being netted off investment return. However, it will be important to ensure consistency with unit trusts/oeics, which have certain costs which can be treated in this way." (10.137)
20. This is contrary to the recommendations in the Myners Review x, which recommends greater disclosure of dealing costs. The section headed Brokers' commissions starts:
"The sum which pension funds pay in commissions to investment houses, stockbrokers and so on, for providing dealing and research may well be similar in size to the fees which they pay for active fund management." (58)
21. In addition to hidden charges there are hidden taxes. Stamp duty is hidden as part of dealing charges. Savers generally do not realise that insurance bonds and life policies are highly taxed because life assurance companies pay tax annually on interest and dividend income plus capital gains.
"Message over-load"
22. The FSA says:
"However, in the financial services sector, the sheer volume and variety of material consumers receive is a turn-off and consumers face message over-load." x
There are for example well over 1000 unit trust and OEICS. The Sandler Review complains about the "proliferation of products" (3.13). The article on US pension schemes known as 401(k)s (13) says:
"We regularly read of plans that have expanded their menu of choices to literally hundreds of mutual funds. . . The 'more is better' approach to 401(k) options is folly, not wisdom." x
23. The government is promoting "informed choices" by public education and awareness. There are various further adjectives that can be used to describe choices such as "confusing", "tiresome", "hard". This is in any case "conducting the debate on the insurance industry's terms". x An article in The Guardian discussing the Treasury Committee's report on endowment mortgages says:
"At the end of the day, when purchasing a financial product most people find they have to place their trust in the salesman. And when the sales spiel turns out to be total bunkum the customer feels deeply betrayed and thoroughly stupid." (11th March 2004, page 19)
24. This reality is a long way from the Financial Services and Markets Act (2000): x
"consumers should take responsibility for their decisions." (5 (2) (d))
A sales orientation
25. The government encourages people to save, that is to become "savers". They then find themselves referred to as "investors" and "consumers" who are "responsible for their own decisions". The term "consumer" is often used to mean a "saver" or "investor", rather than a consumer of financial services. The Financial Services and Markets Act (2000) refers to "the protection of consumers". x This sounds vague and condescending. Savings and investments need protecting in the first instance rather than "consumers". They need protecting by the regulator, not from stock market fluctuations, but especially from excessive and hidden charges. An "Authority for the Protection of Savings" is proposed in Italy following the Parmalat scandal. An article Italy approves bill to create new regulator in the Financial Times reports:
"Under the bill, a new regulator, provisionally called the Authority for the Protection of Savings, will replace Consob, the stock market watchdog," (4th February, 2004, Companies International, page 33)
26. A problem with "the protection of consumers" in comparison to "the protection of savings", is the different kinds of consumer. The definition of "consumer" was discussed by the Treasury Committee. x "Consumer" generally means "retail consumer".
"The protection of consumers" has a sales orientation in comparison to "the protection of savings". The Financial Services and Markets Act says in Section 5: x
"5. - (1) "The protection of consumers objective is: securing the appropriate degree of protection for consumers."
27. This seems like a tautology.
"(2) In considering what degree of protection may be appropriate, the Authority must have regard to-
(a) the differing degrees of risk involved in different kinds of investment or other transaction;(b) the differing degrees of experience and expertise that different consumers may have in relation to different kinds of regulated activity;
(c) the needs that consumers may have for advice and accurate information; and
(d) the general principle that consumers should take responsibility for their decisions."
(a) - (d) relate to sales. The "market confidence" x and "public awareness" objectives also relate to sales. How do you measure the extent of market confidence except by the volume of sales?
"Shopping around"
29. The FSA uses terminology e.g.
"Do you agree that consumers of SCARPs should have the same right to periodic information as consumers of packaged products?" x
giving the impression that financial "products" are "consumed" - like hamburgers. The Sandler Review also refers to "consumers of long-term retail savings products" (3.1), which are "consumer goods" (15), for "consumers" who have an "appetite for equity investment" (7.64).
30. I am unhappy with the term "product" as in "retail savings product". Sir Howard Davies also seems to be unhappy with such terminology. In the 2003 AGM of the FSA he said:
"Indeed many firms are happy to see themselves described as 'product providers', terminology which in itself distances them from their customers." x
31. The term "product providers" is used extensively on the FSA's website. x Comparing savings "products" with "consumer goods" is not comparing like with like. A washing machine is in your house. You can see what you have bought, whereas a personal pension is still with an insurance company or fund management company. You benefit from the washing machine immediately, but from the personal pension some time in the future. The washing machine has been manufactured, whereas the personal pension is a contract for looking after savings.
32. The term "shopping around" is the same kind of terminology. In its Consumer Help literature the FSA says:
"You can save yourself lots of money and get a better deal by shopping around." x
This suggests that investing in retail savings "products" is similar to weekly shopping for groceries. The FSA says:
"In some ways, buying financial products is similar to buying household consumer goods - you have to do a bit of research. But there are differences." x
33. "There are differences" is an understatement! Buying a washing machine cannot, and should not, be compared to investing your life savings. It is easy to distinguish between consumer goods, for example to choose between buying a washing machine or buying a television. It is less clear whether you should invest in a personal or stakeholder pension or in a unit trust or OEIC - perhaps through an ISA. There is a limited choice of very similar washing machines in comparison to over 1000 unit trusts and OEICS.
34. The FSA states that many people do not "shop around":
"With four out of ten people saying they consider only one company when buying a financial product, the Financial Services Authority is today reminding consumers that shopping around is key to finding the best value deal on financial products and services." x
"Our research shows that lack of understanding of how to shop around (or in some cases, such as pension annuities, lack of awareness that it can be done at all) leads to consumers losing out." x
35. Many people do not have time to read the material they receive or "shop around". Most people have to earn their living have family responsibilities, work for an NGO and so on. They need somewhere safe to put their savings - a collective scheme they can trust.
36. The DWP booklet Stakeholder pensions - Your guide states there are charges outside the one per cent cap on charges:
"As well as the one per cent, the law allows pension providers to recover costs and charges they have to pay for certain other things. For example, when they have to pay any stamp duty or other charges for buying and selling investments for your fund, or for particular circumstances such as the costs of sharing a pension when a couple divorce. These expenses are found in other pension schemes, not just stakeholder pensions." ( page 6)
31. In the case of occupational pension schemes you do not have to "shop around". Defined benefit schemes do not have the (up to) one per cent charge. From this point of view the 1% charge is an additional "management charge" paid to the provider rather than a ceiling on charges. However much you "shop around" you still have to pay this management charge.
37. Investors who have time to take an interest in their investments and buy shares can outperform professionals. Warren Buffet said:
"In the investment world, someone who believes in American business - and who seeks out the lowest way to participate in business and do it consistently - will achieve results which exceed those of investment professionals as a group." x
At the point of sale
38. As mentioned above (8) the Green Paper on pensions refers to "information tailored to individual circumstances". In the FSA's paper With-Profits Revue: Disclosure to Consumers (2002) x there is a heading "tailoring of information". This is information provided at the point of sale. In the FSA's literature the words "tailoring" and "tailored" are also applied to "advice", "sales process", "marketing" which again relate to the point of sale.
39. More generally "informed choice" refers to the point of sale. Someone may be told by a salesman that a product is "simple", "flexible", "low-cost", but subsequently the saver often finds that it is in fact not so simple, flexible and low-cost. Dealing costs and portfolio turnover are not disclosed or explained by salesmen at the point of sale. At the point of sale investors generally do not have time to go into anything very deeply.
Mis-selling
40. A feature of the retail market model is that companies have to promote themselves to survive by selling "products". This creates a powerful sales incentive - leading to mis-selling.
41. Mis-selling is a reason for the present enquiry. It is hardly possible to talk to anyone or open a newspaper without coming across examples. In recent years your Committee has published several reports concerned with mis-selling. Most recently, at the time of writing, Transparency of Credit Card Charges (2003). The Conclusion refers to: "the deliberate obscurity of information", "the leisurely publication of consultation papers", "the passivity of the statutory regulator". x John Tiner, Managing Director of the FSA, said:
"Arguably, mis-selling is not a regulatory concept at all." x
42. A colleague bought a life policy with the (verbal) promise that the company would provide a loan against the policy. This promise has since been broken. Discussing the mutual fund late trading scandal in the US, an article in the Financial Times Regulators' tensions flare over fund fees deal (17th December 2003, page 32) reports:
"Fees are at the centre of the scandal. It was to increase fee revenue that the fund companies tried to bring in assets at any cost and without concern for their investors. As a result of their abuses, they increased their fees."
43. Many Equitable Life members are regretting that they signed The Compromise Agreement. x x I attended one of Equitable's roadshow meetings on this Agreement. We were told that signing the Agreement would stabilise the company. As far as I remember the meeting, I was given the impression that Equitable Life would eventually be able to open for new business. x
Confusing names and numbers
44. Looking at a small number of PEPS, TESSAs and ISAs, there is: "account number", "plan number", "contract number", "reference number", "your reference number", "client reference number", "your client reference number", "your TESSA number", "ISA account number", "PEP plan number", "customer reference number".
45. There are several changes of "account number" and a change from "account number" to "your reference number" and from "Account Number" to "Client Number". (These terms may start with capital letters.) Funds and providers sometimes change their name, as the result of mergers and demergers. You thought you had chosen company A only to find there is a metamorphasis into company B. This makes it easy to lose investments.
The FSA is financed by the industry
46. The Green Paper on pensions says:
"We reformed the regulatory framework for saving, replacing ten regulators with a single one - the Financial Services Authority (FSA) - enabling consumers to save with more confidence" (page 2)
47. The FSA is financed by the industry. Many or most people think that it is therefore controlled by the industry following the motto: "He who pays the piper calls the tune." This does not inspire confidence. There are answers: yes: 5%, no: 95%, to both the polls: "Is the Financial Services Authority an effective watchdog?", x "Is FSA doing a good job?" x The formation of the FSA is discussed in a previous submission which I made to your Committee. x
48. The FSA has issued 209 consultation papers at the time of writing. It has a considerable Consumer Help section x. This has general information such as "guides" and "tips". For example "ten tips to boost your finances" x. These mainly recommend "shop around" and "switch", concluding: "Take on a part-time job/ second job.", "Take in a lodger.". It has developed aids for consumers including Comparative Tables x and decision trees for stakeholder pensions x. (The decision trees do not specify whether or not to contract out of SERPS.) It lists sources of information such as:
"Look for tables comparing accounts, loans, investment funds and so on, as well as detailed articles on particular products." x
All this work does not change underlying realities - such as individual amateurs doing business with professional organisations.
49. We can define a saving scheme as "collective" if it cares for the savings of a defined group of people. Someone is a member of the scheme if and only if they are a member of the group. There must be a genuine group, not one set up to have its own scheme. The scheme must have its own organisation dedicated to running the scheme. The organisation must not be concerned with making money to promote itself on the market or pay shareholders. It must receive contributions to the scheme, and be responsible for investment policy. That is to say it is a funded scheme. It must have its own headquarters, and trustees or equivalent.
50. Stakeholder pension schemes are not collective schemes because apparently anyone of working age can join any scheme, and they are not run by dedicated organisations but instead by providers who compete with each other for business.
51. All the employees of a particular employer are a group. Persons with particular qualifications defining professions are a group, which may or may not have a pension cheme.
45. Collective schemes have advantages:
1. The scheme does not need to employ salesmen to recruit members.2. Members of the group do not have to concern themselves with shopping around, gathering and reading information, comparing "products", coping with complexities, negotiating charges etc.
3. There are economies of scale.
4. The scheme has more negotiating weight with the financial services industry than individuals.
5. Tasks can be performed in-house rather than requiring the services of the financial industry, and schemes are able to employ people who are more knowlegeable than individual members - reducing the likelihood of mistakes.
6. Insurance provided collectively for all members of a group is inherently cheaper than when purchased separately by each member.
52. The latter advantages 3 - 6 are to a large extent dependent on resources of the collective scheme and hence on the size of the group. With about a hundred thousand occupational pension schemes x there are many small schemes. Parliament has an Industry-Wide Pension Schemes Group. There are so many industries that it does not seem possible for everyone to be covered by industry-wide schemes.
53. Occupational pension schemes are supervised by employers and OPRA. New collective schemes would need to be supervised. OPRA is a possible supervisor.
The decline of defined benefit pension schemes
54. Many defined benefit schemes are converting to defined contribution schemes. The results of a survey reported in an article in Accountancy Age Pensions Survey - the final countdown (5th December 2003) found that:
"Nearly half the respondents have already closed their final salary pension schemes to new members - and most of those have done so since the beginning of 2001." x
55. This survey shows that a substantial proportion of the final salary schemes which are closing are being replaced by stakeholder schemes. These have the one per cent charge. Thus pension schemes are becoming more expensive. Pension schemes seem to be becoming more expensive also because of increased hidden charges. There is a need for the development of suitable new collective schemes. There is a similar trend in the US, with the growth of 401(k) plans:
"In a 401(k) plan the employee will usually be offered several investment options from which to choose. Almost always these options are mutual funds. Mutual funds charge retail management fees for 401(k) accounts, usually from 100 to 300 basis points--1% to 3%--of the assets in the employee’s account every year! These are truly exorbitant fees compared to fees charged to traditional defined-benefit pension plans: 7 to 20 times higher." x
56. This results in poor investment performance as mentioned in the article on 401(k)s (13):
"Between 1984 and 1995 the average stock fund posted a yearly return of 12.3 percent, while the average investor in those funds made just 6.3 percent." x
SERPS/State Second Pension
57. SERPS/State Second Pension is cheap to administer per member, but permitting people to contract out has resulted in the erosion of the scheme. People or occupational pension schemes should arguably not be allowed to contract out. There is a similar debate in the US, such as: "hand over social security to Wall Street". x Ned Cazalet said to your Committee on 11th November 2003:
"We have had a ludicrous debate in the industry recently about opting in or out of SERPS: it has occupied many newspaper column and taken up a great amount of brain power trying to work this out." x
Child Trust Funds - an opportunity for a new collective scheme
58. CTFs are based on a well defined group. It should have an associated scheme run by its own organisation. In its memorandum on CTFs, the Consumers' Association said:
"CA does not believe that the retail market model chosen by the Government for providing access is the best approach given the comparatively small contributions involved and the low return environment and is not in the best interests of consumers and taxpayers and may be ultimately counterproductive." (5)
"The level of charges providers require to distribute products and provide advice on terms which meet the needs of their shareholders and commercial models would we believe reduce consumers' investment returns to such a degree that the benefits of stockmarket based investment would be effectively wasted." (7)
Four existing collective schemes
1. The Universities Superannuation Scheme x
59. The trend from defined contribution schemes to stakeholder schemes was discussed above (49). This is a trend away from collective schemes to the retail market model. An example of a change in the opposite direction is the Universities Superannuation Scheme (USS). This was founded in 1975, replacing the Federated Superannuation System for Universities (FSSU). This had a panel of providers from which members could choose policies. But this retail market model was found to be unsuitable. The current proposals for CTFs is going back to FSSU, in the sense that there is a well defined group, but instead of setting up a collective scheme, providers will be selling "products" to scheme members.
60. The USS Report and Accounts for the year ending 31st March 2003 states that total funds are £ 15.6 billion on 31st March 2003 and administration costs are £ 7.6 million for the year. x Because USS replaced FSSU universities no longer have to pay providers' management charges, which at 1 % of capital would be £ 156 million per annum.
61. The equivalent organisation in the US is TIAA-CREF x founded in 1918. This is a defined contribution scheme. It has mutual funds which have expense ratios about 0.3 %. " Mutual Funds Expense comparison"
2. US Federal Thrift Savings Plan x
56. In its memorandum on CTFs the Consumers Association mentions the US Federal Thrift Savings Plan (FTSP),"The main attraction for the UK CTF is that rather than require FTSP scheme members to choose from numerous retail investment providers, the board which runs the scheme appoints the investment managers on a competitive tendering basis using "beauty parades" usually associated with the employers pension fund market. This provides massive economies of scale and the use of an intermediary in the form of the board levels the playing field between individual consumer and the investment professionals. As a result the fund charges on the FTSP are in the region of 0.35% a year, and the actual investment management charges are around 0.08% a year." (13)
61. There is a choice of five funds with varying levels of risk. x There are low charges. Expense ratios from 1996 are less than 0.1% of capital per annum. x For members of the Federal Employees Retirement System, a contribution to the scheme equal to 1% of pay is made automatically after 3 years' employment, and there are matching contributions up to the first 5% of pay. x
3. The Danish ATP Scheme x
63. The Danish ATP scheme was founded in 1964. It is compulsory for employees and optional for the self-employed. Contributions "typically amounts to DKK 2,684 for a full-time employee, equal to 1 per cent average employee income". x There is also a compulsory Special Pension Saving Scheme for which contributions are 1% of earned income. ATP is a mutual organisation controlled by "partners to the labour market". There are 4.3 million members. The scheme is highly efficient:
"Pension activity expenses amounted to DKK 27 for each member, while investment activity expenses were DKK 16 per member." x
DKK 2,684 is about £250, which is the lower initial payment into a CTF. DKK 27 is about £2.5, that is 1% of £250. It seems that the ATP scheme is costing about as much for regular contributions, as the CTF will charge per annum just for the initial payment.
4. The Swedish Premium Reserve Scheme x
64. The Swedish Premium Reserve Scheme (PPM) started (accumulating contributions) in 1995. It is compulsory for employees who contribute 2.5% of pensionable income. It is administered by the Premium Pension Authority. Members have a choice of a range of 400 + funds. This scheme seems expensive in comparison to the other three schemes:
"You pay an annual fee of 0.3 percent of the balance of your premium pension account to PPM. In the funds you choose you will pay a fee to the fund manager... PPM gives a discount on the fund managers' usual fees." (page 18)
The Compulsion Debate
65. The British USS scheme has optional membership. The Danish ATP and Swedish PPM schemes are compulsory for all employees. USS and the US FTSP scheme have substantial employer contributions. Such large incentives surely make compulsion unnecessary.
66. Is it publically acceptable to compel people to take risks with their money? Surely employees or employers should not be compelled to contribute to a scheme which is part of the retail savings model, such as personal pensions? A collective scheme for a group of people is less risky, because of the advantages set out above (45).
Where do we go from here?
67. Many people are not saving enough because they do not know who to trust. Who can be trusted? Large occupational pension schemes are trusted. Everyone should have the benefit of being a member of such a scheme.
1. Everyone who is not a member of an occupational pension scheme, should be a member of a group.
2. There should be little or no option about which group to join.
3. The group must exist independently of the existence of the scheme, and not set up for the purpose of having a scheme.
4. There should be a saving scheme attached to the group, so that members of the group are members of the corresponding scheme.
5. If the saving is towards a pension, the scheme should provide a pension without requiring members to buy annuities from insurance companies.
68. CTFs are based on a group according to date of birth, and should have the safety of a scheme based on this group. Many people already belong to groups of employees based on their employment. The problem is to identify groups for which schemes could be created. Should we consider people living in counties or regions?
69. Some people know where to place their savings, and there is plenty of information to help them. Other people who do not have this self-confidence need to have a scheme based on a group to which they belong.
The British collective tradition
70. In 1941 Sir William Beveridge and his committee surveyed the growth of friendly societies and schemes for groups of people against life's contingencies. These collective groups were, wrote Beveridge, "the natural way in which social security began in Britain... There has been a unmistakable movement of public opinion in favour of pooling risks." Beveridge divided the population into six classes of persons sharing collective needs. Retirement was his sixth class. His chapter on the Problem of Age begins:
"Provision to be made for old age is the most important and in some ways the most difficult of all the problems of social security."
x % be the ideal participation rate
(which we assume is the same for opt-in schemes as for opt-out schemes)
x = % of employees should opt in for an opt-in scheme
(x - 50) = % of employees should opt in for an opt-in scheme but do not
(100 - x) = % of employees should opt out for an opt-out scheme
(100 - x - 10) = % of employees who should opt out for opt-out schemes but do not
72. Suppose 100 people become employees of two companies which have defined contribution pension schemes. According to the ideal participation rate, x should become members of these schemes and 100 - x should not join. Whether or not someone should join depends on personal circumstances. Divide the 100 people into a group of x who should join such a pension scheme and 100 - x who should not join. Suppose the first group joins the first company which has an opt-in scheme and the second group joins the second company which has an opt-out scheme. All the 100 employees should act, the first group opting in and the second group opting out, but actually:
( x - 50 ) + ( 90 - x ) = 40
do nothing.
3rd January 2003