Pensions Age DC roundtable

The passing of new legislation, the replacement of Andrew Smith, changes to MNT rules, and lots of pensions press coverage in between – and it has only been three months since our DC panel last met. So what does this all mean for the future of DC?

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Chairman: Roger Cobley having recently been re-elected as President of the Pensions Management Institute (PMI), boasts extensive experience in the pensions sector. He is currently a director of Stamford Associates Limited, the investment consultancy firm, chairman of several pension funds, a fellow of the Institute of Actuaries, an associate of the Society of Actuaries as well as a Freeman of the City of London, to name but a few of his achievements.

Robert Branagh is director of client development at Paymaster, having joined in 1999. He is responsible for Paymaster's relationships and service offerings to existing clients and is a fellow of the PMI.

Jeremy Ward is head of pensions marketing at Friends Provident, where he has worked since 1994. Previous roles at Friends Provident include head of product management and head of strategic marketing.

Richard Parkin is head of DC product development at Fidelity Investments, having joined in September 2002. He has also been an associate of the Pensions Management Institute since 1992.

Andrew Cheseldine is a senior consultant in Watson Wyatt's Benefits Practice. His principal area of expertise is in advising on and implementing employee benefit programmes, particularly DC pension arrangements in replacement of existing DB pensions.

New legislation

Chairman: "Since we last met a number of things have happened – the Pensions Bill has finally become the Pensions Act; we have a new secretary of state for work and pensions, Alan Johnson; and we have had the Pension Commission’s interim report.

There have also been some funny goings-on relating to the Financial Assistance Scheme and the PPF; as well as some other developments within the DC market. So, how do we think all of this is going to affect DC schemes in particular, and the pensions industry as a whole?

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Cheseldine: There doesn’t seem to be any one issue that will make
or break DC. I do think, though, that the issues about the PPF and its use retrospectively will be a great boost to the DC market because more employers will simply opt out of DB provision. I certainly wouldn’t want to continue to offer a DB scheme if I thought the government was going to use my fund as a piggy bank to fund its social responsibilities.

Parkin: I guess the biggest risk is not just to the DC market but to the concept of pensions in general. There is so much legislation out there and it has become such a minefield that the value of retirement benefits in a lot of consumers’ minds seems to have been lessened.

My fear is that the big industry employers may turn around and say ‘right, I’ve had it with pensions, let’s give people increased cash benefits instead’, and the only thing stopping that from happening would be for the government to lead very firmly in the other direction and say that there must be some sort of retirement provision.

Chairman: So you think that Turner should recommend compulsion or some form of indirect compulsion?

Parkin: No, and I don’t think he will either. Reading between the lines I think Turner has recognised that in a lot of places where compulsion exists, all it does is displace other savings. He seems to prefer the idea of removing some of the barriers to pension provision, in particular separating state and private provision.

Although he wasn’t asked to talk about state pension it seems a lot of his focus has been on the complexities that the integration between state and private provision throws up and that if you did separate the two, the pensions industry would eliminate a lot of the problems it has got itself into including contracting out, means-testing benefits etc. In effect, we could get a form of pseudo compulsion through the combination of stakeholder pensions, auto-entry and a system similar to that in the US where tax-relief for higher earners depends on the coverage and contributions of lower earners
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Chairman: We do, of course, already have compulsion – it is called National Insurance! So one route would be simply to increase that. I think there is a lot of pressure for a change to the structure of the state benefits, although I don’t think it will come out until we see the election manifestos.

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Parkin: The Liberal Democrats seem to be coming out in support of the Citizen’s Pension – although they remain coy about how that is actually going to be funded. The Tories have got their own ideas, but they are open to suggestion on the whole S2P issue; and clearly Alan Johnson is keeping his cards very close to his chest, maybe firmly held there by Gordon Brown.

Branagh: Having said that, Alan Johnson has been more vocal than his predecessors since being appointed and he has taken a step forward in putting current government thinking further up the agenda. As a consequence, this has prompted the Conservatives and the Lib Dems to come out a bit more.

Ward: I think how much pensions policy is revealed by the government in the run-up to the election will depend very much on how much of an issue the press can make of it – and I very much hope they can make it a big issue, because then we will know what we are being asked to vote on.

The current approach taken by the government is to keep its cards as close to its chest as possible on the basis that everyone is waiting for the Turner report to come out, which means that we will have to wait until after the general election to know their policy on pensions, which seems to me rather weak.

Cheseldine: Part of the problem is lack of government understanding and conflicting legislation. For example, while everybody else agrees that automatic entry would be a great way of increasing take-up of pensions, up pops a Distance Marketing Directive that says, ‘no, you can’t do that’.

Tax incentives

Chairman: Would offering more tax incentives give us what we need?

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Ward: I think more tax incentives are unlikely, seeing as everything seems to be going the other way – tax benefits have even been reduced on ISAs. However, it is the best way forward. We know what makes people contribute into a DC scheme is the thought of free money from somewhere. Free money from the employer transforms the take-up rate and free money from the government would do so too, and the more there is the better.

Branagh: I think the main problem is that you have got those on lower incomes who have no carrot or stick to incentivise them – and it is these people who, arguably, the government should want to bring into the net and do more for, especially coming up to election year.

Ward: The other issue at the lower end is the plethora of means-tested benefits, which actually makes it very difficult to be firm about giving those people advice that says it is worth investing in pensions.

Branagh: Exactly, and if you heard some of the recent government publicity about the Pensions Credit you would think it had been the most fantastic success story this government or any government has achieved, when in reality the number of people that have been getting less or being brought into the means-testing net
has been increasing.

Chairman: Do we think Alan Johnson will have an influence on Gordon Brown in the run-up to the election and will want to shift basic state pension up a bit, at the expense of getting rid of some of the means-testing?

Cheseldine: I don’t think anyone has that much influence on Gordon Brown, and he has made it clear he is against raising the state pension.

Ward: He sees it as a dangerous short-term expedient, and herein lies the difficulty of the long-term versus short-term argument i.e. a lot more pensioners may have been taken out of poverty under means-testing, but is that a long-term solution?

Member nominated trustees

Chairman: Focusing on the announcement that 50 per cent of trustees must be member nominated – do we think that’s a good thing or a bad thing?

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Ward: I think the law of unintended consequences applies here – while it may well be a good thing for those DC schemes that remain trust-based, it may also encourage a move away from trust-based schemes.

Chairman: Will schemes also lose some of their independent trustees and if so, what would be the consequences? For example, where you have people like the finance director and the HR director as trustees, who at the last minute can’t attend a meeting, is there a risk that the member side of things will have the majority and vote in a way the employer wouldn’t like?

Branagh: I think that is a real risk. At the moment there are situations where employer sponsors want to go to meetings precisely because union members or pensioner trustees are a lot more vocal than they have been in the past. As a consequence it would be a real shame if independent trustees got squeezed out because they are usually key in preventing policy decisions which are not really in the interests of all the beneficiaries.

Chairman: So does this mean we are going to see more DC schemes going contract-based?

Parkin: Yes, and we are already seeing that happen. People are already starting to talk about migration. Schemes have already done the ‘DB to occupational-DC’ jump, and have maintained the trustee board as they didn’t want to change everything at once, but they are now thinking they should make the ‘occupational-DC to contract-DC’ jump.

Cheseldine: I am not totally convinced that the market will completely go contract-based, or even largely – I see about 50/50 at the moment. Certainly new schemes that are being set up – particularly for smaller organisations – will nearly always be contract-based, but we do see quite a few employers that actually value trustee groups.

Branagh: At the end of the day, employers are going to have to come back to the fundamentals about what’s in it for them – is having a pension scheme about retaining staff or is it just some sort of provision to keep a certain number of people happy?

Provider stability

Chairman: There is talk in the press that at least one of the bigger DC providers, Invesco, is pulling out of the DC market – does that suggest that costs have been squeezed too far?

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Parkin: Invesco is one example but there are others. We have seen Credit Suisse, perhaps for similar reasons, putting Winterthur up for sale. It is not just happening in the bundled market. Something else that has happened since we last met was the Profund issue, which has caused massive repercussions in the administration market. I think a lot of it comes down to increasing complexity on the one hand, and costs being screwed down on the other.

In some ways you can’t resist consolidation, but what does worry me is the effect it may have on confidence, as it is already a minefield for consultants to try to recommend providers. The challenge for a lot of us, I think, is to be realistic about what can be achieved for a certain level of cost – yes, stakeholder is challenging and it has rightly challenged people to cut down, but there is a danger of screwing things so tight that even if people are making money they are doing so at the expense of tying up a high amount of capital which would be better employed elsewhere in the UK plc.

Chairman: From the point of the view of the DC market, therefore, do we think it will polarise?

Ward: I think seeing major providers leave the DC market indicates that scale is very important – and when we talk about the development costs of systems, it is the members that will have to pay these costs. If you are small then you won’t have enough members to pay for these costs, whereas if you are big then the development costs become relatively insignificant by comparison with the revenues that are coming out of a big book.

Parkin: In addition to scale, proper financial management is key as you can have a large-scale business but still give stuff away, and thus lose a lot of money. So I think it is about balancing the two – being able to build your business to a point where you do hit a critical mass to benefit from economies of scale, or not doing so in a way that leaves with you with a very unprofitable basis from which to sell from.

Cheseldine: As a consultant you would argue that Invesco leaving the bundled market was a move you couldn’t have called, as it was an organisation that had only recently put a lot of money into its systems. But there are others providers coming in – HSBC, for example, has come in with a good product. I am also aware that there is another investment manager coming into the market as they were reported to be looking for a head of DC – I don’t know who it is though.

Saying that, some of the existing DC providers will probably go as well. For example, I know of a traditional insurer which, although in theory has got SMPI right, if you ask them for SMPI statement on one of their schemes you can’t have it until April next year as they have got such a back-log, which is appalling. That organisation, I understand, has no hope of hitting the simplification deadline, and I hate to think what that does to your business plan.

Branagh: But they won’t be unusual, there will be others like that.

Chairman: Does that suggest there will be fewer but bigger providers?

Ward: Yes, it isn’t just having the systems, that is just one part of it. You have got to be excellent in a whole range of different aspects – you need to have the systems, you need to have the people that work the systems and provide the service that the employers are looking for, and you need to have the range of investment options – all at the right price.

Cheseldine: Saying that, a lot of organisations today are just putting out lots of external fund links. To use Friends Provident as an example, they will soon have a Shariah law link, which is an HSBC fund at a rate cheap enough to fit into a stakeholder environment.

Boosting contributions

Chairman: In terms of our DC programs, how can we encourage more saving on the one hand, while not have lots of employees investing in vehicles that may not be quite right for them. Is there a case for restricting choice, and is there a case for further pushing the default options?

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Ward: The default options are already very popular and are taken up by most members, so I think we should be less worried about investment choice than we should be about membership numbers and contribution levels.

Cheseldine: Quite often the default is a lifecycle design and we would like to see more than one lifecycle option – I suppose it is a balance between practicalities and theoretical utopia – you want as many people as possible to have the right product for them, but you also want people to actively make a choice.

Parkin: I was reading the recently published DWP regulations around stakeholder and the requirement to have a default option with a lifecycle structure and they are, to say the least, woolly. They basically say that you must offer something which starts switching assets at least five years before retirement, and that it does something to reduce the risk to members’ benefits.

Cheseldine: Ideally, you need to give people stochastic valuations that give them an idea of the width of risk and what the odds are, but I don’t know how to explain that to the man on the street – I have enough difficulty explaining the implications of it to trustees.

Branagh: That’s without looking at the fact that with flexible retirement you might not even be going at 60 or 65 but maybe at 70.

Chairman: So what steps can the industry take to get contributions up?

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Ward: There isn’t one answer, given the constraints we have already talked about i.e. government policy, which is outside our hands (apart from the fact that we can vote, once we know what we are voting for).

Parkin: In terms of DC, I think we need to lower the pitch of the conversation. One of the things in the Turner report which was seized upon by the media was that it defined the “haves” as the long-term DB members and senior executives in
DC schemes, and the “have-nots” as everyone else in DC.

There is a real danger that DC gets given a bad name and that is something we have to address at all levels – DC schemes don’t make poor pensioners, poor funding makes poor pensioners.

Conversely, DB is fast becoming like the nasty old aunt who, now that she is dead, is being remembered as a lovely old lady – DB served some people well but it was also bad for a lot of people and now that it is gone for many, everyone is saying how fantastic it was.

Ward: We also have to keep developing online planning tools and look at the experience that people get when they are on there. Saying that, I also don’t think enough people are using them in the first place. More education is also needed through the employer and we need to work to improve the things we are already doing like worksite marketing in order to get employees more motivated to contribute.

The future

Chairman: Do we have any thoughts about where we might be in 12 months’ time. Might things be better, or will they be as confused?

Cheseldine: I don’t think it will be as confused, however, we will have certainly found that there are a rogue five or ten sections in the Pensions Act that no-one had expected. All the other legislation, including the EU Pensions Directive, will be keeping us busy, so where will we be – don’t know, but we’ll still be busy.

Branagh: I think we’ll be in a slightly better place – more information will have come out, we will be more certain about what is going to happen in April 2006, and employers will have more of an idea of what they are doing. I also think members will be better off as there will be a lot more communication coming through about choice and what is going to happen in the new world, post-2006.

Parkin: I am really positive – I think this time next year Adair Turner will have given us the Holy Grail, we will have a government that is clear for the next four or five years and it will all be fine."