Pensions Age DC roundtable 2004

New pensions legislation may offer DC members increased flexibility and investment choice, but it also adds complexity to an already over-complicated system.

No doubt more financial education will be necessary for members to make the most of these changes, but who is going to meet the cost of this? Does this extra choice really represent change for the better? And will it lead to a better world for DC members?

BACK TO ROUNDTABLE ARCHIVE

BACK TO ROUNDTABLE MAIN

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: "The Pensions Bill is, slowly but surely, grinding its way through Parliament and since we last met, a few further legislative changes have come to light. What impact will these have on the DC market?

top

Parkin: A few things of relevance have been added. First, the vesting element – which the government has confirmed to be a three-month period – could be something that may make employers less attracted to occupational plans (or at least put them on a par with personal pensions).

A second, more unexpected change was the removal of LPI on DC occupational pensions, which was welcome. It’s just a pity they didn’t go the whole hog and take it away from DB too. Given that research shows you need to live until about 91 years old before the LPI protection actually pays off, it will not only mean that members are going to get a slightly better deal at retirement but from an administration point of view makes life that much easier.

Branagh: Certainly from an administration point of view it is also very welcome as it relieves things going forward. But, there is a slight concern that members still need to be educated if they are going to benefit from the change. This leads on to the question of how useful SMPI is. The feedback we have been getting from members has been mixed. In fact, not many of them think these new statements offer anything substantially better than what we had before.

Parkin: Another concern I have about SMPI is the fact that some of the assumptions about contributions are pretty dangerous, particularly if you have age and service-related contribution structures. So, it would be helpful if statements basically said: this is what you’ve got now, this is what you might get if you stay until retirement, and this is what you would get if you stayed for the next, say, five years. From an administration point of view, though, that might create a monster.

Chairman: But let’s not lose sight of the fact that one of the main reasons behind the SMPI was to wake members up to the fact that they need to save more for retirement – has this been achieved?

top

Cheseldine: I think it has forced people to take the first step in that direction. For example, at Watson Wyatt we have had feedback from members saying ‘hang on, this isn’t giving me as much I thought’. This in turn has led us to conversations with employers whereby they are slightly more prepared to fund financial education in order to try and raise awareness among employees.

Branagh: And post-2006 this is going to be more important as members will have more power to make their own choices. Trouble is, if you still only have about 20 per cent of the population who are financially literate it won’t matter a jot if there is more modelling – you still have got to tell people that they need to take ownership themselves and we have got a responsibility to help them do that.

Chairman: But whose responsibility is it to educate members on financial issues?

Cheseldine: I think there is a general consensus that employers are going to have to take more responsibility for this and that is partly driven by the consultation rules that are coming in as part of the Pensions Bill, as well as the DTI employment relations consultation rules.

Trouble is, while it appears that the government is making employers responsible for financial education, is the infrastructure there in terms of allowing them to give information without breaching the Financial Services Act? That is debateable.

Chairman: But whether they are breaching the FSA is a fixable problem – the more pertinent question perhaps is to what extent will employers be required to do this?

top

Parkin: There are two levels to this. I think it is right that employers should be encouraged to promote their pension schemes more clearly and try to encourage membership; but it becomes more dangerous when they are trying to encourage members to make additional contributions as there may be other places their members should be putting their money, for example paying off their credit cards.

Ward: Yes, it becomes dangerous for employers when they cross the line into individual financial advice. While for the majority of people it will be fairly clear whether or not it is beneficial to be a member of the pension scheme, once you start looking at how much should be contributed you are getting into the whole issue of individual advice which employers aren’t generally best placed to provide.

Chairman: But if the employers aren’t best placed to provide it, will the employer be virtually required to provide this as an additional service by, for example, appointing an IFA?

Branagh: I think it will come down to normal commercial pressures – if you are in an industry where you are using your pension scheme as a business tool to retain staff then you will do as much as you can to maximise the return on that tool.

However, the general perception is why spend money to educate your workforce if they are going to go down the road to your competitor two weeks later? As a result, employers are less inclined to do anything extra for their members unless they absolutely have to and eventually compulsion will be needed to make employers take more responsibility.

Ward: But I don’t think compulsion is where the government is heading.

Branagh: Well, once more people have retired from DC schemes we will see if there is a backlash of employees blaming their employers for their disappointing investment returns. If that starts happening on a large scale I think you are going to see encouragement for employers to do more, and that may be in the form of compulsion.

Chairman: But there was talk that the government would exonerate employers and give them some sort of leeway if they were expected to give advice.

Parkin: I think the rules being proposed by the FSA are fairly limited around being able to promote the scheme and membership of the scheme, and it is when you go beyond that the problems arise.

top

Role of IFA and the stakeholder cap

Chairman: Going back to the whole business of financial education then, is this open season for IFAs and is that good news or bad news?

Parkin: IFAs do have the potential to play a role but I think in a corporate pension scheme it is questionable whether an employer would want to pay for an IFA, and that could lead us back to schemes being written on commission. But, even then, does that necessarily promote the right type of advice?

Ward: We are seeing more being written on commission and I think an interesting legislative change that has come in since our last meeting has been the cap being raised on stakeholder charges from one per cent to 1.5 per cent for the first ten years (which from the provider’s perspective offers the worst of all worlds in that it makes things more complicated).

I think a number of corporate IFAs out there, though, might be thinking this offers them scope to make a bit more money. Although the actual figure doesn’t provide a lot more in reality.

Chairman: This issue of advice brings us back to Branagh’s earlier point that you almost need some crisis cases before that message comes home.

Branagh: Yes, and another good example is where we see people putting all their money into second and third homes on the expectation that the increasing capital value can be utilised instead of a pension – reality is, of course, if there is a correction in the housing market those people’s assets could be wiped out.

top

Alternative investments

Chairman: Well, let’s extend the debate – the new investment opportunities that have been introduced under the new legislation coincide with what has already been identified as a lack of financial education – good or bad?

Cheseldine: I have to say bad. If you don’t get the education right while you create extra choice things will go wrong and I have a feeling that some of the extra investment choice that is being made available has been done under a false premise.

We have just completed a FTSE 100 DC survey looking at the average number of investment options available under DC schemes (around half were retail schemes – i.e. stakeholder and GPP, and half occupational). The results showed, as you would expect, that retail schemes have vastly more choice than occupational.

The difference is, in retail, you have got a provider behind you that is offering (albeit limited) financial education, and usually offers a default; but in occupational schemes you are not necessarily doing all of that.

Ward: There does seem to be some tension between the needs of the average member and the state of requirements of some advisers. We are always increasing the fund choice but that isn’t driven by the demands of the members, it is driven by the demands of the advisers. Advisers have their favourite funds and if those funds aren’t on our platform, they won’t use us. But does it make a difference to the members? I think not as most research shows that people are better able to make choices from a limited number.

Chairman: So, are providers going to have to offer an option for people to put pension money into residential property?

Ward: We could – but is it appropriate for most people to fund their retirement through residential property?

Parkin: If we could be sure that people were going to construct well-diversified portfolios with an element of residential property then we would make a vehicle available; but we know certain people will just put all their cash in it and rely on the property market.

Chairman: Do you think the DC market will move into offering alternative investments like hedge funds, venture capital, and private equity?

Parkin: As direct investments they are probably not appropriate – whereas if it they are part of a broader portfolio they may be. There are also other forms of structured products which effectively do dynamic allocation between equities and bonds – but it all comes back to the problem that most investors are not going to be financially sophisticated enough to make a decision about these.

Cheseldine: Saying that, I do like the idea of having a fund of funds or manager of managers addition to DC where you would have some non-correlated risk investments, some distressed debt, some venture capital, some hedge funds and so on.

top

Role of the adviser

Chairman: The providers here today keep referring to the “demands of the investment adviser”. If the market is being totally dominated by the investment advisers, is that good?

Parkin: The market is dominated by the advisers and they do add value in guiding the trustees in the DC market where it is all very new to people and clients do need a lot of advice in terms of setting up their plans.

I do think, though, that there are always complications when there is such a diversity of views and in our experience it does cost a lot of money to meet that diversity of views. That, coupled with the natural instinct of the adviser to try and get the best price in the market, causes a lot of financial pressure on the providers.

Chairman: So, is the proliferation good or bad for the market?

Parkin: I think there are dangers in not offering diversity although I think things could still be simpler – less investment choice and slightly clearer contribution structures in some cases of DC.

Cheseldine: Part of the problem is that we change our minds all the time but that’s because the market constantly changes – new evidence comes to light, the economy alters and on top of that, legislation changes things too.

Chairman: But have we not, between us all, conspired to create a very complex market with lots of added costs, which at best is confusing and at worst is cost inefficient?

Ward: I think if you look at where most of the member money is going, it is going into the default fund, which, on the whole, is very simple to understand. I think where you do have the proliferation is around the edges.

Branagh: I disagree. I think it has all gone too far. There is too much choice, too many decisions to make and the trustees are asking what is this going to mean to me if any of this goes wrong? Isn’t it better to invest in the core product for the benefit of members and make that the best possible product we can, rather than invest in tweaking the edges, throwing money at slight improvements here, and adding more investment choice there?

Parkin: But, as providers, we are trying to stay competitive. We are always trying to add the latest bell and whistle to our product so we can be better than the other providers.

Ward: Saying that, by far the bulk of the investment that providers are putting in is targeted at developing pension products and targeted at improving the service and systems ,than it is towards proliferating funds.

Branagh: Well that’s not necessarily the perception in the marketplace among trustee bodies and members.

Chairman: Well, maybe providers are not communicating that message."