Henrytapper's Blog

Meeting expectations?

The Pension Play Pen had a debate last November when we tried to set an order of importance on the six things that the Pension Regulator said , made for good DC pensions (outcomes as they call them).

The top of the list was “contributions” with the old truism that the more you put in , the more you get out, but this seemed to me a weak argument. You can pour a lot of water into a leaky bucket and still carry more water to the trough than a small amount of water in a trusty bucket. When water or money is in short supply, we look to the efficiency of the bucket.

My answer to my question is “efficiency” a good DC pension is one that efficiently transfers money in into pension out.

From this we may deduce that the measures of a good DC pension scheme are to do with efficiency.

Compound interest, the 8th wonder of the world as Einstein’s supposed to have called it, does weird things. Over time, it can distort financial results  through tiny fractions of interest change. Bankers talk about “PV01” the present value of a 0.01% change in interest rate changes over time (or duration as they’d say). It’s an important number.

We do a lot of work trying to help people see the importance of a 0.01% change in the charges on a pension scheme. To use our banner headline, a 0.20% reduction in a charge on your pension fund makes as much difference as you paying an extra 1% into your pension (over 35 years). Put it another way, for a 30 year old, reducing the pension annual management charge from 0.7% to 0.5% is like giving him or her a 1% pay rise.

As a rule of thumb, if your DC pension plan has a charge of more than 0.7% pa on the fund, you are probably in an ineffecient arrangement.

Now I’d really like to say that all this is dwarfed by the differences that you can achieve by getting your investments right but I can’t. Not because a difference in fund returns of 0.20% is just as important as a differential in charges but because you have very little real control of the return you get on your investments. You have (if you are the person negotiating the pension charges) every chance of negotiating a 0.20% reduction in charges.

I hear a huge number of my friends in pensions throwing their arms up in disbelief at the last statement. Is Tapper saying that we cannot improve investment returns to members of DC plans? My argument is that the only way we can substantially improve the returns people get is by influencing the investment decisions they make. The fractional improvement in returns we can give people are achieved by altering the fundamentals;- increasing shareholder value through good governance being an example. I do not believe that as a society we can stock-pick our way to a happy retirement. Across the board, stock-picking is a zero-sum game where the winners and losers are in equal measure and the only sure fire money-maker is the stock-picker who takes none of the risk but pockets a % of the fund. Roulette is the business model with the active manager’s charge equating to “OO”.

So in my world, the charge on your pension savings is the most important element of a good DC pension followed by the availability of the right investment choices, presented so that suitable choices are made is the second.

The third element that I look for when I look at a pension scheme is the help given to members when they really need to take the right decision (eg when they come to cash in their fund and buy a pension- see my recent blog on this). More money is wasted on bad decision making here than is wasted on trying to get out-performance from stock-picking (which is saying something).

Trailing in behind these essentials are the Pension Regulator’s other criteria

Assets in funds must be safe – important for those ski-ing off piste but for those on the superhighways of default funds- this is a gimme- it is not the big deal.

Administration must be sound;- you’d have to be unlucky now to pick a pension provider who screwed up. Again, sticking to the mainstream players who employ straight through processing to the whole kaboosh should make administration a hygiene factor  – this is more an issue for legacy unbundled pensions which most people have very little exposure to.

So to sum up, when I do my Arthur Negus bit and look at a company pension scheme, the first thing I look at is the charge that is being paid, then I look at the way the investments are set up, then I look at the help for people retiring, then I look at the admin and the security of the set up and then I ask the question- is this pension worth paying into?

Funnily enough, when the answer to this is “yes” contributions made by members and their sponsoring employers tend to be high, when the answer is “no” they tend to be low, But there are skews.

The skews are created by “advice” or at least the concept of advice that’s been promoted by those “enrolling” members into DC plans (typically GPPs and stakeholder pensions).

The skew is created by performance fees and the way it is paid. The performance fee is paid as a commission to the company enrolling you into the pension. If you do not sign up, no fee is paid and the enroller has failed, if you sign up , up to 0.5% of your fund per year (till you take your fund) is taken as a charge. This money is either paid on the drip to the adviser or is paid over up front as an initial commission which can be as high as 25% of your first year’s contribution.

This commission is justified by advisers and providers as necessary to pay for the “advice” given to those about to enroll. Since this advice usually amounts to the words “sign here”, you might consider this money for old rope but that’s unfair. The commission covers all the expenses the adviser incurs including compliance with regulations, travel , risk and marketing costs.

Ironically , this practice can lead to close to 100% take-up of expensive, inefficient pension schemes.

The point is not that the advisers are ripping people off; the point is that most of the cost is totally unneccessary. This is leaky bucket stuff.

There are three reasons why this will come to an end. Firstly, this market efficiency will self-correct. People will not put up for ever with the inefficiency of enrollers being paid as advisers but acting as postmen. Secondly it is fundamentally unfair and to a Regulator who’s credo is “treating the customer fairly”, it is an unsustainable practice – hence the retail distribution review’s strictures on adviser charging on corporate pensions. Thirdly, Government has worked out that a system of auto-enrolment where people have to opt-out rather than opt-in to being in the pension plan, will solve the problem of people not joining without the need for an adviser to be paid to extract signatures from reluctant savers.

We’ve yet to see whether the “apathy sale” will work but whether it does or not, the combination of market, regulatory and legislative pressure is going to do for the market skew I’ve outlined above.

Increasingly , I believe that we will start looking at DC pension plans in the UK as the Americans look at mutual funds. The Americans talk of “load” and “no-load” funds, the former carrying a commission loading for sales and advice and the latter being free of advice and commission.

I think that UK employers will increasingly see their role as providing “no load ” pensions that are seen by employees as good because they offer low charges and default positions that do not need advice. If they also offer strong governance from either the provider or from the employer via a governance committee or a trustee board – so much the better - this itself will be seen as part of offering a good DC pension. Employers who encourage higher levels of contribution either by throwing money as employer’s contributions or offering matching contributions or using salary sacrifice (or best- all three) will once again become employers of choice.

However, employers who do nothing to take the current loadings out of their pensions and continue to allow their staff’s funds to be eroded by unnecessary commissions, will be seen as uncaring , inefficient and lacking in general governance. Market , regulatory and legislative pressure will eventually force them to change and when they do, they will wish they had got their act together sooner.

If this sounds like a commercial – too right – it is! If you are an employee empowered to do something about your company’s pension or even if you’re not but would like to be, it’s time to pay attention. Get on down to your IFA and tell him you want to move to a no-load pension, you want to review your investment options , get your at retirement support right and make sure contributions to the new scheme are as efficient as possible. If he looks blankly at you, contact me @ henry.tapper@firstactuarial.co.uk.

If you are not directly influencing your company’s pension decisions, print out a copy of this article, highlight the previous paragraph and put it on the desk of the person who is!

It’s time to restore faith in British pensions, this is not going to be easy and it’s going to involve some fundamental changes to the way we do things. Upgrading the stock of company pensions is a part of the fundamental change and like all change it will only happen because of strong leadership – from you!