What a charge cap would mean for insurers

lunchIt was not until I sat down with a grim-faced group of insurance executives at yesterday’s pension play pen lunch, that I grasped the gravity of their situation.

Here is how my source close to Government approached the subject sees the issue

At the end of the day I see financial services as a massive example if market failure rather than what they see it as which is the efficient market working. It is so beset with asymmetries of knowledge and levers that inevitably the punters get taken for a ride.

I see the SW (Scottish Widows)  survey out today says that pension saving is an all time low. No wonder.

The outcome will be straightforward. Either industry follows NEST and L&G into the 0.5% charge for default funds or they are out of this market.

As I wrote earlier in the year, it’s STICK OR TWIST for the lifecos.

But it’s worse than that; the “market failure” that my friend refers to includes sponsoring the commission frenzy of 2012, sanctioning the inappropriate use of active member discounts and continuing to invest in vanity projects (corporate wrap).

Now there no obvious way to reward intermediaries from within the AMC, it’s time they put the tank in reverse, even if it means rolling over some of their own footsoldiers.

The insurance industry needs to distance itself from the practices of the past. It also needs to distance itself from the provision of non core services. In particular the provision of services it is currently offering from free (AE payroll support and on-site on boarding).

Auto-enrolment h is a payroll problem. Bundling the payroll software needed to manage auto-enrolment into the price of a pension is an act of gross rashness.

I was asked by L&G 18 months ago whether insurance companies should provide payroll support as part of the pension proposition and I said “no”. Those who choose to bundle the support within the AMC are giving away the software for free, but more worryingly still, they put their organisations at risk of managing the on boarding process which could do their balance sheets serious harm.

That the payroll software companies have been slow to bring product to market is not the insurer’s problem. The market as a whole has been quick to fill the gap with middleware. Providers with “middleware” capabilities of their own should compete with their products, not use them as marketing freebies.

Similarly, insurers with the capability to manually onboard pensions, should sell this service and not give it away within the AMC.

The charges cap is coming and it’s time insurance companies stopped claiming they are doing stuff for free. While there is no cap, they are relatively unconstrained by EIOPA‘s  pillar 2 and 3 issues which will apply to DC. The other side of a charges cap and they may find themselves with a hefty reserving bill and little or no wriggle room with their expectant customers.

But it gets worse, as one of those at lunch wrote yesterday evening.

Henry, the Embedded Value write offs if the cap comes in at 0.5% will be in the £bns

It’s not just the cost of providing too much for too little going forward, it’s the opportunity cost of not charging more for what you’ve already got.

Auto-enrolment looked at outset as a means for the insurers to absorb close to 12m customers into the system on their terms – a huge plus. But along came NEST and then the mastertrusts and now the odd insurer behaving like a master trust and “the price to compete” for new business has become 0.5%.

But , until there is a cap on charges, the legacy books are still in play and most of the insurer’s legacy book is written at more than 0.5%. The embedded value of the legacy book assumes it will be used to manage auto-enrolled pension schemes at the contracted price. For that price to fall from say 1% to 0.5% means the insurers having to take a hefty haircut on their assumptions for future profitability (which drive their embedded value computations).

And in case the insurers think there is a sunnier side to the street, they should think again. Steve Webb is a State Pension man for whom auto-enrolment is a sidebet. Gregg McClymont and his bosses, Balls and Milliband have put down their marker and they will campaign and govern on a “screw the charges” down ticket. The insurers have every reason to want to see a charge cap under a coalition Government, especially if they can get themselves  a commitment of restraint from politicians and regulators not to meddle with the mechanism.

There were, at the lunch , a lot of well stated arguments surrounding the perils of setting a charge cap (too low).

  1. The charge cap limits innovation, limits competition, creates a “too big to fail” outcome and results in the development of a political football, not least because we have already seen the NEST price set too low to be sustainable without subsidy and potentially intervention.  Similar but different outcomes emerge in the private sector.

  2.  The charge cap when read across to the Trust based world will have a series of unintended consequences, especially for Trustee fees.

  3.  It will be nigh on impossible to have innovation in the defined ambition/guarantee space, without a carve out, and even then the challenge will be to define what is allowed and what is not allowed. Horribly complex and open to a raft of challenges.

The point is also well made that

The press will accuse the powers that be of be economical with the truth when it is stated that NEST comes in below the charge cap. This will be a horrible place to be for the Pensions Minister. The only alternative will be to have two caps. AMC only and combination eg 1.5% amc only and 5% contribution charge and 0.5% amc

I don’t think that Steve Webb wants a charge cap, that’s what all that guff about not having to regulate the price of a can of baked beans was about, but as one of our luncheon stalwarts put it. “Webb will say that the industry has only itself to blame”.

Pot follows member doesn’t work with schemes that produce price spikes, even if those schemes offer all singing all dancing defined ambition like investment defaults.

The cold cruel reality for the insurers is that Webb and his mandarins will say

“you’ve had your chance – you blew it-now live with the consequences.”

There is a short period over the summer , while the OFT report is still brewing in some Whitehall back passage, for the insurers to make their case. Every basis point they can get above 0.5% is another lifeboat for embedded value. The ship has sunk and it’s now damage limitation; that’s why it was the lunch that it was.

To those who were there, thanks! Of our 44 lunches this was the easiest to chair so focussed were we on the issues at the hand. But- why all men?


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
This entry was posted in Australia, auto-enrolment, Financial Education, Payroll, pension playpen, pensions and tagged , , , , , , , . Bookmark the permalink.

14 Responses to What a charge cap would mean for insurers

  1. Martin says:

    Ought we have any sympathy for insurers embedded value? Isn’t it just a accrual for future profit assuming the world stays as it is? Like Tesco capitalising the present value of their future milk sales on the assumption that the price stays at £1.20 a pint.

    • henry tapper says:

      We ought to have a mind to the shareholders Martin, after all they are often relying on insurance company dividends to help out in retirement! should we be rewarding these shareholders with a kick in the proverbials (which is what slashing embedded value does) on the basis of a change in the political temperature?

      I’d rather be having a go at the managers of these businesses who have flagrantly put their bonuses before the interests of their customers. Maybe the cap should be on the bonuses and the pensions of the senior managers of the insurers with a strong warning to employers that high charges are bad for your employee’s wealth!

      • Martin says:

        Glad for that since I am a shareholder in a number of insurance companies and I rely upon those dividends to fund my “retirement!”

    • henry tapper says:

      Do you have shares in the Milk Marketing Borad or something?

      • Martin says:

        And I thought you were going to say I got the price of a pint of milk wrong – more like £1.20 a litre. Mrs Thatcher always made a point of knowing that price so she could say she was in touch with average people. Nobody spotted my mistake.

  2. Steve Jackson says:

    Henry. Good debate yesterday. My view, prior to the meeting, was that a % of fund AMC charge cap was likely for default funds, because:
    • It would help maintain confidence in auto-enrolment and alleviate concerns about new savers being “ripped-off” by high pension charges (regardless of the validity of those concerns).
    • AMC is (relatively) simple and already ingrained in the industry, thanks to Stakeholder pensions. If there has to be a charge cap it’s preferable that it’s simple to articulate and understand – rather than, say, a combination of £ and % of fund.
    • Most importantly, % of fund AMC works well at protecting the very people targeted by AE – those with small contributions and funds. A per-£ cap could be detrimental to these customers.

    On top of this, it looks like a benchmark AMC has already been set by NEST, NOW, People’s Pension and most recently Pension Playpen at around 0.50%.

    However, the key thing I took from the discussion was that even if the market was saturated with products offering 0.5% and lower for a simple group pension (and as technology improves, operations become slicker and AE funds grow, this charge is likely to come down) – Auto-enrolment will not succeed unless the cost of setting up and running a compliant auto-enrolment scheme is also borne somewhere.

    I suspect that many employers (particular smaller ones) will be unable or unwilling to pay the true costs needed to support a new auto-enrolment scheme – so should some of these costs be loaded on to the employee? Probably not, because bundling non-pension costs into an employee fund charge won’t help transparency and is unfair on different generations of scheme member.

    I agree with your point that providers needs to make it clear what is and isn’t included in an employee fund charge. Unfortunately the industry has been heavily influenced by the Stakeholder pension charge cap – which meant that a % fund AMC was used as a home for most costs and expenses (including remuneration cost, pre-RDR). Not ideal, because there is usually a real mismatch between the timing of costs and when these are paid for via a fund charge.

    In the post RDR, auto-enrolment world I suspect all charges will become much more unbundled. It’s already happened with remuneration. So employers will face an additional cost burden. It also means that the wider industry, employers and policy makers need to understand the value of additional advice and services. Otherwise, auto-enrolment, and the market generally, is likely to struggle once smaller employers start to stage from 2014.

    So, my view is that a % of fund default charge cap is likely and, for the reasons above, probably beneficial because it helps consumer confidence. I’m not sure of the appropriate level. 0.5% is probably too low, 1% is too high. Something in-between?

  3. Faisal Aziz says:

    Hi Henry
    Interesting post, thanks. I suspect that most large DC schemes (say the top 3000 employers) are probably running at AMCs at or below 0.5% AMC, certainly my last three workplace pensions all with large employers, were all run at an AMC well below 0.5% . The large bundled providers are focused on these large employers so in terms of new business would be largely unaffected. A charge cap would probably cause medium and small employer schemes to shift to NEST or toward a master trust structure. A retrospective charge cap on legacy would clearly be another matter but much of the damage to pot values has already been done with initial units and deferred member charges so feels like closing the proverbial barn door.

  4. henry tapper says:

    I’m sure you are right, there are however 800,000 employers with less than 5 employees and I guess they matter as much as the 5000 employers with more than 800 staff!

  5. henry tapper says:


    The debate also made it clear to me that there is little to be gained and much to be lost by driving the charge too low.

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