There’s a great saying in racing “I’d follow that horse over a cliff”. It’s a morbid comment on most gambler’s instinct to chase losses for sentimental rather than economic reasons.
When conviction sets in, then rationality is the loser and an idea can detach itself from reality, we really can follow ideas too far.
There are a number of Webbian ideas floating around at the DWP and pot follows member is one of them. Steve Webb was long on ideas and short on time to execute them. His term of office ended before those ideas reached the cliff-edge of execution. I would put CDC in the same category.
Why I’m writing about this today
Yesterday I arrived at Centaur Towers to do a podcast with Sam Brodbeck. I had no idea what about nor whether I was podding solo or casting with a colleague. Sam announced as he switched on the mike that we would be talking about Pot Follows Member and that the gentleman I was sitting beside was Ben Cocks of Altus, who is in the thick of it (PFM speaking that is).
This blog is the result of a sleepless night trying to work out what I would have said if that Broadbeck hadn’t played that trick on me!
What Ben, Altus and the PFM crew get excited about
it will help avoid a proliferation of small and easily forgotten pension policies but more importantly it will show both customers and the industry that pensions can be quickly and easily transferred between providers. Without this free flow of assets between providers it’s hard to see how pension freedoms can be effective or more generally how competition can work at all.
This statement suffers from the myopia of the enthusiast (punter follows horse). The idea’s of pots free flowing between providers in a game of musical chairs. When the music stops, so to the pots, leaving one big fat pot for the retiree to enjoy in later years.
This works for ISAs because of the simplicity of ISA structures. ISAs have no nasty little secrets, like capital units, guaranteed annuity rates or guaranteed minimum pensions. ISAs are all taxed in the same way and they all invest in transparent investment vehicles without Market Level Adjusters.
Most importantly, the ISA pot is transferrable in specie. “In Specie” means that not just the value of the pot , but the actual investments, can be transferred as they are, without them having to be bought and re-sold. This process is called re-registration. It makes pot follows member as easy as sticking a new label on a tin of peaches.
So why can’t we have re-registration in pensions?
It’s a good question with a bad answer. The bad answer is that when your contribution is received by the pension provider it buys units in a fund that is typically created by that pension provider in a policy that is owned either by trustees (occupational schemes) or by the contributor (personal pensions). The policy may be owned by the trust or beneficiary but the assets within the fund are owned by insurance company issuing the policy. The insurance company typically outsources the management of those assets to another party who in turn sub-contracts many of the duties of fund management to other parties. The result is a buggers muddle of ownership.
Ownership issues in pensions are so complicated that the only way most pension pots can follow the member is by being “cashed out” and reinvested when they get to the next pension provider. While the money is in transit – it is “out of the market”, if the market falls while you are out of the market- you win, if it rises – you lose. It’s a zero sum game overall, but (as usual) the policyholder takes the risk and losers lose.
Not only is there the zero sum game of out of market risk (with winners and losers) , there’s also the frictional cost of buying and selling units. Insurance companies are fond of telling the market that they can manage the buying and selling of units across vast books of business at minimal cost. It is true that the process known as “crossing” means that insurance companies can minimise the number of units actually sold and bought, but they cannot eliminate the costs, especially in thinly used funds for which a seller may not find a buyer.
The ideas of a “free switch” of funds, or indeed a “penalty free transfer” are myths created by insurance company marketing departments. The process of moving money from pot to pot is fraught with potential costs , many of which are crystallised. You will not see the costs show up on your transfer statement because of the subterfuge of another insurance company invention “the single swinging price” of a unit.
The single swinging price
This wonderful invention allows insurance companies to portray the buying and selling of units as being at no cost. But this is not the case, if you do the maths you will often find that the value of the units you sold (at the previous day’s price) does not match the value of the units you buy (at today’s price). Something’s happened.
What has happened is the imposition of what is wonderfully called a “dilution levy”. The dilution is in the price of the units you have sold, which have swung from one price to another. So you have lost money. The justification for the single swinging price working against you is that the insurance company has to make up for losses created in trading.
Theoretically the single swinging price could work for you as well as against you. But there is little chance of that. The single swinging price is not producing a zero sum game, there are a lot more losers than winners and that is why so many people on the wholesale money markets in the City- drive Ferraris.
The risks of Auto- Pot Follows Member.
Pension are complicated – every fool knoweth that. But why pensions are complicated, very few know. That is because the complication is papered over by half truths like single-swinging price, free switch and penalty free transfer. There are many other phrases used to explain away complexity and most of them are invented to disguise the cost of the complexity – to policyholders (and ultimately pensioners).
We cannot have pot follows member till we have assurance that the costs of transferring pots from member to member are fully disclosed and are kept to an acceptable minimum.
The arguments put forward by Ben Cocks and Altus are right at a high level. If we were talking ISAs , where all these issues disappear because of the simplicity of the ISA and because we simply re-register , then I would have no problem.
But to have an automatic , or even a default mechanism to transfer pots from place to place, we need to be certain that there will be fairness in the process.
The current proposals draw an artificial limit on the auto-transfer process, which will only apply to pots under £10,000. This artificial limit has no sense at all. £10,000 to someone who has £1,000,000 in his big fat pot is a huge amount. But £10,000 to someone with a big fat pot of £20,000 is a third of their pension savings.
Unless the insurance companies are prepared to guarantee “loss-free-transfers” to all with pots of less than £10k, I cannot support a blanket switch. I have seen no evidence they are thinking of doing so.
Follow the member where?
There is a final point to this. The pot may follow the member to a better place, generally pension plans have been getting better for the consumers (especially with the abolition of commission). But that’s for new savings.
Existing savings, where the bulk of the costs may have been paid up front, may well be better left where they are (especially if there are guarantees in the air).
And some of the new pensions we have researched (and are accepting contributions under auto-enrolment) aren’t very good at all. Indeed we’ve had to report one or two to Action Fraud.
So to suppose that money flows around the system to the betterment of DC outcomes is naive. Generally things are getting better, but try telling that to people for whom things get worse.
Where I stand
In 1999, I wrote a paper for the Government’s stakeholder consultation (via Eagle Star) which argued for a system similar to that in Australia where members determine where money goes , employers pay money into a central pot and it gets dished out to the member’s pot using technology. You can see how this works by going to SuperChoice’s website. Australia adopted this system, we didn’t. Tough on us.
We are where we are, there is so much spaghetti out the back of the hi-fi, that I’m tempted to ditch it and start again with an MP3!
But we can’t do that with pensions, we have to live with the legacy and make the best of a bad job. We cannot insist on pot follows member to clean up the legacy.
The best we can hope for is that “scraping technology” as used by the likes of MoneyHub can pick up live fund values and give people the semblance of one big fat pot -despite the pots sitting with differing providers.
The big issue is where those pots go – and as I have no confidence that those pots would go to a good provider who would help the ordinary person spend their savings as income effeciently, I say – for the moment- keep the money where it is.
Do not press any buttons, do not incur any (extra) charges, do not follow the pot over the cliff.
If we get a default decumulator that is as good at helping us spend our savings as build them.
If we get a way to satisfy people that they will be protected in later life through such a decumulator from living too long (or even from nursing fees).
If we have a radical simplification of taxation to make pensions as structurally simple as ISAS
If we have a no-loss guarantee from participants in the transfer that makes the phrase “penalty free transfer” real.
Then I am for pot follows member. Right now I am giving it an amber light and it won’t get a green light till I can see that the pension landscape is clean enough to see money’s flowing freely through it in the ideal way promoted by Ben, Altus and those who will follow pot follows member over a cliff.