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Between the lines

Howard Davies&#39 letter on polarisation to Chancellor Gordon Brown is open to more than one interpretation. It could well be construed as a total failure to understand the significant advantages of the present polarisation regime. Alternatively, it could be construed that he and the FSA have been forced into a corner by Brown, Treasury economic secretary Melanie Johnson and the Treasury together with the entire Government machine.

Have they instructed Davies to do the Government&#39s bidding and scrap polarisation somehow or other? I believe it was on the Government agenda to do this from the moment it swept into office. Davies&#39 letter to Johnson certainly did not give the Government all it wanted, namely the almost immediate and total abolition of polarisation.

Another construction could be that the FSA understands the damage potential of the Government&#39s plans and is trying its best to delay the changes wanted by the Government in the hope that time, debate and sensible discussion about the practical problems of multi-ties and effective abolition of independent financial advice may yet prevent the wholesale implementation of the Government&#39s depolarisation agenda.

Davies and most of the FSA (with a few exceptions) are sufficiently intelligent, apparently unlike the minister, to understand that the changes clearly sought by the Government are so dramatic that implementation cannot take place in a few months.

Feedback from changes in respect of depolarisation of stakeholder will not be completed in time to allow for lessons to be learned, a compliance regime created and the industry make changes all by the end of 2001. That unrealistic target does not satisfy Johnson, according to her letter to the FSA.

How many people spotted the two-line paragraph at the end of Johnson&#39s reply. “I have therefore decided that it will not be necessary for the Treasury to issue a directive to the FSA using powers under S121 3 B Of the Financial Services Act 1986.”

Using the act, Johnson had power to instruct the regulator to take action if it had not come up with a conclusion which addressed concerns about anti-competitiveness. The Treasury had to take action. Under the new regime, the Treasury will be taken out of the loop and will give power in such cases to the Competition Commission. Clearly for political reasons, Johnson is a woman in a hurry.

This means that unless the FSA does as it is told by the Government, it can be ordered to do so. If this is the implication, it is clear that Davies was unable to fight the Treasury&#39s demands head on, no matter what he might think of them. The best he could hope for was some sort of delay or damage limitation. Let&#39s not forget that the outgoing PIA is against any significant changes. If this scenario is correct, then the art icle by Joanne Gill in MM two weeks ago could well correctly describe the true picture, namely that the FSA may have little room to manoeuvre in a battle with the Treasury mandarins and they are purely and simply the unwilling poodle of the Government.

If this is correct, Davies could then only have one alternative course of action open and that is to resign.

Neither the OFT report nor London Economics report suggested the dramatic changes which it appears the Government wants. Anyway, the latter report is somewhat discredited by cessation of trading of London Economics.

The nub of this problem is obsession with competition for its own sake. That polarisation has in some way restricted competition is a red herring. Competition in financial services in the UK is ferocious.

The problem is that competition has worked too well. It has caused the downfall of the direct salesforces because they were too expensive to run. Competitive and freely available publication of charges, costs and performance plus much well publicised anecdotal and statistical evidence that direct salesforces and banks in particular have not looked after the public as well as IFAs have helped to increase IFA business at the expense of the tied sector.

This has prevented British bankers from succeeding in taking over the business as they expected to. Banks decided to make their beds by providing their own financial products. Many retained a modicum of independent financial advice availability should a customer have had the temerity to insist on independent advice.

The fact is that Joe Public has decided that they want independent financial advice. Yes, I know that, as the FSA rightly says, a third of the public still live under the illusion that highstreet banks supply independent financial advice. Hardly surprising as the notices in the banks are usually so inconspicuous that some may be fooled. If this is the problem, then a simple ad campaign at the expense of the industry will put the public right about independent advice and where to get it.

It is obvious that the banks have been very successful at bending the ears of the regulator and the Government to have the rules of the game changed having lost the game, the argument and the business.

Despite the above, the obvious reason for the Treasury demand for changes seems to be the obsession of the Government with its own design of pension called stakeholder pensions in the naïve belief that this amazing, new improved product is magically poised to excite the imagination of the £10,000 to £18,000 a year earner to entice him into saving for retirement instead of relying on the minimum income guarantee.

The problem is those who do not invest in pensions seldom can afford to at a level which will make it worth while because of loss of MIG. I understand many actuaries consider a sum of £100,000 to be a realistic minimum savings at retirement for a woman aged 60 (for a man of 65, it is £80,000) in order to create the same level of income now given under MIG.

Do not lose sight of the fact that when the FSA set up its own defined-benefit pension scheme it budgeted for about 25 per cent of the wage bill to achieve maximum benefits under Inland Revenue rules. On this basis, our £18,000 a year person might need to save £4,500 a year. (indexed) throughout life – well above stakeholder maxima.

But how does this all affect the distribution of stakeholder pensions? The Government wants stakeholder to be widely available, including I assume, via banks, supermarkets, etc. At the moment, a minority have registered schemes with Opra. If we assume that they all will, then the distribution of stakeholder on the high street is assured. If only some of the high-street institutions offer them, then I suppose it tells us something.

The message could be that banks do not like losing money. We know there is no money in the advice service. The Government never meant them to be sold with advice. But, wait a minute, stakeholder plan providers can now pick and choose their target markets and may not have to offer to accept any and every proposal given to them by a client.

A provider could decide to target only big premiums. We know that many are going to offer lower charges for £200 plus monthly contributions. Cherrypicking is here.

Imagine a number of possible scenarios. First, the banks deciding that, as there is no money in providing stakeholder, they will only offer those from other providers. Under the present polarisation rules, they would have to refer the matter to an IFA. Some banks do have IFA divisions.

No problem, then. Halifax and Barclays do not have IFA divisions but Woolwich, being taken over by Barclays, does, so no problem here. In practice, this argument that high-street outlets are necessary for stakeholder and therefore need to abolish polarisation is nonsense.

Suppose the high-street providers decided they were going to reluctantly offer stakeholder schemes. I say reluctantly because no business organisation, be it a mutual or joint stock company, should ever invest to lose money. Under a new depolarised regime, they could offer any stakeholder, including their own.

Now imagine this after next April. A client walks into the bank and asks about stakeholder pensions. A quick bit of tree-climbing with brief assistance of the multi-tied adviser using the decision tree process establishes that the stakeholder is a “buy”.

The client can manage £20 a month. Aware of the fact that this means £2.40 a year of revenue for bank and adviser between them, he places the plan not with the bank&#39s own stakeholder but with one of the other providers that can be used under multi-tie.

As this client only makes very small contributions, he understandably would not want to load up his own company with such unprofitable business, would he?

However, the next client in the queue, after climbing the same trees in the same forest, also needs a pension and he is able to invest £300 a month. Now this is good business worth £36 a year and our friendly multi-tied adviser might expect to get paid a modest commission for his time and effort and make some profit in the future for his bank&#39s own pension company. That plan could be in profit within three years.

I leave you to draw your own conclusions.

If, however, it is the bank&#39s view that all stakeholder business is good regardless of contribution and that the very, very long view is what matters (this would be a remarkable volte face for a bank to take a long view over anything), then imagine this situation.

Our multi-tied adviser has a client in front of him with the same trees to climb and it is dec ided again that the stakeholder plan is suitable. The problem now is who to place it with. After all, now multi-tied, he is like one of those lucky IFAs who are spoilt for choice. He can choose from probably any of the range of stakeholder plans in the marketplace.

How does he advise his client where to place his contribution to keep the wolf from the door in his dotage? Clearly, doing his job properly – putting clients first – just like IFAs used to do before multi-ties, he places the business not with the bank&#39s own plan but with another provider, stating in the reasons-why letter that he had chosen that product in preference to the bank as the fund offered by them was in his opinion likely to be “best execution”, so as to make him wealthier in his dotage.

Ah! How does he decide that? Past performance cannot be taken into account, can it? However, he still thinks that that is best advice. Will his bank be really happy about that? Will there be absolutely standardised commission on all stakeholder products so as to remove selection on account of the commission variations, you know, like IFAs were claimed to do by their detractors before the days of new multi-tie? Will there be total freedom of choice with no coercion for an adviser to provide what he feels is best execution, with no pressure from above? I think not.

Another thought. The Government feels that it needs to have the banks and high-street providers to supply this new product because ease of penalty-free switching between providers is essential. How will it be possible in the future for banks to provide advice to a shopper who breezes into the bank and asks to see the pension adviser about his current, say, Equitable Life pension fund, which by this time perhaps is closed to new business.

A bit like stakeholder really. Will the bank agree to take the plan over, transfer it into their own fund and then take the clients future £20 a month?

However, think why someone would want to switch. The charges are a flat 1 per cent a year maximum.

Past performance is not a reliable indicator for the future, so why switch? There is no financial advantage. Indeed, it might be ideal to spread risk throughout life by having perhaps 20 different stakeholder pensions.

If stakeholder is to work, then providers must not be allowed to cherry-pick. Charges should be the same regardless of the amount invested, otherwise it will be the policyholders who run the risk of being selected against. But I suppose stakeholder will also conform to the law of nature that “unto those who have shall be given” over the charges and suitability for a client.

It does seem that if my appraisal of the situation under stakeholder is correct. There really is no need at all to worry heads about the need for any tied adviser to be able to deal with any stakeholder. The solutions are to be found above, with the assistance of decision trees. All the banks have to do is to expand their IFA force and maybe trim down the tied side.

We all know that, for a person who is a standard-rate taxpayer while working and in retirement, the tax advantages of DC pension plans without employer contributions only offer slim tax advantages over an Isa.

Stakeholder pension plans in their present form are clearly designed to be brilliant plans for the following clients.

The spouses and children from birth to working age of the wealthy. Those who have inherited considerable capital and want a good tax break especially if they will change from being higher taxpayers now, to lower taxpayers in retirement – controlling directors need not apply.

Those who want to pay some big contributions at or near retirement to take advantage of the rules which allow five years&#39 contributions to be based on one year&#39s earnings, regardless of future lower or nil earnings. Clearly, stakeholder plans are a well thought out way to benefit Champagne socialists, comfortably off barristers, etc.

This article was meant to be a critical appraisal of the hard to understand reasoning for the Government&#39s anti-polarisation plans and questioning the FSA&#39s apparent willingness to meet the Government part way.

It seems, however, that it has been embroiled inevitably in stakeholder.

Really, depolarisation is driven by the Government&#39s panic that, if it does not work, then what next? If they do not increase the total amount of money invested overall in all pension plans, then all will be lost unless compulsion is introduced.

Everything must be sacrificed on the altar of stakeholder. In reality, the depolarisation measures which are clearly on the Government&#39s agenda are looking very foolish as they are irrelevant to the likely outcome of stakeholder.

Every time Governments interfere in marketplaces because they think they know best, it ends in disaster.


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