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Family values

The Government should remember that low value does not necessarily mean the best value

What is the difference between a teenager and her parents?

One of my friends has an interesting answer. He says the teenager boasts how much her brand-name jacket costs. Mum boasts how much she saved by buying it in the sale. Dad keeps quiet but thinks they should have bought an unbranded jacket for a fraction of the cost.

Two of the family have made potentially costly assumptions. High cost does not guarantee superior quality, nor does low cost guarantee best value. As usual, mum is right.

This tale of home politics has a financial services parallel. Recent years have been dominated by the mums of this world. The stakeholder charge cap effectively extended to all personal pensions. Fuelled by RU64 and its successors, the basic 1 per cent a year has provided much more than the one-size-fits-all originally envisaged, and quite sophisticated arrangements have featured similar pricing. The customer has benefited from this at the expense of providers and distributors.

With the increased charge cap and the slightly relaxed regulatory requirements, providers who could not compete profitably in the 1 per cent world have increased charges, and others are likely to follow. We will move towards charging levels and structures that are more commercially attractive, where the different costs driving the charges may be more transparent to consumers. But we must not adopt a teenager mentality.

For example, it is widely assumed (even after the pre-Budget bombshell) that Sipps are the product of the future. That is probably true but a Sipp without any self-investment is just a personal pension with a trendy name. High-charging products must give consumers something extra. High cost does not guarantee superior value,

But while some could become like our teenager, the dads are fighting back. The Pensions Commission believes a realistic charging level for a state-run pension is just 0.3 per cent a year. Its view is that the cheaper the cost, the better value this product is likely to be.

It is instructive to examine where the commission believes costs can be driven out of the system. They concluded that there were two key drivers of the cost of stakeholder pensions, which they took to total 1.3 per cent AMC on average – up-front costs accounting for around 0.42 per cent AMC, and poor persistency costing a whopping 0.5 per cent AMC. Removing these costs and gaining economies of scale could bring charges down to the level the commission is looking for – and its proposed methods are blindingly simple.

The National Pension Savings Scheme is seen as feasible without any advice, without any personal contact and without any active choices. The theory is that because employers will be forced to contribute, the decision is a no-brainer and it is almost impossible for the individual to lose out.Distribution cost is almost entirely driven out of the system.

Poor persistency can be eradicated equally simply. The NPSS will be a monopoly, with no option to transfer anywhere else. We go from a position where those who become unsatisfied with a provider can move elsewhere without penalty to one where there is no way out if things do not work out as hoped.

This is the implication of rock-bottom charges. The NPSS could be a fantastic deal for consumers if everything goes well and investment returns are consistently good. But customers with little or no understanding of investment risk (and no one to explain it to them) are likely to get very upset if they start losing money. A quango under huge pressure to minimise costs and with no competitive forces to motivate it may not make customer satisfaction its top priority. Taking cost out of the system removes understanding, flexibility, choice and the personal touch.

The Pensions Commission has made enormous efforts to analyse the problems with pensions in the UK and to find solutions. We must not dismiss lightly any of its recommendations and if we are unhappy with some we must find workable alternatives – at the request of pensions reform minister Stephen Timms, pension providers are doing precisely that. But many remain unconvinced that the NPSS is the answer. Low cost does not guarantee best value.

In assessing its options, the Government should consider what can happen in our fam- ily situation if dad puts his foot down and insists on buying the cheap garment. When it is washed, it shrinks and the colours run, making it unwearable and then everyone knows who to blame…..

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