Should the IPA tail wag the stakeholder dog? To many, the Individual Pension Accountis the pension product solution in searchof a problem.
The IPA does not put itself forward as a product designed specifically for stakeholder, nor claims to be a solution to the widely perceived problems of stakeholder. However, while at a recent IPA workshop, I became convinced that not only are IPAs good but they could also be crucial to the success of stakeholder.
However, to be a success, it is essential to recognise what this product is, how it is different to the currently available pension options and how it should be costed.
So what are IPAs? The IPA is an “elective” contract that an individual enters into. It is not clear, however, whether the individual enters into an ownership contract with the pension scheme governor, be that a manager or trustee.
What is clear is there needs to be a contract between the IPA beneficial owner and the IPA provider. If this does not happen, then the contract would have to be between pension scheme governor and IPA provider. The result of this would be ownership and contractual duty being paid to the scheme governor and not the individual. The product would then have to be called something like a trustee investment plan – and we already have one of those.
So, if the IPA is an elective contract outside the normal stakeholder arrangement, then the individual is entering into an arrangement for an additional service that the stakeholder provider is not offering, much like advice to the individual.
Like advice, it would be up to the individual to initiate the service and therefore would not be compulsory. Similarly, the service might qualify under the law as it will probably stand for the levying of an additional charge above the charge that the stakeholder scheme is allowed.
This suggests a contradiction to the way the Government wants IPAs to be used. It would mean the overall cost to the individual entering into a pension arrangement would be higher than the maximum 1 per cent stakeholder charge.
From both an ideological and practicalperspective, it could be argued this is, in fact, the correct case.
First, the ideological argument. Stakeholder pensions are meant to be simple. They offer cost, access and terms that we all know. The maximum 1 per cent AMC is low because they are simple pension schemes. An indi-vidual is able to enter into the arrangement simply and without risk by the use of decision trees. The investment choice risks have been negated because there will be an investor-neutral default fund.
However, IPAs reintroduce the element of choice. Choice in this context is whether or not to invest in the default fund of the scheme. The IPA investment can be via a plethora of different, and even exotic, asset types. With choice, the decision trees which the FSA has prescribed cannot work as they simply cannot take into consideration the wide number of investment styles, asset classes or sectors that the IPA will bring.
For these reasons, a charge that assumes no choice and no element of risk – in making a wrong investment decision – is not appropriate. If the IPA is to have a role, then the security of the purchaser must be protected by the ability to take advice on its suitability. The practical reasons for an additional cost are legion, but I will select two.
First, the stakeholder scheme is obliged to maintain costs at or under 1 per cent of funds a year or risk the removal of its approved stakeholder status. If the scheme accepted an IPA product from another provider, the scheme governors have two choices:
l Reduce the costs of running the schemefor that individual to 1 per cent, less the costs of the IPA, or
l Negotiate with the IPA provider to reduce costs of the IPA to fit into the overall scheme charge.
The provider of the IPA is not duty-bound to amend the underlying cost of the IPA and would not do so. The scheme must therefore reduce the remaining charge – administration, governance, etc – for that individual.
This means that the other members ofthe scheme must pay for the IPA holder's scheme costs and this is not possible because the costs to the other scheme members cannot exceed 1 per cent.
The second point is one of delivery. If you accept my argument above, then stakeholder schemes must remain with a maximum charge cap and IPAs must have an element within their pricing that pays for the advice that the individual needs to receive.
This should be reasonably easy to justify financially as the scheme takes care of the scheme functions – collections, reconciliations, tax relief, member communication, etc – and the IPA provider merely has toinvest the money and provide data feeds tothe scheme .
The stakeholder scheme could charge up to 1 per cent because it provides the majority of functions of the scheme and it is also poss- ible for the IPA holder to move funds backinto the default fund. By continuing to charge 1 per cent, there is a natural disadvantage to moving outside of the default fund and theindividual is likely to think long and hard over this advised decision.
It actually makes stakeholder more attractive to providers as they do not risk losing accumulated funds to the vulture operators that have already made their presence felt. The provider is able to separate the costs of investment management away from the scheme provision and it is not so disastrous if funds should be lost to another investment manager.
Contrast this with the current position where the provider could be left administering a scheme without an investment management charge that had until now paid for the administration.
Then we come to the financial advice and consumer protection. If we accept that IPAs can make an additional charge, we havea possible mechanism that will allow advisers to spend time with those who require advice. At the same time, there would be a natural barrier to overcome before IPAs could be justified. Those individuals who did not want to run this risk would stay with the default fund.
What remains to be seen is whether the DSS/Treasury teams looking to implement IPAs really understand the stakeholder proposition and truly believe that IPAs fit within its simple, no-risk, value-for-money message or whether IPAs are merely a political gimmick.