The need to incentivise people to save and the cost of advice appear incompatible in the Pension Commission's eyes, placing question marks over the future of IFAs in the pension market.
In a report published last week – Pensions: Challenges and Choices – Pension Commission chairman Adair Turner claims the cost of advice is disincentivising consumers from saving while recognising that any further drop in pension charges will make the products uneconomic for intermediaries to continue selling.
Turner says: “Unless these costs are covered by the price charged, IFAs, who form the dominant sales channel for personal pensions, will not sell pensions but focus on more profitable products. It is clear from industry statistics and interviews that most IFAs now see personal pension sales as a low priority.”
Yet Turner acknowledges that people need advice, citing a wealth of research proving that people seldom make appropriate saving and investment decisions, such is the emotional nature of the decision-making process.
This need for advice is difficult to fund without charges having a serious reduction in yield on individual's pension at retirement. Stakeholder, the Government's low-cost solution, is a case in point. The charge cap on stakeholder pensions, which rises from 1 per cent to 1.5 per cent next April, is high enough to result in a significant reduction in yield on maturing individual policies, yet still does not provide sufficient margins to generate either provider or adviser interest in the product. This is one of the key reasons why the product has not been successful, according to Turner.
He says: “There is little evidence of a net increase in ongoing pension contributions flowing into personal and group personal pensions as a result of the introduction of stakeholder pensions.”
Despite the price cap, a pension saver contributing over 30 years and achieving a 4 per cent return after paying a 1.5 per cent annual management charge will see 24 per cent of their accumulated pension pot absorbed by expenses by the time of retirement.
Given that the average pension contract lasts less than 10 years, the annualised reduction in yield is higher still under the new charge cap. Over a decade, the reduction in yield weighs in at 1.6 per cent annualised.
Turner's preference appears to be for occupational schemes to be at the centre of retirement saving, with a revamped state system playing more of a supplementary role. The role of IFAs is likely to be limited in such a scenario and if some form of compulsion is introduced it could be even further reduced. He says: “The only way to deliver private pensions at low cost is via economy-of-scale intermediaries such as large companies.”
The lower cost of occupational schemes is one the main reasons given by Turner. His research contests that big occupational schemes, whether defined benefit or defined contribution, can have explicit costs as low as 0.2 per cent a year while for small occupational schemes this typically rises to around 0.5 per cent. On top of this, the overall average administration cost for occupational schemes is 0.4 per cent.
Individually-sold personal pensions typically have a reduction in yield of 1 per cent or more and, although evidence is more anecdotal, GPPs tend to suffer a 0.5 to 1 per cent reduction in yield for companies with between 50 and 1,000 employees, according to Turner's report.
But Hargreaves Lansdown head of pension research Tom McPhail questions whether occupational schemes really are that much cheaper. He says, for schemes up to £30m, it is typically cheaper to set up a GPP or group stakeholder scheme than a trustee-run occupational scheme.
McPhail says: “There is a clear implication that the IFA distribution mechanism using insurance company policies is relatively expensive alongside occupational and state pensions. IFAs can do a much more efficient job on GPP or group stakeholder schemes up to £30m, though.”
Scottish Life group head of communications Alasdair Buchanan agrees that only the very biggest occupational schemes have the scale to be cheaper, such are the high fixed costs of employing trustees, lawyers and actuaries, for example. He says: “The percentage costs for massive schemes will be relatively low but in monetary terms will be millions of pounds. Most companies offer schemes through a provider.”
Turner says the proposed basic advice regime is the only real solution for getting low earners into occupational schemes. But Buchanan notes that it is very difficult to provide bulk advice to employees without taking into account how the pension credit or other means-tested benefits may affect their individual circumstances. This also throws up risks of misselling claims further down the line.
The lighter-touch regime was proposed by the FSA in June but this new basic advice salesforce has yet to be trained or accredited.
Turner says: “It is unclear if the industry will actually develop and deploy this salesforce in large numbers. Discussions with major players in the IFA market have revealed considerable doubts as to whether the option of using the new basic advice salesforce will make a significant difference to the attractiveness of pension sales to lower-income, small-premium customers.”
With a third of the current workforce, particularly low earners, not saving for their retirement, a solution must be found that has consensus backing from the three main political parties. Policy recommendations will have to wait until after the next election but the debate over the cost of the IFA channel is set to run and run.