To do this, it needs to have a realistic view of its running costs and to make some important assumptions on employer and employee behaviour. It has to test its market in advance as much as it can to establish sensible estimates of unknown factors such as the percentage who will opt out. By doing this in the early stages, it can model its running costs and set the right level and shape of charges to match its outgoings under various scenarios.
The right shape of charges is as important as the right level. Most of the costs of establishing pension plans are incurred right at the beginning, even if no commission is paid. Setting a charge as a percentage of the fund value means that the money coming in will initially be low, as fund values will be small, and will not cover the costs incurred for several years. Setting a more reasonable shape of charges, for example, a contribution charge with a smaller fund management charge, will still be palatable to most people but means the scheme will not be as much in debt in the initial period.
If Pada does not match the amount and timing of money coming in through charges to the money going out through costs, say, because it sets the wrong shape of charge or underestimates the opt-out rate, it will have a black hole. This will have to be filled through borrowing as the Government has already stated that the taxpayer will not subsidise the personal accounts scheme.
As millions of Britons already know, debt is expensive. This would not leave the Personal Accounts Board with many options. Having to fall back on exchequer is one, raising charges is another.
It is important that the PAB is given the right to increase charges although it is hoped that Pada will build in the appropriate margins early on to avoid this happening. Giving it that freedom will reduce the amount of capital it has to hold in reserve but it is equally important that any possible rise in charges is made clear to all members at the outset to avoid rocking the confidence people have in the scheme. This could be further explored in the consultation on charges that Pada will have next year with the industry and other interested parties.
The former consequence is also deeply unattractive. The PAB will be loathe to go to the Government cap in hand as, again, this will damage public confidence.
Pada chairman Paul Myners has recently admitted that although the personal accounts scheme will cover its on-going costs, it is still in talks with the Department for Work and Pensions as to who will meet the establishment costs. This means who will cover the costs of hiring and paying the Pada staff and the product development costs. The taxpayer has met a number of these costs already.
The Government has more than once said that personal accounts will complement, not compete with the existing market. To do this, it is essential that it operates on a level playing field. As all providers know, the initial period of designing a product is expensive and ultimately has to be funded through product charges. Taxpayer subsidy of this development phase gives an unfair advantage to the personal accounts scheme. The Government needs to make it clear when its subsidy will stop and when the scheme will stand on its own two feet.
The next few months will be crucial for the success or otherwise of the personal accounts scheme. Pada has to investigate its market thoroughly, model its cashflows and arrive at the right level and shape of charges. This is not a decision it can afford to get wrong, as the consequences could be severe for personal accounts and the rest of the pension industry.
Rachel Vahey is head of pensions development at Aegon