When I read last week that the pension black hole of the FTSE 100 companies has reduced by £13bn, I should have been pleased and slightly relieved. I should have also been pleased to hear comments relating to developments in the Sandler products and child trust fund along the lines of “The 1 per cent world of stakeholder is dead – long live the 1.5 per cent Sandler world” and “A 50 per cent increase in revenues is a major improvement and will surely solve the problems created by stakeholder pensions.”
These optimistic views certainly reflect one side of the reactions across a spectrum of interested parties. Responses have ranged from scepticism to outright hostility. Trying to make sense of all these reactions, while also seeking a balanced view on the subject, seems quite a challenge.
When the 1 per cent world of stakeholder pensions was introduced, one of the consequences was a knock-on effect on the pricing structure of all pensions. Non-stakeholder pensions were all subject to fee pressure and the result was a substantial squeeze on margin for new pension business combined with the defensive repricing of existing business. The result for pension providers was a lose/lose scenario. This was characterised by reduced profitability on existing business which was then not balanced by reasonable volumes and quality of new business flows.
The fear of history repeating itself is one major factor in understanding the reaction of those who express concerns about the 1.5 per cent world. Contagion of other product areas is a major factor when examining the economics of distribution. The 1.5 per cent world could well work effectively under the following conditions:
Simple, basic products.
Low levels of advice required.
High volumes of business written.
These conditions would meet the needs of a mass homogenous market. This is why so many predict that bancassurers will be the winners. But a significant amount of business transacted in the investment and long-term savings world requires a different model. The following conditions prevail:
Products need to be more sophisticated.
Specialist and comprehensive advice is required.
Lower volumes of business are transacted with bigger case sizes.
This world, which is inhabited by wealth managers, private banks, stockbrokers, discretionary managers and many IFAs, is unable to provide the initial level and quality of advice required, as well as the ongoing service expectations of clients, within a 1.5 per cent cap.
While these advisers are not required to provide their services within a 1.5 per cent world, contagion and margin pressure could severely limit their ability to operate a commercially viable service.
One potential solution to those operating at the higher end of the advice market may lie in the unbundling of the cost of advice from product costs. In this manner, the product cost contagion of a 1.5 per cent world would be limited to its impact on the manufacturer of the product, its assembly and governance costs, administration requirements and some basic marketing requirements.
Advice would become a separate part of the client relationship. A fee-based service would no longer be a one-size-fits-all service, rather it would be one where advisers could really demonstrate an ability to add value in a transparent way related to the differing demands of their clients.
From a fund management perspective, it seems that the 1.5 per cent world is also based on an assumption which is open to debate. The wide assumption is that trackers should be used because they are cheap. Clearly, in the 1980s and 1990s, when markets continued to rise, this was a credible view. However, we now live in more volatile and less certain times. In this environment, tracking the index can provide very little real return. While our pension deficit is £13bn better off, we still cannot afford to ignore the fact that stakeholders are going to need active fund management to help clients live comfortably in retirement.
The increased costs of effective active management, which can produce enhanced returns, would seem more important than a pure cost-driven commoditised approach to fund management.
Overall, the potential impact, whether positive or negative, of the 1.5 per cent world is not as clear as some would have us believe. It will take time before we can pass full judgement on the impact, but we can be sure it will shape the development of the long term savings industry for the foreseeable future.