Contracting out is a risky business these days. So too is contracting in and remaining in Serps or its replacement, the state second pension. But there are things we can do that will help customers to understand the risks they face.
Re-educating them will be an important first step, particularly if they have been contracted out before. If this is the case, the chances are that the advice they were given was along the lines of “provided you are below the pivotal age, most experts calculate that you will gain by contracting out”.
On this basis, literally millions of people have put their trust in their financial adviser and taken the Government incentives that were on offer for contracting out.
We have a duty of care to let customers know those incentives have been withdrawn by the Treasury.
The principle of prudence that underlies everything that moves in Chancellor Gordon Brown's domain certainly applied when the latest National Insurance rebates were being calculated by his actuaries. Labour's approach to contracting out is one of “actuarial neutrality”.
This is a far cry from the Conservative approach of old that was sufficiently generous that we could reassure customers that, on any reasonable economic assumptions, they would be okay contracting out.
Is this change of tack at odds with the Government's proclaimed desire to see more private funding for retirement? I think not.
Remember, what the Government wants is for people to save more of their own money for retirement, not more of the Exchequer's money.
I believe we have an opportunity to play the Government at its own game. Let us tell customers that the rebates have been calculated by the Government Actuary's Department to be neutral, so customers should neither expect to win or to lose by contracting out.
Their contracting-out decision should not be driven by thoughts of financial gain but by their risk preferences. Here is the real element of advice – helping people to understand how to choose the risks they prefer. On the one hand, contracting out is an investment in the stockmarket. They get the money in their own account today, which means they take the investment risk as markets may go up or down.
On the other hand, staying in the state second pension means relying on a Government promise. This is an unfun-ded promise as there is no money behind it. Delivery of the Government promise assu-mes a willingness to honour that commitment from a future generation of taxpayers, many of whom will not even have been born yet.
For most customers, the choice will come down to “who do you trust more – insurance companies or the Government?” The results will tell us quite a bit about our public image.
I see a clear pointer here that we should not waste time chasing rebate-only pension business. In the political sense, rebate-only plans are “off message” as they do not involve any additional personal saving for retirement. In terms of the customer's risk preference, if they do not trust an insurance company enough to place their own money with it, then they are probably the sort of person who feels more at home with a Government promise than with a stockmarketbased account.
Conversely, if we are advising a client who is a member of an employer-sponsored stakeholder pension or GPP, then we can draw a more convincing picture. The pension plan to support them in retirement is like a three-legged milk stool, with contributions from their employer, their own sal-ary and from the National Ins-urance rebates, each providing one leg of the stool.
This approach to advising on contracting out is very much of a generic nature rather than individual advice.
As such, it sits comfortably with the approach many advisers are taking to stakeholder pensions, where communications take the form of worksite presentations, promotional material and phone helplines rather than individual fact-finding and analysis.