Despite the recent increase in the charge cap on stakeholder products from 1 per cent to 1.5 per cent for 10 years and 1 per cent thereafter, we believe the majority of financial services companies will decide not to sell them because concerns about their profitability remain.
The questionable commitment of those who do decide to sell them and the suitability of the products themselves create substantial doubts over the ability of stakeholder products to encourage people to start saving more.
How profitable will stakeholder products be?
The Treasury has done much to convince the financial services industry of the attractiveness of these products but their assumptions are overly optimistic and do not paint a realistic picture.
We believe that the expense, persistency and business volume assumptions which have been used by the Treasury are too aggressive.
They are based on a financial services company having extremely efficient processes and lapse rates of 1.3 per cent for pensions and 3 per cent for savings, which, in our opinion, are too low when you consider the target market and the portability of the underlying contracts.
We find the Treasury's conclusions about acceptable provider economics to be derived from a string of assumptions each of which may be achievable on its own for some providers but, taken together, appear to be optimistic and unrealistic.
Figure 1 published below shows break-even case sizes (the case sizes at which policies begin to make a contribution to fixed overheads) that we have calculated under the Treasury's central scenario and our overlay of more realistic assumptions.
Our analysis shows that, for the worksite model, the monthly break-even con-tribution required under the higher charge cap doubles from just under £60 to over £120 on more realistic assumptions.
Minimum lump sum contributions rise to over £3,000. The monthly contribution level for the bank channel rises from £48 to £94. Objective observers would conclude that these contribution levels cannot be expected from the lower to middle income markets.
Not a priority for high-street banks
Policymakers clearly believe or hope that high-street banks and building societies will enter the market and help penetrate the target customer groups. However, we do not believe this will happen because the margins on the products are insufficient.
Making active marketing and selling of these products an organisational priority would require:
Training of non-qualified (that is, non-FPC3) staff to give “basic advice”.
Active lead-generation planning and execution beyond current efforts.
Making further progress in the retail networks towards an active sales and advice orientation from a traditional culture.
The profitability of credit cards, deposit accounts, current accounts and consumer loans is signific-antly higher and will take priority shelf space in the network.
The effort required to make selling stakeholder products a success will inevitably rank low on the list of retail bank priorities.
Some banks may decide to sell stakeholder products but they will market them only passively via in-branch leaf-lets, phone fulfilment and some direct mail. Branch staff will be available to give basic advice in some high-street networks but this will be marginal activity alongside other more valuable sales and servicing of core bank products.
However, we believe that banks will be proactive in the longer-term savings and investment business in the higher income and case size segments where comprehensive advice is required – that is not the stakeholder market.
Stakeholder products are not suitable for many
Stakeholder products benefit from simplicity and ease of understanding on one level – but suffer suitability problems for many. The problems centre on:
The 60 per cent maximum equity content in the saving product.
The “lifestyling” of pension funds.
Oddities in the product range.
The most appropriate investment allocation for many long term investors without medium-term liabilities could be a 100 per cent equity exposure if they understand and can withstand the volatility.
Over the long term, this could cost long-term investors for whom a 100 per cent weighting is appropriate, around 1 per cent gross return a year.
Lifestyling also raises concerns. A fixed schedule of transferring bonds before retirement assumes that the client will buy an annuity at retirement so as to match annuity returns.
However, because the requirements for buying an annuity will be removed by the pension simplification proposals, despite annuities being appropriate for many at retirement, the investment horizon may need to be far longer for many who choose not to buy an annuity. Progressive switching to bonds would need to take place later.
Finally, we believe that there are two oddities with regard to the stakeholder product range.
The first is that there are no guaranteed equity-type products in the range despite this being a natural first step after cash and bond investments.
The second is the inclusion of a cash deposit product which seems strange, given that the existing market for deposits is simple, transparent and competitive enough without the need to introduce an advice regime.
Despite these concerns about the future success of stakeholder products, they will deliver two benefits.
First, even with their limitations, stakeholder products, along with depolarisation and the simplification of pension tax and benefit rules will advance the public policy goal of increasing long-term market efficiency and competitiveness. Customers will have a greater choice of products and also of the type of help they can receive in the long run.
Second, a by-product of introducing the basic advice regime with standardised products will be that the “full advice” proposition offered by many providers and advisers will need to be clarified and improved.
Providers of “full advice” will have to justify their value proposition against the costs and against simpler and more basic alternatives.
We believe that advisers' more “professional” propositions will increasingly have to embrace asset allocation, optimising investment tax positions in view of wider pensions flexibility, better at-retirement and in-retirement advice and investment aggrega-tion and reporting. We argue that this is a benefit because we feel that the future role of genuine advisers will be secured if they move in this direction.
Product providers have the opportunity to differentiate themselves in the way that they equip their supporting distributors to offer a more professional advice and service proposition.
Opinions vary as to the number of existing advisers who could migrate to a more professional, differentiated proposition but we believe that, with the appropriate advice tools and regular training, a substantial proportion can.