UK: Win, lose or draw. What the Turner report could mean for you

Introduction

On 30 November 2005 Lord Turner published his eagerly awaited recommendations for pension policy in the UK. This short paper offers our views on his recommendations for a National Pension Savings Scheme (NPSS) and the possible implications to the Financial Services industry as both employers and providers of pensions business.

Turner’s key recommendations The Turner report represents a positive step in helping to address the looming pensions crisis in the UK by tackling both the adequacy of state pensions and widening private pension provision. The key recommendations of the report include:

  • Linking the state pensionable age (SPA) to life expectancy which could therefore raise the SPA from age 65 to 68 by 2050.
  • Linking future increases in the basic state pension in line with earnings rather than prices.
  • Changing the State Second Pension to a flat amount.
  • Encouraging more private savings through setting up a National Pension Savings Scheme (NPSS) for everybody in the workplace. This could be introduced by 2010. Employees would automatically be enrolled into an NPSS, unless they opted out. Contributions of 8% (3% from employers, 5% from employees) of relevant earnings (between £4,888 and £32,760) would be paid into individual accounts. A limited set of investment choices would be available.
  • Reducing the cost of pension savings by lowering the need for advice via autoenrolment and use of default investment funds, collecting premiums through existing PAYE systems, and administering the funds centrally.

Impact on the Financial Services Industry

Fund management

Greater inflow of funds, but potential increased fee pressure.

  • Over time it is estimated that up to an additional £5 billion per annum in incremental new pension savings will flow into long term savings from the 12 million individuals currently not in a "good" workplace scheme. Individuals can invest this money in a limited set of investment options run by private fund managers. Turner recommends that 6-10 mandates are issued to fund managers. This is to avoid one of the problems faced by the Swedish compulsory pension system, where availability of 600+ fund choices led to confusion and poor investment decisions by individuals, who ended up rejecting most of the funds and investing 85% of their money in the default fund.
  • If a fund is mandated by the central administrator, fund managers will have to offer an institutional fee schedule and service level commitments. Thus fund managers will have access to new flows, but at competitive prices e.g. in Sweden, fund fees range from 0.15% to 0.42%.
  • The successful fund managers are likely to have retail brand names and strong individual servicing capability. In the U.S. the majority of 401(k) retirement money flowed to the largest fund groups and funds with Morningstar 5 star ratings. This will cause an increase in marketing spend, greater industry concentration and potentially consolidation.
  • The perceived opportunity might attract additional investment from large international fund groups, as was the experience in Australia.
  • Greater competition will emerge for business outside NPSS, especially from fund managers who are not selected to be one of the fund providers for NPSS.
  • The greatest worry for fund managers will be any contagion effect, where 8% contribution (3% from employers) becomes the norm and more generous pension schemes reduce contributions down to these levels. The average contribution currently in defined benefit schemes is 18% and 10% in defined contribution schemes. In addition, fund management fees on existing pensions business may be squeezed down towards levels earned on NPSS.

Life & Pensions industry and its Distributors

A significant, generally negative, impact will be experienced by the Life & Pensions industry. The changes recommended by Turner will substantially reduce the role for private pensions providers and for those that distribute pension products, although Life & Pensions companies’ fund management arms can manage NPSS funds. This dramatic change is consistent with the consumer scepticism of the pensions industry, given its lack of enthusiasm for current stakeholder products, mis-selling incidents, perceived high charges and distributor focus on higher income individuals. Today’s multiple products and charging structures are also regarded as driving up complexity and need for advice, which substantially increases pension costs. As a result, Turner concluded that a large, publicly run pension scheme will be significantly cheaper to administer (estimated at 0.3% vs. 1.3%+ for the pensions industry currently).

As currently recommended the changes will lead to:

  • A substantial potential economic impact for the Life & Pensions industry.

– Reduced revenue flow. The loss of up to £10 billion per annum in personal pension premiums (Stakeholder, contracting out of S2P) and up to £40 billion annually if existing pension contributions were all shifted into NPSS.

– The potential loss of 25-30% of current revenue flow could lead to more offshoring and the need to reduce costs significantly.

– Minor capital release as reduced operational risk.

  • The diminished role of the private pensions industry will threaten jobs and consumers’ access to advice and products over time.

– Up to 50,000 private sector jobs at risk in administration and distribution.

– The actual impact will be less damaging initially as the industry will still write higher margin group and individual business targeted at higher earners, and providers may be pleased that some low margin defined contribution group business will be diverted into NPSS.

– The longer term impact will be driven by the extent to which existing group pensions business is re-written into NPSS. Total assets in insured schemes today represent about £600 billion, while total contributions are about £40 billion per annum.

– A knock-on effect on both Life & Pensions companies’ ability to offer other savings and protection products, and the availability of financial advice.

– Distributors will lose their group pensions related income stream which may drive further consolidation and a reduction in the availability of high quality independent advice around financial products.

– Life & Pensions companies will need to cut back overhead costs dramatically which will affect their overall level of product development, risk management and marketing.

– Profit margins may be squeezed as companies lose scale and critical mass.

– Consolidation in the industry could lead to fewer providers of annuities for those seeking to turn their pension funds into a steady income.

  • Further consolidation. The effect of a centrally administered fund will be greatest on the six large insurers who write around 70% of group pensions.
  • Intensive lobbying as the industry challenges the assumption that moving to a centrally administered fund would cost less:

– Pension providers have become much more efficient over the past 3-4 years. Administration of large schemes currently only costs around 0.25% and fund management costs of 0.1% basis points. The 1%+ cost often associated with the industry includes advice and distribution costs. If these are stripped, out the actual administration costs are close to 0.3% that Turner feels is a efficient cost.

– The Life & Pensions industry already has the infrastructure to run NPSS accounts, while it will take time to build a government-run administrative capability.

– Pressures on the Life & Pensions companies will reduce competition and choice for the consumer.

Banks and other financial institutions

  • Existing fund management arms may pick up mandates from NPSS.
  • No role to pick up administration of NPSS, unless the government decides to contract this out. In this case, one or two banks might be well positioned given their transaction processing and record keeping capability
  • Potential increase in need for advice from a trusted source, such as a bank.

– Overall access to advice will decrease due to consolidation in traditional IFA channels and lack of advice in the workplace due to low levels of charges and auto-enrolment.

– Banks may be able to fill this gap, but there are concerns over the issue of profitability of such an activity. Today few advisers can afford to serve the mass market due to the small sums involved.

– This may trigger some banks to review their ability to maintain a regulated salesforce thus reducing access to advice in the high street.

Impact on employers

A mandatory contribution to the NPSS could have a significant impact on employers, particularly those who have previously not sponsored a pension scheme for all staff. It is likely to:

  • Cost UK Plc up to £4 billion per annum. It is conceivable that the cost of extra pension contributions for the FTSE 100 alone will be an average of £10m per annum per company. Currently, only 60% of the 2.5m UK employees in FTSE 100 companies participate in pension arrangements. For the very largest companies, the extra cost could amount to as much as £50m per annum.
  • Impact pay reviews and wage inflation in general, as employers seek to absorb the cost of the contribution. To mitigate additional costs, employers should consider introducing flexible benefit reward schemes, where employees are rewarded by reference to total pay and benefits, including pensions.
  • Have a profound effect on certain sectors, such as Travel and Tourism and Retail where there are large numbers of low paid employees, low current take-up of occupational pension schemes, and transient seasonal workers. These industries have less ability to recover costs through future wage reductions.
  • Be especially hard on small employers who have traditionally not provided benefits to their employees. They will find meeting the additional costs disproportionately hard because the infrastructure within their businesses will not be in place to comply with the requirements.
  • Fuel inflation as some companies look to pass on additional costs to their customers.

Impact on company pension schemes

  • We expect to see an early impact on company defined contribution schemes, whether they be occupational or group personal or stakeholder schemes.

There may well be a levelling down of employer sponsored provision. There is evidence in Australia that several years after the introduction of a compulsory minimum contribution, this has become the market norm and little other contributions are provided via employer sponsorship.

  • There is unlikely to be any immediate impact on defined benefit schemes as employer commitments will still need to be met. However, it may speed up the closing of these schemes as employers choose to offer the NPSS only.
  • The gradual phasing out of the ability for company pension schemes to contract out of the State Second Pension will increase National Insurance costs and further strain employers offering these schemes.
  • We believe that the NPSS will lead many employers to review their overall reward strategy, and raise the question of whether pension contributions become a differentiator or a hygiene factor.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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