Simplification is the key - Centre for Policy Studies

Both businesses do have important contributions to make to retirement saving, but
savers would benefit from product unbundling. Ideally, fund managers should focus on
asset performance (“manufacture”), with life insurers acting as IT and customer service
providers, and addressing longevity risk (including the provision of annuities).
Historically, life insurers were major providers of longevity risk hedges in the guise of
With Profits funds and deferred annuities, but when markets were strong they gravitated
towards providing DC scheme platforms (which appeared relatively attractive at the
time). But then DC performance declined and there was no way back to the With Profits
world because, in the interim, the label had become tarnished (Equitable Life, et al). In
addition, many in the industry have failed to make the necessary investment in IT
systems (to cut costs).
4.3 Unsustainable costs
Over the last 15 years the cost of operating a self-administered pension scheme, for
example, has nearly doubled, from 3.5% to about 6.5% of pensions in payment. 85 Without
any changes, one would expect the cost to decline slowly with technological
improvements, automation and the benefits of globalisation (such as off-shoring). The
reasons why costs have risen include the cost of meeting pensions regulation, a result of
successive governments’ “wedding cake” (i.e. multi-layered) approach to regulation, and
significant ongoing compliance burdens. The consequences are felt by the beneficiaries,
the power of compounding costs acting to reduce their asset pots.
4.4 Unsustainable commission structures
High operating costs have forced part of the industry to focus on the short-term (sales
volumes and market share), rather than executing a sustainable business model for the
longer term.
An example should suffice. One report 86 highlighted the risks of the industry’s approach to
group personal pensions (GPP), some of which based their design on the flawed
stakeholder pension structure. This requires the full fund value to be payable at any time,
with penalty-free transfers, in return for an annual management charge. Unfortunately the
widespread use of initial commission (to boost sales) initially puts providers out of pocket.
The report combined financial modelling of GPP schemes with the real world experience of
scheme persistency (with the same provider). It found the latter to be around four years
85
86
ONS, MQ5, 2008; and Con Keating and Andrew Slater, Costs, Risks and Security for voluntary defined
benefit pensions (Part 1), BrightonRock Group, 2008.
Cazalet Financial Consulting, Polly put the kettle on, 2006.
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