June 2007

Only fools rush in

Rachel Vahey, Aegon Scottish Equitable

Later this month we will take another step towards the launch of personal accounts when the Government issues its feedback statement on the White Paper consultation that ended in March. This statement will include decisions taken by the Government following consultation.

But one area I hope the Government doesn't make any hasty decisions on is both the level and the shape of charges. This area is crying out for more analysis, and it would be a mistake to rush into making decisions.

The new personal accounts scheme is going to be a massive operation - a multi-employer occupational pension scheme, with between five and 10 million members paying in £8bn in contributions a year. It will be a centralised model, and will contract out the operation of some form of clearing facility, one or more administrators, and a range of fund managers.

The personal accounts delivery authority will design the scheme and commission the contractors, and the Personal Accounts Board (PAB) will be in charge of the ongoing running of the scheme. There are some parallels with the financial management of the long term business of a life office, and it is imperative that both organisations understand their financial management responsibilities and have the skills to carry them out.

Central to this is consideration of the costs of the initial set-up of the personal accounts scheme, the costs in setting up and maintaining each policy, and importantly how to recoup these costs.

Personal accounts must not be subsidised by the taxpayer to bring about an artificially lower charge. Existing pensions and personal accounts will operate alongside each other, and it is paramount they do so without personal accounts having a discriminatory competitive advantage.

Fortunately, it looks like James Purnell, the Pensions Reform minister agrees, and he confirmed at the ABI 'Thinking for Tomorrow' conference in early May that there will be no taxpayer subsidies for personal accounts.

It's also important that the charging structure for personal accounts reflects the incidence of underlying costs as closely as possible. This will mitigate some of the financial management risks, and make it easier to adjust charges fairly in the future. The ideal charges shape to do this is probably a combination of a one-off upfront cash fee for each member, a yearly cash deduction for each policy, and a modest annual management charge.

This, however, wouldn't appeal to customers, so we are going to have to depart from this 'pure' starting point. Instead, the best charging shape might be a modest fund-related charge and a contribution-related charge. This would come closer to recouping costs on a similar basis to which they arise than a simple fund based charge would.

There are two reasons why careful financial management is important. The first is that wherever the incidence of charges diverges from the incidence of costs there is a mismatch, and where costs exceed charges this needs to be financed and the gap filled. The delivery authority has a tough game on its hands in the next few years considering this. It is going to have to negotiate how to remunerate each contractor. This may have to broadly mirror the incidence of their costs, if contractors are not in a position to raise capital to cover shortfalls.

The second reason is that it is going to be very difficult to predict customer behaviour, so the PAB must be ready to move if experience of things like the number of people opting out proves different to that assumed.

While many things are difficult to predict one thing is for sure. Experience will be different to planning assumptions, and that has to be financially managed.

Rachel Vahey
Head of Pensions Development
AEGON Scottish Equitable