Chris Curry

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Charging Structures for personal accounts
Chris Curry Pensions Policy Institute PADA
Consultation Event 28 March 2008 www.pensionspoli
cyinstitute.org.uk
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Charging structures for personal accounts

• Evaluated different charging structures against
  the Governments criteria
• Concluded that no single charging structure, or
  combination of charging structures, has all of
  the desirable attributes
• So there are trade-offs that have to be made

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Five charging structures were analysed
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The PADA criteria

• Retirement outcomes for members
• Participation
• Sustainability

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PADA vs Government Criteria
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What is fair?

• There are different definitions of fairness, e.g.
• Everybody pays the same (for example broadly the
  cost of running their account)
• Everybody pays the same proportion of their fund
  value

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A contribution charge has a consistent impact on
the of fund lost
Saving later in life
Saving earlier in life
Full saving history
Median earnings
Median earnings
Low earnings
Employer scheme from 45
Starts saving at 45
Saves from 55 for 4 years
Median earnings
Saves from 25 for 4 years
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An AMC is better for people who save later in life
Saving later in life
Saving earlier in life
Full saving history
Median earnings
Median earnings
Low earnings
Employer scheme from 45
Starts saving at 45
Saves from 55 for 4 years
Median earnings
Saves from 25 for 4 years
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1) Fair to all members
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2) Simple and easy to understand
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Sustainability Financing analysis

• Made projections of future annual costs (set-up,
  administration, fund management)
• Compared them to annual revenue from charges
• Any deficit is assumed to be made up by borrowing
• Calculated
• Amount of borrowing needed (initial and peak)
• Duration until borrowing is paid off (payback
  period)
• The cost of interest on borrowing
• Important in determining the level of charges and
  how they change over time

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An AMC would not cover costs in the short term
Projected cash flow for personal accounts, m,
2006 earnings
Borrowing fully repaid in 2030
Payback period of 18 years
Revenue from charges
Costs (including the cost of capital)
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A combination AMC and contribution charge could
cost less
Projected cash flow for personal accounts, m,
2006 earnings
Borrowing fully repaid in 2017
Payback period of 5 years
Revenue from charges
Costs (including the cost of capital)
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Combining an AMC with a joining charge could
reduce the duration of borrowing even further
Projected cash flow for personal accounts, m,
2006 earnings
No borrowing required
2 bn
Revenue from charges
Costs (including the cost of capital)
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3) Reducing financing costs
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No charging structure is ideal
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Paying for Personal AccountsHelen
WhiteAssistant Director Retirement Policy
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Key objectives

• Recoup start-up costs within reasonable period
• Long-term financial viability sustainability
• Encourage participation, short long term
• Manage risks costs of many dormant accounts
• Fair balance between active dormant members
• Fair balance across generations
• Fairness to both members taxpayers
• Transparency / effective communication of
  charges rationale

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Options

• Annual Management Charge based on individuals
  fund size
• Contribution charge
• Joining fee
• Hybrid / combined charge
• Others? Charge to employer?

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AMC

• Negatives
• Too slow to recoup set-up costs (15-28 ys),
• Increase borrowing needs
• Unfair on those not actively contributing

• Positives
• Relatively easy to understand?
• Somewhat familiar?- same as Stakeholder
• Some justification for taking more from larger
  pots than small pots
• Becomes a significant amount as funds build
• positive or negative??

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Contribution Charge

• Positives
• Easily understood concept?
• Could raise enough to cover annual
  administration costs incurred from 2012

• Negatives
• Unfair burden on active members relative to
  dormant members
• Dormant members contribute nothing to the
  costs of running dormant accounts
• More burdensome on older people saving late

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Joining Fee

• Positives
• Would generate income quickly, so relatively
  quick to recoup start-up costs
• Easy to understand concept and amount
• Appeal in subsequent contributions growth
  being charge free?

• Negatives
• Barrier to joining risks encouraging opt-out
• Unfair to older joiners
• Would the fee be refundable?

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Hybrid charge structureAMC Contribution Charge

• Fair balance for all generations, active
  dormant members, taxpayers
• Manages risks of many dormant members while
  reducing their costs
• Manages risk of fall in fund value assets
• Short-term and long-term financial viability
• Recoup costs within reasonable period, reducing
  total borrowing requirement
• Spreads costs for members, no disincentive effect

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Communication

• BUT, how easy to understand?
• Need clear and understandable communication of
• Charge structure,
• Rationale,
• , most importantly
• Monetary cost to individual
• e.g. personal annual quote of how much paid in
  charges how this compares to contributions
  total fund

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Other issues to consider

• Correct assumptions underlying charging needs
  time to recoup set-up costs
• Ability to change charge levels if initial
  charges prove inappropriate
• Variations in charge levels according to fund
  chosen and costs of offering that fund? e.g.
  ethical, Sharia, lifestyle, managed, tracker
• Additional charges for optional extras

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Pension Charges

• The Consumer view
• Dominic Lindley, Principal policy adviser

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Consumers views of pension charges

• Pensions market perceived as complex
• Not particularly price sensitive
• Find it hard to determine whether they are
  getting a good deal You dont know until its
  time to collect
• Useful to relate pension charges to levels of
  contributions
• If charges increased from 1 per cent to 2 per
  cent, to get the same pension when you retire you
  would need to increase the amount you put in each
  month by around 20 per cent

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Consumers views of pension charges

• Reluctance to pay high fees and commissions
• Simplicity is important for trust
• General suspicions that industry is not focused
  on giving them a fair deal
• Need to stress different governance structure in
  Personal Accounts On my side

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The bad old days of pension charges

• Bid / offer spread
• Annual Management Charge
• Initial charges
• Administration charge (initial and monthly)
• Termination charges
• Allocation rates

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The bad old days (1997)

• Average reduction in yield 7
• Source Money Management

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White Paper Evaluation criteria

• Simple and easy to understand
• Fair to all members
• Incentivises the scheme operator to maximise the
  fund value
• Incentivises members to help keep the costs down
• Provides significant revenue in the early years

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Which? additional evaluation criteria

• Consumer outcomes
• Participation important public policy objective
• Impact on the existing pensions market
• Impact on Reduction in Yield

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Which? view

• Which? favours an Annual Management Charge
• Provides a good outcome for all savers
• Simple to understand
• Will not discourage participation
• No negative effects on existing pension savers
  and schemes

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Choices

• Investing for 12 years before retirement
• 1,000 a year increasing at 4 a year
• 3,200 lump sum 2 years before retirement
• A Contribution charge of 4, Annual Management
  Charge of 0.5
• B Annual Management Charge of 1.1

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Additional charges

• Should be kept to a minimum
• In a number of circumstances it may be
  appropriate to make additional charges
• Charges for excessive switching
• Extra charges for active management or additional
  funds. There should be no leakage of costs back
  into the bulk-bought funds.