The Industry Model designed by the Department of Work and Pensions (DWP) as an alternative to the National Pension Savings Scheme (NPSS), proposed by the Pensions Commission, will include a small panel of providers chosen by the Government.
At a private meeting on Monday between DWP officials and members of the pensions industry, four models for a low cost savings scheme were shown to the group to discuss the advantages and disadvantages of each.
The DWP Industry Model, which is described as a variation on the Association of British Insurers (ABI) Partnership Pensions model, apparently offers more choice than other models, with the Government setting up a panel of providers to administer the funds.
It suggests having a Government clearing house to act as a ‘policeman’ and collect the contributions from employees and employers, but allow the employee to choose both the provider and the investments.
But if the Government goes ahead with the idea of a hybrid model, and chooses a panel of providers, and possibly gives them licenses, the question is how will the companies be chosen, and could the costs be kept low.
In Sweden, the basis for Lord Turner’s NPSS and his target of a 0.3% annual management charge (AMC), despite a choice of 705 funds, most savers end up in the default fund, the Premium Savings Fund (Premiesparfonden), which is administered by a state run agency called the Seventh Swedish National Pension Fund, or AP7.
Of the 705 funds in the Swedish pensions system, the Premium Pensions Authority (PPM), AP7 runs two funds, the default fund and the Premium Choice Fund, which is an active fund for savers who want a combination of a state linked fund with a more equities heavy portfolio than the default.
However the default fund has special conditions attached to it: for a start people cannot choose to enter it, they can only enter it by making no active choice of another fund, and it is also not allowed to market itself to consumers, while the fund is not allowed a shareholder vote in any of the companies in which it holds shares.
Within the fund the investment portfolio is split into shares, fixed income investments and alternative investments, with 65% held in international equities, 17% in Swedish equities, 10% in Swedish Bonds, 4% in hedge funds and 4% in private equity.
The Premium Savings Fund also features both internal and external managers, with portfolio managers employed by the fund making investment decisions on all fixed income investments, along with currency hedging, while external managers are used for a small proportion of Swedish active equity market and for investments in hedge funds and private equity funds.
In the default fund investments in hedge funds and private equity are made through fund of funds, providing they meet the liquidity requirements of the Swedish financial authority (Finansinspektionen) for these types of investments.
As the default option is also likely to be the most popular choice for the majority of British savers, the DWP Industry Model will also have to offer a fund which requires no choice but will give an equal return compared to the other more actively managed funds, and with no state run alternative, they will also have to choose a provider to administer it, a role for which competition could be fierce.
In Sweden, the Premium Savings Fund offers a wide range of investments with a combination of active management and tracking, and yet it keeps its costs low. This is done by employing a minimum number of employees, and relying on index funds, while the management functions are contracted out to both foreign and Swedish fund management companies.
It also intentionally operates at a loss to help spread the initial start-up costs across a broader set of contributors. Since the system began in 2000, the AP7 made a profit for the first time last year of SEK4.8m compared to a loss the previous year of SEK18m.
However, according to the AP7's annual report, the accumulated loss so far over five years is SEK150m (about £11m), with the Premium Savings Fund having total losses of SEK150,319, while the Premium Choice Fund is finally in profit by SEK90,000.
The board of AP7 claims the annual result will improve successively, with the fund expected to break even in 2006, with the total losses expected to decline until completely removed by 2012.
However until then the losses are being financed by credits from the Swedish National Debt Office, which in 2006 has given AP7 an interest bearing account from which it can draw credits of up to SEK200m along with loans of up to SEK10m to finance fixed assets.
AP7 also operates a discount system with the PPM, which allows the AMC of 0.5% of the assets under management to be reduced to 0.15%. the discount builds up to pension savers as the PPM buys new fund units for the amount of the discount.
The government is unlikely to want a completely state run default fund, like Sweden, as the responsibility could be too great and the last thing Chancellor, Gordon Brown seems to want is to subsidise a low cost pension scheme, as the Government keeps reiterating any solution has to meet five key tests, one of which is being “affordable”.
The proposals put forward on Monday is for a small panel of possibly licensed providers to provide the investment funds, but the providers which are chosen and the funds they offer could lead to issues over the rates of return. There is a possibility in future of savers complaining they were misled about the attributes of specific companies or funds because the government seemed to approve them.
John Jory, deputy director of B&CE Benefit Schemes, says what the DWP is proposing is very similar to what they as a company are already doing, and supports it as a general principle for a way forward.
He adds: “They say they are looking at a small number of possibly licensed providers, and I assume they’re looking at organisations like ourselves who have demonstrated the ability to handle large numbers of stakeholders at low costs aimed at the low to medium earners.”
Jory says he does not know what a "small number" would mean, but as there are currently fewer than 50 authorised stakeholder pension providers, which have been registered to offer the service, it is a possibility the government might look to this sector of the market for its panel, as it has already successfully delivered a service to this target group.
Meanwhile, Mike Morrison, pensions strategy director at Winterthur Life, says it is good the DWP seems to have been thinking outside the box, but warns the criteria for which providers make it onto the panel and which do not, would need to be looked into.
He says: “There is a danger that it may seem like the Government is rubber-stamping some companies, but not rubber stamping others. However there is also the possibility some providers may not want to be involved, particularly smaller ones who may feel they might not be able to meet the cost targets set out.”
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Nyree Stewart on 020 7968 4558 or email [email protected]IFAonline
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