Pensions ‘churning' in an industry-led personal accounts system, but which is not driven by intermediaries, could play an important part in driving down costs.
A new research paper produced for the Association of British Insurers (ABI), by Oxera Consulting, contains an economic analysis of the differences between an ‘industry’ personal accounts model and the National Pension Savings Scheme (Npss) - as proposed by Lord Turner in the second Pensions Commission report - including the effects on competition.
‘Churning’, or switching between pension providers, is currently seen in a negative light because it involves costs and is “driven by commission and IFAs”, says Reinder van Dijk, managing consultant at Oxera and author of the report entitled How to evaluate alternative proposals for personal accounts: an economic framework: an economic framework to compare Npss and industry models.
However, he says from a competition perspective some level of switching is desirable as it puts competitive pressure on providers to reduce costs and improve offerings, and the report points out in the absence of financial intermediaries the cost of switching would be small and would only have a minor impact on the costs for consumers.
The research suggests if competition in an industry model is to be encouraged to keep costs down, then switching should be made easy for consumers by making switching free, for example, with the costs borne by the providers and recovered by charging all customers - not just the ones who switch - a slightly higher annual management charge.
Oxera uses two examples to demonstrate the minimal impact switching providers would have on costs, with one using a switching cost of £107, the estimated cost of setting up a personal account from scratch, and the other a fee of £5, the estimated cost of transferring data between providers once an account is up and running.
Charging an annual switching rate of 5% or 2%, Oxera estimates the effect of a £107 transfer fee on an original amc of say 0.5% would be to increase it to 0.55% at a rate of 5%, and to 0.502% at 2%, while with a £5 transfer fee the increase at both rates would be around 0.502%.
It admits although increased switching will drive up the costs of the system, the impact will be small and may be offset by the benefits of increased competition.
The 129-page report meanwhile also analyses the effect of economies of scale and whether the Npss model will benefit from this more than an industry model in the areas of fund management and administration, and so keeping its costs lower.
Oxera says its research suggests once a fund reaches the size of between £500m and £1bn, economies of scale are no longer significant, and suggests the estimated size of the default funds in an industry model would receive the same benefits as an Npss model, while the non-default funds would achieve the same economies of scale after around 4-6 years depending on the number of providers.
Van Dijk says: “This suggests there is unlikely to be any significant difference in economies of scale between the default funds of the two models, while the cost of managing the non-default funds in the industry model may be a little bit higher for the first few years but the difference is likely to be small.”
Stephen Haddrill, director general of the ABI, says the research provides the first thorough economic analysis of the options that are on the table for the government to consider.
He adds: “It shows clearly cost alone cannot be the decisive factor. It is therefore important now to consider the advantages of competition between providers, together with choice for those who want it."
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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