Implementing personal accounts

Liam Kennedy spoke to Paul Myners, chairman of PADA, about default options, charges and implementing best practice for the new personal accounts system

After initially trumpeting its stakeholder pensions concept in the latter years of the last decade, since 2005 the UK government has changed tack in its workplace pensions policy.

Lord Turner’s Pensions Commission report of November that year recommended the creation of a National Pensions Savings Scheme, now commonly known as personal accounts. And Paul Myners, (pictured right) well known in Europe as the author of the 2001 Myners Review of Institutional Investment, was named last August as chairman of the Personal Accounts Delivery Authority (PADA).

His first challenge is getting personal accounts implemented on time and within budget. Myners is optimistic that this can be done, but the UK government’s track record on the implementation of large scale, data-intensive IT projects has not been wholly successful. The contract won by Siemens Business Services to implement a new passport processing system, for example, led at one stage in June 1999 to a backlog of 565,000 passport applications.

Sir John Bourn, then head of the National Audit Office, noted in a report dated October 1999: “This case highlights a number of important lessons which all departments and agencies delivering services to the public will wish to consider.” These included “a need for a proper testing of new systems before committing to live operation”, as well as “a need to have realistic contingency plans in place”, and a need to keep the public well informed” when service delivery is jeopardised.

For his part, Myners points out that the majority of government-sponsored IT infrastructure projects do not come to the attention of the National Audit Office because they are well executed, in time and on budget. When asked for examples of successfully implemented, large-scale projects, the department of work and pensions cited several, including the new pension credit IT system delivery project of 2004 and the payment modernisation programme, which ended the cash payment of state pensions and benefits. Both projects were recognised by the National Audit office in 2006.

“This is going to be run by people with private sector experience,” Myners tells IPE. “It is a large project but I do not think it is taking us into areas that have not already been well covered by private sector experience. You will find many of the issues that we have to deal with already in place in terms of mutual savings schemes, credit cards and insurance companies. There are several people who are actively presenting their solutions to us.”

The second task is getting the investment options right, and PADA will be issuing a consultation document this autumn on fund choices and the default option, which Myners says he expects a “significant number of personal account holders will select”. There are a number of large-scale defined contribution (DC) pension plans from which to learn, including the €9.3bn Premium Savings and Premium Choice funds run by the Swedish seventh state pension fund, the €157bn Thrift Savings Plan of the US Federal Retirement Thrift Investment Board, and New Zealand’s KiwiSaver plan. The Thrift Savings Plan’s retirement date fund model is one that those close to the matter suggest PADA has studied particularly closely.

 

However, Myners stresses that PADA has looked at a “broad range of financial service product providers to look at the lessons in terms of organisational structure”. He adds that there are some “well developed private sector concepts around a default option design with a balanced fund and we will be testing those against alternatives”.

For his part, Myners has made clear that he thinks passive investment should be at the heart of personal accounts, for cost reasons. At the NAPF’s investment conference this spring, he said he would “caution ministers to avoid adding elements which will increase the cost burden” of personal accounts and said he did not believe active management would benefit individuals.

“What I said at the NAPF is what I believe,” Myners comments. “That passive management will be at the heart of a number of our investment options because we are seeking low-cost solutions.” Proponents of active management, he continues, should provide proof that the higher cost provides for a higher return. “If there is, I am persuaded. If there isn’t, I am driven towards a preference for having low-cost investment management solutions at the heart of the product range, but not exclusively.”

Myners also doubts the long-term sustainability of active investment returns, and suggests that evidence is weak. “There are undoubtedly people with skill - and there are skilful people in choosing fund managers - but I am going to suggest that they are very much in the minority.”

Basing default options on a passive investment strategy begs the question of which indices to use, and here Myners says he is minded to adopt the best practice of institutional investment. This has shifted away from domestic bias and towards global investments both in fixed income and equities. He also says fundamental indices may be worthy of further scrutiny.

“We will be seeking views on these issues and I think this is a distinguishing feature of what we are doing here. Private product offerings on the whole, because they are driven by commercial imperative, have not seen the need for the type of consultation we are entering into. We are essentially a mutual and we will seek to replicate the best aspects of mutuality, which are based on trust and accountability.”

PADA has also consulted on fees and collected a range of submissions on whether a single annual charge should be implemented or an initial charge and an annual fee. It has yet to make a decision on this, but it was notable that the UK life insurance lobby largely favoured the dual charging option, while other submissions said a single annual management fee would be more transparent and would encourage saving. Myners says the consultation on charges was well received by the industry and was seen as “very professional, very thorough and very open - features I hope people will associate with personal accounts going forward”.

The government’s maximum permitted annual charge for stakeholder pensions is 150bps for the first 10 years and 100bps after that. But Myners believes in a much lower target of 30bps. “We aspire to be low cost and I believe we will achieve that goal,” says Myners. “I certainly think that for certain solutions 30bps is a reasonable long-term target but we are likely to get there in due course rather than immediately.

He also points out that the costs of certain foreign national DC funds are subsidised either by the state or by employers, so it is difficult to compare like with like. “My drive here is to deliver the lowest possible cost consistent with a high quality scheme,” Myners comments, and reiterates: “My central contention is that higher cost does not necessarily equate with higher quality.”

Much commentary in the UK has focused on whether personal accounts will work on two fronts - whether employees will opt out in large numbers and whether a segment of the population will fall foul of the system because of the UK’s reliance on means testing in the provision of state pensions and benefits.

Accruing savings in a personal account would, under the current rules, mean that some employees would be better off opting out altogether. Some have also observed that the 8% contribution rate (4% from the employee, 3% from the employer and a 1% state top-up) could set a benchmark for employer pension provision that is too low, and which could encourage employers that currently offer more generous contribution rates to level these down.

Of course, only time will tell whether personal accounts deliver what they are supposed to. But evidence from Italy may be illuminating on the issue of auto-enrolment. Reform to Italy’s trattamento di fine rapporto severance pay system last year was aimed at transferring book reserves built up by employers to pension funds.

By the end of June last year, employees had to decide whether to transfer their entitlement from their employer to a pension fund. If they made no choice - and here is the strongest parallel with auto-enrolment - they would be deemed to agree, a provision known as silencio assenzio.

In the end, only 23% of employees allowed the transfer of their entitlement to a pension fund, which meant that 77% had actively said ‘no’. However, the Italian government’s education campaign only started a few months before the cut-off date. This meant there was widespread confusion about the system. The structure of Italy’s economy is also heavily weighted towards small and mid-sized companies, many of which rely strongly on the internal funding provided by the severance pay system. These companies may have been instrumental in persuading employees not to transfer their entitlement.

Other evidence suggest the prospects for auto enrolment are good, and at least one behavioural finance academic has noted that it leads to much higher take-up rates than standard self enrolment. Observations made by Prof David Laibson, a behavioural finance specialist at Harvard University, suggest that auto-enrolment leads to about an 80% participation level over a four-year job tenure. Using a standard enrolment model, enrolment rises gradually from 20% to a peak of just under 60% over four years.

Opt-outs and private sector alternatives to personal accounts will all have an effect on the level of assets that PADA accumulates, and thereby on the level of scale economies it can achieve as it grows. Myners refuses to be drawn on any precise projections for eventual invested assets over any given timeframe, but says PADA will need to take these various factors into accounts systems. He does say, however, that personal accounts will “grow quite significantly within the first 10 years” and that the system as a whole will become will become “significant in the constellation of European retirement schemes”.

Clearly, the personal accounts experiment is not without controversy, and its eventual success will be determined by the policy framework within which it must work. One or two politicians are already talking about a compulsory system, as in Australia, which would take the UK into an altogether different world of pensions. But the freedom within the existing policy framework is considerable, and PADA has a wealth of international best practice in investments and DC pensions structuring to draw on. 

Myners himself is optimistic about personal accounts as a social tool: “It is a very exciting project and I think we should not lose sight of the idea that we are bringing pensions to nine million people.”