The Government is wrong on pension freedom and choice, asset management models and encouraging pension fund investment in infrastructure, says Financial Inclusion Centre director and FCA board member Mick McAteer. John Greenwood asks why
As the Chancellor’s pensions revolution becomes a reality, most in financial services – publicly, at least – are expressing support for the fundamental reforms being introduced.
They are right to be rubbing their hands, argues long-time defender of the financial services consumer Mick McAteer, because they have most to gain. But they should also base their business models on what McAteer describes as an inevitability that some day these freedoms will be removed again.
One of the few outspoken voices of dissent as the reforms become a reality, McAteer holds a string of influential posts that make him clearly worth listening to. He is a member of the FCA board and chair of the regulator’s Risk Committee, as well as chair of the European Commission’s Financial Services User Group (FSUG). And during his 13-year stint as principal policy adviser for Which?, when he oversaw a number of high-profile consumer campaigns, he became a real thorn in the side of the industry.
McAteer’s perspective on the imminent pension reforms is equally contrarian.
“There are two camps welcoming these reforms,” he says. “First, there are those who are very gung-ho in welcoming them. They are of a neo-liberal mindset and hate the idea of any paternalism. For them it is a question of ideology, regardless of the consequences.
“Then there is a second group, including some of the campaigning groups, which thinks the reforms are good as long as they come with protection and advice.”
He continues: “And there is a third group, which recognised that the existing annuity market needed to change, which was already in the process of reform, but which thinks these reforms take a bad system and replace it with something worse, particularly because it is such a short timeframe.”
For McAteer, the first problem is the level of expectation that things are going to be better.
He says: “Because of the criticism levelled at annuities, there is an expectation – because of what the media and the cheerleaders for the new system have been saying about annuities – that you will get a better return and a better income in retirement than through annuities.
“But you don’t have to do much of a complex calculation to work out that, even with annuities offering low rates at the moment, for a substitute suite of products to offer anywhere near the level of income that an annuity generates it is going to have to, by definition, expose the consumer to significant market risk. Anyone claiming they can deliver an equal or higher return but with an equal risk to an annuity is in fantasy land,” says McAteer.
Aside from the insurance against longevity, he is at pains to point out the simple fact that, for anyone wanting income in retirement, the annuity will always be likely to give the best return.
“Even the most equity-biased promoter would not recommend holding more than 50 per cent of their portfolio in equities at 65-plus. So the equity component is going to have to create spectacular returns,” he says.
“Any illustration has to be disclosed on a true basis that is not misleading. The blended return you are allowed to use is about 4.5 per cent,” he says, adding that, of course, some people may be lucky enough to beat annuities but they will be a minority and will find out only after the event.
New set of costs
McAteer’s other key concern is the way the reforms bring a new set of intermediation costs into the system. He says: “The more intermediation and advice costs you have, the more money you have extracted from these returns. So there is less money to share out among the population.
“Annuities may be complex under the bonnet, and there are risks around inflation and impaired life, but every one of those issues remains in place under the new regime and becomes more complex. So the advice process and the disclosure process, and the capability of the person to make the right decision, are more complex,” he says, cautioning advisers and providers not to make misleading claims about the likely returns from alternatives.
He adds that a switch to drawdown creates ongoing advice costs not present in an annuity-based model, as well as new complexities around product charging structures.
“I can’t emphasise enough that this is a zero-sum game. There are people who believe this is going to unlock hidden returns in the capital markets and make the markets perform better. But it won’t.
“In fact, we have to get used to living in a lower-return environment. So, by definition, the more fees extracted from pension pots, the less value for consumers,” he says.
Not surprisingly, McAteer prefers scale models and sees Nest as a potential way to address complexity and cost in the at-retirement space.
He says: “The industry squealed when Nest was set up. The industry should never have been given access to auto-enrolment – they were allowed to hoover up many of the bigger employers, which meant Nest’s cost of borrowing was even more than it needed to be. Politicians in the past were not bold enough to say ‘This is public policy; we need a collective way of providing public pensions and Nest will be it’. So there was a land grab by other providers.
“And if there were now politicians bold enough, they would say ‘This new pensions system isn’t working. Give Nest the opportunity to offer a post-retirement option to everyone’.”
McAteer continues: “The only thing that can really medicate the decumulation cost risk is if
there is a default decumulation version of Nest; or, if the politicians were to push it and I wish they would, favourable options for topping up state pension. For a lot of people I can’t see a better option. It needs to be formalised and made more attractive. It would give people a real choice.”
Pensions minister Steve Webb has been on the road promoting the freedom and choice agenda, speaking eloquently about people’s right to choose. He cited a typical profile of retirees as a couple with £16,000 state pension plus some DB, bringing them up to £25,000 guaranteed income, meaning they can afford to gamble with their money.
McAteer is unimpressed. “I don’t buy this argument about the state pension providing sufficient bedrock that people can be ripped off.
“We are trying to get to a position in the long term where the combination of state and private is of a decent level. The state pension, while it is improving for some people, is not on its own going to be enough. We should be ensuring that the second tier is as rock solid as possible. These new reforms will reverse the progress made through Nest,” he warns.
A veteran of previous redress campaigns, McAteer sees potential for misselling claims in the future.
“If I think back to my days at Which? when we were doing the mortgage endowment scandal, the industry for a while tried to blame consumers by saying that they had not tried to understand the product. A lot of the people selling the product did not understand it either.
“And there were a lot of unrealistic projections by the manufacturers as to the level of returns that could be generated in these new endowment products. Advisers could have done more due diligence to challenge those returns.
“This time around, the same issues will arise, with the same principle of product manufacturers trying to make unsubstantiated claims about the potential of their new product,” he says.
So could we see another government in 10 years’ time coming back against providers?
McAteer says: “The current system insists that, if you are selling a product or giving advice, you have to be true, fair, clear and not misleading. So any future assessment will be done on that basis. There won’t be retrospective redress because there never has been. Every major redress programme has been assessed on the rules that prevailed at the time. If advisers or product manufacturers do not advise in the correct way, they will be held to account.
“Some sort of commission will be set up to put the system back together again – to go back towards some kind of annuity,” he says.
So when will this policy U-turn take place?
“I don’t know – it all depends on how badly it goes in the first few years,” says McAteer.
“If we are lucky, the early years could be a damp squib. But if it takes off in the way some fear, it will be awful for some people coming to retirement. The worse it is, the sooner we will have to have an inquiry to put the whole thing back together again. But we will have one some time,” he cautions.
McAteer’s work in the EC has seen him focusing on under-the-bonnet charges within retail and institutional pensions, including transaction charges, bundled research costs, spreads and FX issues. The FSUG is currently doing work in this area.
“This is a Europe-wide problem,” says McAteer. “There are not only hidden costs but also unnecessary costs for active management. There are layers of intermediation costs that strip value from people’s assets. Financial intermediation costs not only hit investors but also hit the real economy because the more value the asset management industry extracts from the supply chain, the less resource gets through to firms in the real economy.”
The FSUG is calling for big changes in the way the asset management industry operates.
McAteer says: “We think policymakers should consider making the fund manager responsible for all transaction costs. They are supposed to add value through skill and research. They should be required to charge the pension fund a single clean fee.
“The beauty of that system is that the excessive trading causes the fund to beat its benchmark, so everyone wins. But if the trading and speculation cause the fund to underperform, the fund manager takes that. It makes them work for their money.”
He continues: “There are conduct issues, and there is as much if not more in the institutional markets and capital markets, with FX and Libor and the rest. But the other thing that is more important for the capital markets union is the resource efficiency of financial intermediation. The big game is whether this system is allocating capital in the right ways.
“Nothing seems to have led to better allocation. If we are going to make progress, we have to get rid of unnecessary layers of intermediation. There is more we can do to support genuine innovations. Most progress will be made in tackling those issues.”
For McAteer, the big development that will really hurt is the push for pension funds to get involved in infrastructure funding.
He says: “That is great news for pension funds because they will demand a risk premium, which the taxpayer underwrites. It’s PFI 2.
“But it’s bad news for taxpayers and future generations. Infrastructure funds are a raid on the future incomes of younger generations. So I hope one of the solutions isn’t to create infrastructure funds. That is not a way to allocate capital in the most productive and economically useful way.
“The more efficient way is government funding. When you have long-term government borrowing rates at such low levels, it is a scandal to not be locking into them. If the UK won’t do it, this will rank alongside the failure to set up a sovereign wealth fund with the North Sea oil money.
“But instead, to avoid the perception of money being on the balance sheet, the pension funds will charge us 2 or 3 per cent more as a risk premium, plus the intermediary costs, which could be another 2 per cent, for infrastructure we could have paid for with government borrowing at a far lower cost.”
ABOUT MICK MCATEER
– Founder and director of the Financial Inclusion Centre, a not-for-profit think-tank that aims to promote fair, inclusive, efficient and accountable financial markets
– Board member of the FCA
– Chair of the FCA’s Risk Committee
– Chair of the EC’s Financial Services User Group
– Member of Caritas Westminster Advisory Board
– Member of the Registry Trust Consumer Panel
– Trustee of ShareAction
– Formerly principal policy adviser for Which?