Provider pricing models are about to be blown out of the water. 11 Consulting director and former Aviva pensions head Paul Goodwin, assesses the likely fallout
For many insurers, projecting the profitability, and therefore the long-term value of workplace pensions has always been more art than science. But pressure is coming from many fronts that could have serious long-term implications for those that have ambitions in this market, and those that just want to protect what they already have. Join some of the dots and it’s an interesting market picture that could appear.
At its heart, a workplace pensions business is pretty simple. Income is made up of all the annual management charges collected and other ‘look through’ profits. Expenses are all the costs going out, and include payments to fund managers, administration costs, overhead allocations…it’s a long list. The pricing models, unsurprisingly, try to ensure that the income number is bigger than the expenses number. This seems obvious and pretty straight forward, unless something comes along that blows all your assumptions out the water. That’s happening now on a number of fronts. Let’s have a look at just three of these.
Firstly, the hot topic today is the level of pension charges. Pressure is mounting and the DWP consultation is likely to lead to a charge cap for auto-enrolment schemes. That’s fine for new schemes, or new categories on existing schemes, but over time surely all open schemes will be auto-enrolment schemes, so the charge cap will apply across the board, whether by legislation or market pressure. If charges do come down to a cap of 0.75, and this then applies to the whole book of business, the income side of the P&L looks pretty sick.
Given that, for an insurer, the embedded value of the workplace pensions business is based on the profits emerging over time, you can start to see the implications for decisions about which markets to back. So it is not surprising that the Regulatory Policy Committee has asked the DWP to look again at the impact analysis. If we overlay what could happen with the second of the issues I’ve highlighted; pot follows member the plot thickens further.
The consumer argument for pot follows member is compelling. Helping people aggregate their pensions has to be a good thing. For insurers though, the outcome is interesting. If an insurer is active and ambitious in the workplace market, then they should be net winners – more schemes, more members, more incoming pots. For those not active or ambitious, persistency assumptions will need to be revised and the income side of the P&L adjusted. An interesting dilemma if your strategy is to buy and manage closed books of business.
So, we’ve looked at charges, without even going near active member discounts, and pot follows member. The third issue is the impact of auto-enrolment. There is market talk of a capacity crunch, and it does seem inevitable that most insurers will have to staff up to deal with staging spikes. Another entry on the expenses line. There will also be a quality dilution, where schemes written for, say, a management tier of a business, then may have to take in all employees. That is likely to lead to lower average contributions and higher staff turnover – two of the main profit killers. Assumptions will need to change and income/expenses lines amended.
So what’s the emerging picture? For me, this becomes a race to get to scale. Assuming insurers can get scale economies , which is not always as straight forward as it may seem, and are active in the market with a compelling proposition, then they should be able to increase the revenue line and manage the expense line – a classic widen the jaws scenario. The thing with scale though, is that only a few can have it in a limited market. So, who will hit their objectives, get to scale and see their books grow? Who will be left wondering why profit doesn’t match assumptions and why they have to write down the value of their existing book as revenues decrease and business walks out the door? It will be an interesting picture, and will no doubt lead to some interesting strategic choices being made around the top tables of insurers. But I’m not sure that the policy makers will have the foresight to join the dots.