Money: New pension, new problems

The pensions review under Helen Liddell, Economic Secretary to the Treasury, will lead to reforms that could affect generations. What should those reforms be? An Office of Fair Trading report set the ball rolling, but was it in the right direction? John Chapman gives his view.

The OFT report is notable for its originality and its omissions. The main conclusions were predictable. Defined benefit pensions (of up to 60 per cent of final salary) involve penalties for early leavers.

Defined contribution pensions (annuities bought from savings) involve plans with high charges, poor transfer values and limited flexibility. They involve risks for policy holders, and uncertainty over whether the contributions made will be adequate.

Much of the OFT analysis is spot-on. With personal pension plans (PPPs), advisers cannot predict which fund will perform best over the years. Investment performance as a guide to product choice is "insubstantial and illusory". The finding that "in pensions, the level of expenses is the price of the product" is mind-clearing.

The OFT did not wish to add to the patchwork of incompatible products, but proposed a new product - a Designated Pension Plan (DPP). This would involve investment in equities, passively managed through tracker funds, with "gearing" to adjust consumer risk appropriately. Expenses would be simple - a proportion of fund value. There would be advice on the necessary levels of contributions. Employers with occupational schemes would contribute instead to an employee's DPP.

The above features are "indivisible, essential and inter-related" and "their partial adoption might do little to improve matters and could actually increase consumer detriment".

A portable pension plan for one's working life is a great idea. But how realistic are the proposals?

The "play in billions, paid in millions" brigade who manage pension funds apparently add no value, but the argument between active and passive fund management will never end. The gearing and risk management appendix is so theoretical that one cannot judge whether consumers would be as well shielded from risk as in a "with profits" PPP, or particularly in a final salary defined benefit scheme.

Employers will have mixed views about rights to have employer contributions put into DPPs rather than occupational schemes. Some may consider that their exposure to risk would be reduced, while others would be concerned at the reduced chance of pension fund investment bonanzas and contribution holidays.

Legislation could be required. But how could this entitlement to employers' contributions be given for DPPs, and denied for PPPs? An extension to PPPs would be dramatically different.

The proposals on charges and distribution of DPPs are vague. Charges would allegedly be low because fund management would be passive. But companies' fund management costs are relatively minor, perhaps only 0.125 per cent a year.

And marketing costs and commissions are not related at all to projections of possible returns. Could distribution costs spiral with DPPs as with PPPs? Curiously, it is suggested that building societies, trade unions and small businesses might provide DPPs. Their management would be left to "separate corporate entities". It is difficult to judge the likely impact.

Overall, the attractiveness of DPPs is blunted by the probable controversies with the fund management industry, with employers and with the pensions industry and by uncertainties over its workings, costs and possible impact.

No indication is given about how they would fit with the present pensions industry. DPPs would lead to fewer people using defined benefit schemes, which covered six times as many private sector employees as schemes in 1994, and the loss of the protection against risk and the certainty they provide. Ministers should consider pressing for improvements in defined benefit schemes.

The startling aspect of the OFT report is what it does not cover. There have been press reports about a scandal involving group personal pensions with low transfer values, and about employers making inadequate contributions to defined contribution schemes.

A senior financial ombudsman suggested to me that an investigation should be made of pension companies presenting employers with high charge plans which involved employer contributions so low that the employers rushed to accept them. The intended "beneficiaries", the employees, simply did not know what poor value their defined contribution company plans were.

There is the very great, and continuing, problem of the personal pension industry, where at least one in three plans result in losses. Should at least that issue be addressed?

John Chapman was a senior official at the OFT, responsible for competition policy in the financial sector. He was the author of several OFT reports, including one that led to full disclosure by companies of the charges they levy on products they sell.