Personal Finance: League tables could be our saving grace

Very few of us pay into the same pension scheme for 25 years. So, what we need is a comparison of who gives what and when.

HHow can people who take out a personal pension ensure that they are getting good value for their money? More importantly, how can they make sure that if they are forced to halt contributions, the amount invested to date won't be swallowed up by up-front charges?

In March, the Chancellor of the Exchequer announced plans for "league tables" aimed at showing consumers the best and worst companies in every savings field, including pensions.

It is already clear that high charges combined with high "lapse rates" mean losses or poor returns for policyholders.

League tables should therefore show the effects of charges not just on the assumption that policyholders will continue paying into a scheme until it matures. The evidence indicates that fewer than one in five savers will keep up payments that long.

What should also be shown are early and mid-way "transfer values", the amount that would be transferred into another scheme if the policyholder were to switch providers, as well as on the maturity values. They should also show the effects on "paid-up values", where holders stop paying premiums but leave their savings to grow with the same company.

But what other details might the tables provide? Alternatives are illustrated in our first table. The tables would show the projected values, and preferably, the charges taken. For example, the 2-year transfer value for Virgin's personal pension is pounds 2,552, with Virgin taking pounds 25 in charges. For Allied Dunbar the transfer value is pounds 706, with the company taking pounds 1,871. At maturity, Virgin would provide a return of pounds 67,977 and take a projected pounds 10,768 in charges, with Allied Dunbar showing a return of pounds 65,791 and a take of pounds 12,954.

But are such high charges at maturity somewhat illusory? The value of money years ahead is less than today, taking account of inflation and risk. The companies themselves use "discount factors" in working out their returns.

With a discount factor of 8 per cent a year, the projected take in charges by Allied Dunbar would fall to pounds 1,605 on 2-year transfers, and to only pounds 1,892 on 25-year maturity values. But would consumers understand discounting?

Another approach involves "reductions in yield" (RIY). If an investment growth of 7 per cent a year is assumed, and the projected return for Standard Life at maturity is 5.3 per cent, then the reduction in yield at maturity is 1.7 per cent.

Thus presented the RIY concept is easy to understand, and RIYs at maturity are (wrongly) used to compare the merits of different plans. But only a minority pay premiums to maturity. One problem is that tables of rows of figures for 150 plans would be too difficult to absorb. A rating system, such as the one I first illustrated in 1995, could be a great help.

This system is simple and has a statistical basis. At various stages in the life of a pension plan, the projected returns of each company are rated relative to competitors. A projected return within half a standard deviation (SD) of the industry mean is rated B. A return between a half and one and a half SDs above the mean is rated A, and higher returns rated A+. Similarly, lower returns are rated C or C-.

The ABC rating system has been used since 1996 by the specialist paper Money Marketing, and more recently by another magazine, Money Management. It has been championed by The Independent.

Some version of such a system is needed by the Financial Services Authority, the City watchdog, for the league tables. One approach is illustrated in our second table. This covers five key stages: early and mid-way transfer values, maturity values, and the maturity values arising when plans "go paid-up" at early and mid-way stages. At each stage the projected money return is shown, together with the company take in charges, and the rating that accrues.

Alongside any league table, the FSA should emphasise that with current employment patterns many people will stop paying premiums, with only a small minority being paid the projected maturity values.

Another point would be that actual investment performances of companies will be different, but one cannot tell which companies will perform better or worse. Most importantly, the differences in charges are such that there is little chance of superior investment performance closing the charges gap in the first 5-10 years. High charge companies are as likely to underperform as to out-perform.

Consumers should focus on the overall ratings, summarising the strengths and weaknesses of each plan. As most people cannot foretell whether they will transfer, go paid-up or keep paying premiums to maturity, the sensible course would be to opt for plans with the most As and avoid those with Cs, almost at a glance.