Lloyds sets up its pension

The marriage with Scottish Widows leaves the bank well placed to woo new customers, write Isabel Berwick and Peter Koenig

When Lloyds TSB swooped in for a pounds 7bn buy-out of Scottish Widows last week, the management had one thing on its mind: pensions. The potential for making money in the long-term savings market among 20- to 45-year- olds is setting pulses racing among Britain's financial companies.

Long dismissed as the least sexy area of financial services, pensions and other long-term savings plans are poised to undergo radical reform. The shake-out will trigger a further wave of consolidation in the life insurance industry.

Lloyds TSB's coup was to get ahead of the game by snapping up one of the most coveted names in the industry. Scottish Widows' demise as an independent mutual company can be traced back to last December's Green Paper on pension reform. This DSS document set out the Government's vision for low-cost, portable pension schemes. These "stakeholder" pensions are designed to get the majority of lower earners (the target range is those earning pounds 8,000-pounds 18,000 a year) to save for their own retirement. But the schemes will also appeal to higher earners, as payments will be capped relatively high at pounds 300 a month. Stakeholders will be run as high-volume operations in workplaces and by trade unions. Comparable deals will also be on sale direct to self-employed individuals.

The Government will cap charges on these pensions at 1 per cent of the fund under management each year. Current personal pension deals typically charge 3-6 per cent and there are plenty of policies that remove 10 per cent. Only the leanest pension providers are likely to survive in the new cut-throat climate.

"The pensions market is being driven by the ageing population," says Lloyds TSB chief executive Peter Ellwood. "It's being driven by governments which are saying that the system will not be able to look after you the way it has in the past."

Mr Ellwood concluded, ahead of many others in the industry, that the coming world will demand a low-cost philosophy and a strong brand. And he realised the existing Lloyds TSB range of brands was not enough.

In common with other banks, Lloyds TSB sells own-brand life and pensions in its branches. But only 4 per cent of its customers buying a life insurance or pension plan opt for the deals sold in their local branch. The group also owns Abbey Life, a life company with a traditional tied salesforce. But this brings high costs and does not have a following among wealthier customers. These tend to buy from independent financial advisers (IFAs), who control half the sales in the pensions market.

Scottish Widows fills the gap nicely for Lloyds TSB. According to Widows' financial director, Bill Main, it has driven down costs by 35 per cent in the last 18 months. It also has strong links with IFAs, giving Lloyds TSB its much-needed access to this market. In return, Scottish Widows will get a shop window through Lloyds TSB branches. Observers believe the bank will waste no time in dumping its own-brand investment operation. The lure of Scottish Widows' name is also likely to bring non-Lloyds customers into branches for their pensions.

"We're going for a bigger market share," says Mr Main. "Lloyds and Scottish Widows together have 7 per cent of the market. And as the combined Lloyds TSB and Scottish Widows gains market share, the losers will be smaller and less efficient competitors. Two to three years ago, we looked to cut our cost base. Our competitors have done the same. Our goal is for Scottish Widows to be one of the five lowest-cost providers."

The UK life and pensions market is still very fragmented. The biggest player, Prudential, has about 8 per cent of the market, and the combined market share of the top five companies has hovered around the 30-35 per cent mark during the 1990s. Consultants at Bacon & Woodrow first predicted back in 1993 that many of the independent life companies would disappear, leaving about 60.

In fact, the firm's 1999 report suggests 70 active firms, but 12 of these are new entrants during the past seven years.

As B&W says: "Barriers to entry are non-existent to anybody who has good distribution or a good brand."

The likes of Virgin and Direct Line prove that brand is more crucial than track record in getting a pensions business off the ground. If you have a brand, you can simply import investment management from someone else: Scottish Widows has already started to capitalise by selling its pensions through another strong brand name, Tesco. (The future of this deal is up in the air as Tesco's banking services are run by the Royal Bank of Scotland.)

John Turton, head of pensions at broker BEST Investment, believes the stakeholder pension will trigger the demise of several independent life companies plus thousands of salesmen and independent advisers.

"Big is beautiful, and you will have to sell enormous volumes and have huge reserves. Standard Life is huge and is going places. It has good investments and is going to be a winner. Scottish Widows is also strong. Equitable Life is vulnerable - it's not just the court case it's involved in, it's the distribution strategy through a salesforce. I can't see them sustaining it."

The financial sales industry will lose out because stakeholder schemes will not have any commission payments built into the cost structure. In theory, personal pensions could still be sold to wealthier people at a higher cost to cover the advice given, but the knock-on effect from stakeholder schemes is likely to keep charges very low on all pensions.

Pensions Direct, the discount pension sales arm of broker Hargreaves Lansdown is already selling a personal pension deal from Friends Provident with lower charges than a stakeholder scheme. And Legal & General has streamlined its pensions to promise stakeholder-equivalent terms from now onwards.

In future, the well-off are likely to pay a fee for their financial advice, while most people will opt for a stakeholder scheme from work or a low- cost personal pension deal bought direct from the provider by phone or net.

Scottish Widows is one of the few firms to cover all possible sales channels. At the moment, the life companies that rely on IFAs for most of their business do not undercut the intermediary, even when they sell direct to customers.

"As soon as one moves to deal direct, there will be massive changes," says Mr Turton.

Commission-earning IFAs will simply be priced out of the market. Again, Scottish Widows has got ahead of the game: it has a heavily-advertised phone pension sales operation in place, ready for the switch away from an IFA-led distribution network.

When they are introduced in 2001, stakeholder pensions will not be compulsory. Many believe the Government will clamp down and introduce compulsion during a second term of office. This would take volumes right up and give it the chance to nail down providers' costs even further.

There is a precedent for this in Australia, where workers have to contribute 3 per cent of their salary to a similar type of low-cost pension. Peter Carr, chief actuary for AMP-owned Pearl Assurance, used to work for AMP in Australia and says: "Companies' initial reaction was `this is a bonanza' but three years later, there are only three companies left in - AMP and two others. The costs are such that unless you are very big, you can't compete."

After last week, the combined might of Scottish Widows/ Lloyds TSB looks likely to be one of the lucky few.