Managing complexity

Wrap accounts and 401k type plans have all had a lot of hot talk over the past few years, but they finally look to be coming of age this year and next. JPMorganInvest is one of the first out of the blocks with a plan that allows any employee – not just senior staff – to keep pensions, shares and savings in the same aggregated account. It is targeting FTSE350 companies with its product early this year, but most of the traditional pension providers are looking to follow suit. Axa Sun Life says it will have a product ready in about a year, Scottish Life says it will in 2009, while Standard Life has not given a date but is looking to capitalise on its self-invested personal pensions and wraps expertise in this area.

The basic logic of these plans, (for which no one has yet come up with a standard name, although aggregated retirement solutions is one term), is that an employee is given an account in which they can keep savings other than pensions in the same place as their pension scheme. If they so choose they can, with little fuss (say perhaps a phone call or the click of a mouse), tip over some of these savings into their pension pot (the freedom given by pensions simplification to make such one-off top-ups is a key attraction of these plans).

In the best use of these plans the employer acknowledges that the employee might wish to plan for their future retirement income by saving for a property. The employer then is prepared to push money earmarked for pension into a corporate individual savings account (for some this will be a product that only vests after three years) that can produce tax efficient investments.

An additional element is that these plans will also entail a commitment to a greater level of employee education, but of more immediate concern is how they will be administered.

Dealing with complexity
As wonderful as these plans are, the complexity of the administration appears daunting. A common message from providers and consultants is that the more choices and products you put in the “wrap” the more complex you make it, and if you want simplicity you should restrict this.

Scottish Widows senior marketing manager Anne Flynn makes a parallel with the complexity of flexible benefits.
She says: “Employers are keen to do something, but nothing as complex as flex. They are concerned that it is not too overwhelming; historically some of the flex packages have offered benefits that were not relevant to the employee or the employer.”

A sterner tone comes from Standard Life, which already has a lead in providing self-invested personal pensions and wrap accounts. While it hopes for a big development of these accounts, it says there are some barriers to be crossed.

Standard Life head of communications Mark Polson says: “From an administration point of view many employers struggle now to administer their employee benefits correctly. While logically the aggregation of legacy DC schemes and group ISAs is attractive, it is a huge shift from where things are at the moment. It has often been remarked that flex benefits systems bring their own challenges, and to then add a further layer of complexity is not something to be done lightly.”

One worrying thought he puts forward is what happens to these wrap accounts when an employee leaves. While senior employees in a wrap account will have an adviser to help them through this, this is not the case for junior employees.
Polson adds: “It might be the case that we will be providing people with more than they actually want. Our desire to provide and sell is not always matched by people’s desire to buy.”

While this might sound like gloomy stuff, the logical pattern for these plans is that they will be implemented first by the big employers that are used to such complexity and perhaps already offer free financial advice to staff.

Axa Sun Life business development and marketing director Mark Rowlands says: “Our research is telling us that lots of employers will need convincing of the extra administration. There is a concern that it increases complexity and potentially increases costs. We don’t think it does either of those but that is a concern that needs to be overcome.”

The technology needed for such wraps needs to perform several functions. Firstly, to connect deductions from the employer to the provider and the ability to channel this to various pots. It then needs the ability to allow the employee to move money between the various pots either online or by phone. And lastly it would need to be able to generate statements online or on paper that show employees the money they have invested across savings, shares and pension.

Part of the difficulty in creating this new technology will be in meeting the different scheme rules that employers require.
Rowlands says that some employers with a paternalistic streak will insist on putting a regular employer contribution into their employees’ pension pot regardless, even if they allow employees to make contributions into a savings account.

Other employers will allow a basic employer contribution into a pension and any extra employer contribution to be put into a savings account.

Rowlands says: “We think there will be lots of different flavours, and that will be driven by consultants and employers working out what is most appropriate for their particular workforce, what is most appropriate given that particular employer’s business objectives, and their own view of paternalism versus commercial reasons for running a pension scheme. But the core underlying solution will be the same.”

One option that Axa Sun Life is looking to cater for is DB plans too. This will work for additional voluntary contributions schemes that sit alongside a DB scheme. Here employees will get the choice to save into a savings account and choose whether to vest it as cash or switch into an AVC pension according to their needs.

Cost
If the technology is complex then what of the cost? Providers are keen to downplay this, by citing how reasonable their charges will be. Some see the ability to gain more assets under management as a way offsetting the costs.

JPMorganInvest director Jonathan Watts-Lay makes the analogy of walking into a high street bank and opening an ISA account. The bank will not charge the individual for that deposit; rather they will pay interest on it. Likewise JPMorganInvest will not charge employers for offering this service.

On this principle too JPMorganInvest says that it will not charge for the admin and education that comes with the pension and the switching of money between accounts, but just for the management of the pension assets.

Watts-Lay says: “We are trying to help employees understand the benefits package. We will talk to people who are in debt, we will talk to them all so they get the right financial education for their circumstances.”

JPMorganInvest is very excited about its new proposition and hopes to take a significant part of the market as a result, but it is just focusing on FTSE350 companies to start with. A key part of its offer is that it will look after shares gained through all employee share schemes and then let employees put gains from share schemes into their pensions.

This is potentially a big win for employees, as not only is money put into a share scheme free from tax, but any capital gains tax payments made from the shares can be offset if they are then transferred into a pension scheme.

At the moment JPMorganInvest says most employers are fighting shy of letting employees do this. “If you want to put your shares into a pension scheme the company pension schemes will not take that fund, because from an administration perspective it is just a nightmare,” says Watts-Lay.

“They have their chosen funds and the cost is too high for the company to change the rules.”

Another element of the JPMorganInvest offer is that it will let employees consolidate any other legacy pension funds they have from previous employers, which their present employers may have resisted doing for administration reasons. It will hold these consolidated pensions within a SIPP that will be optional to any employee who is part of the arrangement.

Again there is the offer that the employee has their current pension paid into this SIPP too.

Consultants’ view
Consultants are getting involved in this area too, in response to demand from some clients.

Watson Wyatt says it is investing heavily in web front end products that will allow employees to view all their savings and investments in one place, but it believes the management of the assets is best done by a separate organisation chosen on a best of breed basis.

Senior consultant Gary Smith says: “One of the problems going into this space is asking yourself ‘do I want to be buying all these different products from the same insurer?’ Because clearly one insurer is not going to be the best at all of them. I would feel it is better to take a more independent platform and then choose the products you want and the providers you want and put them together yourself.”

At this point it should be noted that many of the providers should be prepared to offer either the whole solution or just part of it and work alongside consultants.

Mercer, which has just set up a system that enables employers to pay money into either a pension or a savings pot, follows the same line as Watson Wyatt on this, but it has already got its own platform up and running.

Mercer UK head of defined contribution pension services Tony Pugh believes Mercer’s scaled down system is one of the most simple and cost effective ways of giving employees choice in how they save for their retirement.

He says: “There are several ways of doing the admin piece. The easiest is to run it on an unfunded basis. The money goes into a plan for three years and rolls forward at a fixed level of interest and the money vests after three years. There is not a huge amount of admin to that as long as you pick up the tax consequences.”

2012
While the above comments do not exactly make a clear cut case for universal wrap accounts, there are several other positives in their favour that would seem to make them nigh on inevitable.

Firstly there is the advent of the government-enforced personal accounts, which will force all employers to offer a basic 3pc contribution into a cheaply government administered pension account. Many wisely predict that employers who have never highly valued their contract or trust-based schemes will ditch them in favour of this “vanilla” scheme. Potentially, this looks like a looming doomsday for many pension providers that do not have a strong grip on the market, and the chance to offer a product that is clearly, unassailably superior to a personal account is imperative.

Fortunately, many employers in the midst of a war for talent are looking at it this way too, not least because they are finding that a generous pension scheme is not always having the desired effect.

Watson Wyatt senior consultant Gary Smith says that he is seeing demand for wrap accounts from clients who are concerned their spend on pensions is not bringing the required return. This is particularly true of clients with relatively financially sophisticated staff, in particular financial services companies.

Smith says: “Where there is a strong demand for bright individuals and it is difficult to retain them, employers are thinking more about what the individual wants and how they can achieve that and help them more with their own personal financial management.

“If you are trying to recruit a good graduate, employers have to ask what are their financial needs.

“Possibly it is about paying off student debts and asking how the benefits I have got can help them achieve that and using financial planning tools to show how these pieces fit together.”

He adds that there is a reputational risk for financial services companies if their employees are not successful in their finances.

Indeed, administration issues are only one part of the consideration for wrap accounts – most come with a key financial education responsibility too. That is part solution and part headache.

Mercer’s Tony Pugh says: “If you look at people coming into the workforce for the first time, they have completely different needs to those starting work 20 years ago. They are looking at eight times salary to buy a property rather than three or four. Plus the average student debt is around £20,000 so when they enter the workforce that will be a more immediate focus.

“There are a lot of studies showing that employees who are worried about debt are not focused on their work. The rates people are paying on debt might be vastly higher than anything they are going to earn from the tax relief on pension. There is power in helping employees deal with their more immediate priorities, then they can play catch up on the pension piece.”