Comments on Sandler Review - Ros Altmann

    Ros is a leading authority on later life issues, including pensions,
    social care and retirement policy. Numerous major awards have recognised
    her work to demystify finance and make pensions work better for people.
    She was the UK Pensions Minister from 2015 – 16 and is a member
    of the House of Lords where she sits as Baroness Altmann of Tottenham.

  • Ros Altmann

    Ros Altmann

    Comments on Sandler Review

    Comments on Sandler Review

    Comments on Sandler Review

    by Dr. Ros Altmann

    (All material on this page is subject to copyright and must not be reproduced without the author’s permission.)

    The original remit of the Review (recommended by the Myners Review of Institutional Investment) was to assess the efficiency of investment decision-making in the UK retail long-term savings industry. However, this involved the need to look at the competitive dynamics of the industry, and the remit became ‘to identify the competitive forces and incentives that drive the retail saving industry, in particular with respect to their investment approach and suggest policies to ensure consumers are well-served.’ The Review suggests that the complexity and opacity of retail savings products is contributing to the low level of savings, particularly among middle/low income groups. The Review, therefore, examines the causes of the complexity and lack of transparency, in order to recommend ways to increase competition in the industry (to create more pressure for price and quality improvements) and to make retail savings products more easily accessible for all.

    The overall objectives of the Review are:

    to examine the ‘economics’ of the retail financial services industry

    to recommend ways of improving the efficiency of the industry

    to increase competition between providers

    to align the incentives of advisers with those of their clients, rather than the product providers

    to improve consumer weakness – help them to better understand the industry by simplifying the products and charging structures, increasing transparency and education

    to increase quality and reduce price of retail financial products and services

    to increase focus on asset allocation

    to encourage people to look at investment performance over a longer time horizon

    to ensure that costs and price of investment, protection and advice are separately identified

    to simplify products, processes and structures in the industry

    to identify tax anomalies in the retail financial sector (e.g. stamp duty, VAT on fees)

    to improve access to financial products for low/middle income groups.

    The Review sets a number of challenges for the investment industry, which include:

    • tackle the structural problems which lead to high cost bases
    • increase investment in automation of sales process (customer information, application forms, standard application and processing on-line etc.)
    • tackle legacy systems
    • make end-to-end electronic transaction processing the norm
    • rationalise and simplify products
    • introduce common standards and increase co-ordination across the industry
    • ensure new products are more standardised, simpler and easily transferable – design new products on a template of existing products, rather than being entirely new.

    The Review focuses on the ‘economics’ of the retail savings industry in the UK – in particular looking at

    • competition between providers
    • efficiency of the products and firms (value for money of products, advice etc)
    • a small amount on the effectiveness of the investment decisions made
    • extensive discussion of the problems of the insurance industry
    • the inappropriate incentives surrounding the advice and distribution processes
    • the weakness of the consumer in retail financial services
    • the role of regulation, taxation and education.

    The Review’s recommendations focus on themes of:

    • simplification – of products, processes and structure
    • improving regulation
    • government design of new simple, safe products
    • improvement of advice and distribution processes
    • rationalisation of retail financial services providers
    • addressing inefficiencies of the insurance industry
    • increasing competition between providers and distributors
    • improving the taxation environment
    • improving access for low/middle income groups.

    The Review’s analysis of the problems of the UK retail savings industry is, in many places, excellent. It is well-argued, forthright and sensible. The identification of the many problems is impressive. Sandler is not frightened of suggesting changes to FSA practices or previous consultation recommendations.

    His proposals for improving the market are interesting, radical and likely to have far-reaching consequences for the whole of the savings industry, if adopted. In fact, they may have a powerful effect just by being published in the Review, even if they are not ultimately adopted! There seems to be a clear ‘anti-insurance company’ agenda and a desire to see the banks take a bigger share of the retail savings market. He is recommending removing the tax favoured status of insurance company products and radically altering with profits management, as well as aiming for significant cost reductions in insurance company investment operations. The drive to increase competition, improve efficiency, increase use of technology and reduce costs are all likely to have a major impact. The Review states that reducing the number of distributors and providers will enable easier introduction of streamlined systems and process, better use of technology to reduce costs and simpler saving products. There is also an underlying message that suggests ‘active’ investment management does not add value.

    Potential problems with Review’s recommendations

    I believe that there are areas to consider which have not really been specifically addressed in the wide-ranging discussions within the report itself. The risks inherent in the recommendations are not discussed. The Review’s proposals could fundamentally change the insurance and fund management industry in the UK, but it does not discuss all the possible consequences.

    The retail savings industry in the UK is around £800billion and pensions and life assurance funds are valued at around £1.5trillion. Over 25% of this is in with-profits. Life companies own over one quarter of quoted UK equities. A serious shake-out in this industry could have substantial effects on UK financial asset prices and confidence in the City generally. The City is a major contributor to the invisibles balance of payments, so the effects cannot be ignored.

    It is important to explore and analyse the possible negative consequences of the recommendations made in the Review. It seems to me that one of the reasons that pensions and savings policy changes often have ‘unexpected consequences’ is that there is insufficient attention paid to analysing the possible effects of policy changes in advance. The effects on tax receipts and public finances is thoroughly considered, but the effects on consumer behaviour and industry practices are less well thought through. There is no point in having great, efficient products, if people are frightened off putting money in them because they fear the effects of the shake-out.

    The Review highlights the inefficiencies and distortions of UK retail savings – both from the point of view of the insurance sector and the advice sector. It also highlights some of the complexities and inefficiencies of using the tax system to incentivise savings. It highlights the need to have more efficient products, processes and structures and to simplify the workings of the industry. The Review highlights the lack of trust in financial companies, but there is a risk that highlighting the problems publicly could cause confidence to diminish even further in the short term. In addition, the report talks about ‘consumer weakness’. This is also a function of ‘consumer reluctance’ – people do not always want to save at all – they would rather spend than save. If there are reasons not to save, they will be even more reluctant to do so, and lack of confidence in financial institutions and their advisers can provide a disincentive to saving. In addition, the Pension Credit and system of means tested benefits could add to the savings disincentives in the UK. It is disappointing that the Review does not highlight these. In addition, to encourage people to lock their money away for the longer term, they are also likely to need incentives to save. Currently, these are in the form of tax breaks. The Review questions the effectiveness of tax incentives and suggests that a system of ‘matching payments’ would be better.

    At least these issues should be considered.

    1. The implications of a serious shake-out in the UK insurance industry.

    Increased competition and rapid rationalisation do have associated costs. Many of the companies in the industry will not be able to compete for new business in the more competitive environment that is proposed and there is an apparent underlying suggestion that insurance companies generally will lose market share to the bankassurers. There are suggestions that we need to have fewer and larger players in the industry. But, insurance companies control a huge portion of UK financial assets and a sudden forced sale of equities by companies which have to close could have significant effects. The Review explains clearly why merger of insurance companies is not especially attractive – they are unlikely to be able to capture significant efficiency/cost reduction benefits. The old policies they have to keep running, the legacy systems that are in place, the cosy culture of cost over-runs, the lack of focus in the past on efficiency improvements all suggest that many companies are more likely to close than to merge. There are also fears of substantial hidden liabilities, which would hamper any merger or acquisition activity. What happens to all the people working in these companies? What happens to the money that people have in these firms? What about the effect on owners – i.e. policyholders – of mutual companies? These issues are not considered in the Review, but I believe we should be trying to quantify the likely impact, if possible. This industry has been built up over hundreds of years and we perhaps should consider downsizing it over a period of time, rather than a brutal shake-out in the face of market forces. The reputation of the City could be damaged by such a move.

    2. Confidence in financial markets.

    The Review’s proposals could well shake confidence in the UK financial services sector generally. If the hidden costs are revealed and many firms are found to be too inefficient to survive, the inevitable shake-out could be very painful. These companies own a huge slice of quoted UK equity What happens to the share prices of insurance companies? What will be the knock-on effect on UK financial asset prices? What will be the effect on public confidence in the financial system? If the changes suggested are desirable, Government does not want to be accused of being responsible for the consequences and might be advised to distance itself from the recommendations at first. We should be saying that we would like to examine the possible effects on the industry, try to ensure that any rationalisation occurs in an orderly manner and so on.

    3. How can we increase UK savings – people need to save more.

    The Review’s assumption seems to be that by improving the efficiency of the industry, reducing the number of products and players, simplifying products and making advisers’ costs more transparent, more savings will be forthcoming. However, I think there needs to be a fuller discussion of the disincentives to saving and need for better incentives, to encourage ‘reluctant’ consumers to decide to save for the long term. In particular, he suggests that a system of matching payments, rather than tax incentives, would be helpful. If we could simplify the incentive system and make it fairer (by not offering the biggest incentive to the better off) we could really begin to attract lower and middle income groups into the savings arena. These are important public policy issues.

    – disincentive effects of Pension Credit.

    The actual situation with regard to savings in the UK is also not thoroughly discussed. Surely, the ultimate aim of the improvement in products, sales processes, efficiency and regulation should be to ensure more people put more money into savings and pension products. It is therefore necessary to look more completely at the factors affecting the UK savings ratio. In particular, there are issues of whether there is sufficient incentive to save (which are to some extent addressed in the Review) but there are also powerful disincentives in place, which are not all thoroughly discussed. The disincentives include the Pension Credit, which is a major disincentive to putting money into a pension. The first part of the pension could be taxed at 100%, even with Pension Credit (because it is calculated from a floor of the Basic State Pension, but if a person does not receive the full Basic State Pension, the first part of any pension will be completely wasted – Pension Credit is only received for amounts above the BSP). These people have been told that ‘it always pays to save’, but this is just not true!

    – possible disincentive effects of radical shake-up of UK financial services industry.

    The other disincentives are the general lack of trust of financial institutions and products. The Review suggests that introducing simpler products and a clearer sales process will help here, and that is probably true, but there could be serious short-term effects which have not been considered. For example, if large numbers of UK insurance companies suddenly close, this is likely to knock confidence in the industry further, rather than improving it. If the closure of these companies causes panic selling of equities (the share prices of insurance companies will be hit hard for a start, plus any portfolio rebalancing effects of selling equities) then confidence in longer term saving will also be hit.

    – How can we provide better incentives to save?

    Then there is the issue of incentives. There is only a rather cursory discussion of how to provide better incentives to get lower/middle income groups saving more or starting to save. The Review alludes to published literature on the effect of tax incentives and suggests that this shows tax incentives do not have a large impact on the aggregate savings level. I believe this conclusion is unsafe and a substantial body of literature – some very recent – highlights that tax incentives do actually increase saving. However, the Review does rightly point out that evidence suggests that for low/middle income groups, the best incentive system is via some form of matching payments. In this regard, my proposal for taking pension contribution incentives outside the tax system and using a system of monetary top-ups on fixed amounts of contribution would be very useful. For example, some people find the concept of tax relief confusing (apparently some lower income groups even perceive it as something negative!). However, if you were to top up the first part of everyone’s pension contribution by a standard 50% (say on the first £1500 per year that is put into a pension), this would be a powerful incentive, simple and easy to understand. Given that 50% of the population apparently doesn’t know what 50% is, you could easily explain such a system as a ‘matching payment’ i.e. for every £2 you put into your pension, Government will put in £1. Simple, powerful, clear.

    4. What should the financial advice process focus on?

    The Review contains an excellent discussion of the problems of the current system of financial advice. The commission bias, the excessive compliance burden, the opacity of the cost and value of advice, the extensive focus on products and tax, rather than financial or portfolio issues and the misalignment of incentives are all thoroughly examined. However, there is little, if any, discussion of what the purpose of advice should be, or how this purpose can be achieved. In particular, in the case of pensions, the adviser needs to help people understand how much they might need to save, in order to achieve a particular level of income from a particular age. In the case of precautionary savings, the adviser needs to consider what kind of emergency funding might be required to tide the person over for a certain time, whether this could be achieved via insurance, rather than saving, the advantages of building up a stock of assets etc. These issues are only addressed indirectly, but need to be directly considered. The UK savings rate is low compared with the rest of Europe and pension coverage has been falling, as have contributions to pensions. The adviser should be able to help with financial planning for the future, budgeting, forecasting how much would need to be saved at particular ages and so on. The focus of the review’s comments on advice are still more about getting people to buy products (albeit simple ones) rather than showing them why and how much they need to save. The risk is that this will still not increase the amount of saving – ‘you can lead a horse to water…’

    5. There is a risk that the new ‘stakeholder’ suite of products will be seen as ‘poor man’s products’.

    The Review may seem to be saying that an inferior kind of sales process and product will be fine for lower/middle income groups. The products will be designed by Government and FSA – who do not have any clear record of expertise in this area. There will not be products suitable for different ages, for example. There will not be products offering passive management instead of active and so on. Perhaps it would be better to focus more on reducing the fixed costs of giving advice.

    One idea might be to suggest that these products would be a useful way to start the investment of Child Trust Fund monies – especially as a default option for those who do not want to choose a provider themselves.

    These products should also be designed to be suitable for specific age ranges – different asset allocations would be appropriate for different ages.

    6. Competition not driven by superior investment performance.

    The Review expresses concerns that superior investment performance is not a major influence on competition for retail savings. However, it is not clear that investment performance should be the main driver. Client service, advice available, reliability and so on will also be very important to retail customers.

    7. I think it is a huge shame that neither this Review, nor Pickering, have focussed properly on annuities.

    In terms of offering a simplified advice process and streamlined application forms, standardised procedures etc., annuities offer excellent potential. The adviser knows they will make a sale (because people have to buy an annuity), and there are opportunities to advise on other products too at the same time. I have been working with Hargreaves Lansdowne and Standard Life on starting to identify areas where processes and application forms can be streamlined and perhaps moved on-line. This would be an excellent way to try out some of the ideas.

    8. The Review is unclear on recommending who will actually design the new ‘stakeholder products’ and how this should be done.

    The Review’s comments on asset allocation and investment efficiency are well made, but there is an over-riding concern about dictating how the industry should manage money, who will decide what asset allocation software to use, who will make the assumptions required to optimise the portfolio distribution and so on?

    9. The Review clearly suggests that it believes active management currently does not add value.

    The Review contains very interesting analysis of the costs and charges associated with active management and this suggests that active funds total charges are generally over 3% per annum. It suggests that active fund managers cannot outperform over time, current investment policy has tracking errors which are too small to allow outperformance and that charges are, therefore, too high. The clear suggestion is that it is better to choose passive managers for most of one’s portfolio, with some exposure to aggressive active management for a part of one’s funds. There is also a clear steer that funds should not be selected on the basis of past performance, because this is not a predictor of future performance. They should be selected on the basis of charges (ensure charges are low) and brand (favours biggest players). The problem here is that by far the majority of funds are actively managed and advisers hardly ever recommend tracker funds for retail investors. The vast majority of personnel involved in fund management are involved in active management and most of these would be laid off, if retail investors suddenly switched away from active funds. The stakeholder suite of products does, however, need to be actively managed in terms of asset allocation, and competition in this area will be fierce. Again, this suggests that smaller players are unlikely to be able to compete in the new ‘simple’ low cost product markets.

    10. Stakeholder pensions.

    Most people suggest that those companies which have decided to enter the stakeholder pensions market have done so in the knowledge that they may not make any money on them for 10-15 years. They believe that 1% charges are not high enough to cover costs unless the providers gain significant volumes. The reasons why companies offered stakeholder may well have been because they could fund the initial losses out of their ‘with profits’ pool of capital. Many people suggest that it is the ability to use capital from with profits funds to fund projects like this, without calling on shareholders funds, that has allowed enough firms to enter the stakeholder market. This is obviously not desirable in an ideal world and the Review’s analysis of the unfairness of with profits is persuasive. However, in the short term, it may well be that firms which can no longer hide the costs of undertaking long term projects which are likely to lose money at first will simply pull out of the market. There is, therefore a risk that many providers will pull out of the stakeholder pensions market.

    11. Lay-offs in the City.

    The Review clearly wants to see far fewer firms and less industry fragmentation, both at the provider and distributor level. It states that reducing the number of providers and advisers will mean much more chance of efficiency gains through effective IT solutions, streamlined co-ordinated business processes and so on. There are enormous numbers of people involved in the insurance industry and active fund management. The inevitable rationalisation which is being called for in the Review must lead to substantial lay-offs in the UK financial services sector. Those likely to lose their jobs will include:

    staff at smaller insurance companies who cannot compete any longer and who either close to new business, or are taken over.

    staff involved in active fund management – the industry is extremely fragmented and a reduction in the number of funds offered will mean staff needs fall. The staff affected will be back office personnel as well as front-line fund managers.

    compliance departments will slim down in the new environment.

    advisers and sales departments of smaller insurance companies who cannot compete on cost or brand and, therefore, close to new business.

    None of these developments is necessarily undesirable, but the speed of the shakeout could be a cause for concern.

    Sandler Review – Useful Data

    General data on retail savings:

    Pension and life assurance funds total £1.5trillion, with over ¼ in with profits products.

    Retails saving industry is worth £800 billion.

    Over half the funds under management of savings vehicles covered by the Review are personal pensions.

    The UK savings rate is low in an international context. Only the US is lower. (UK 8.1%, France 14.2%, Germany 11%, Japan 14%, US 6.2%).

    Bankassurers have a very low penetration of the UK market – only 13%, compared with 74% in Germany and 61% in France.

    Pension provision has been falling – in 1993 it was 21%, but by 2000 only 16% of households were covered.

    Insurance company data:

    There are 340 life companies in 150 entities, with only 50 active in new business.

    Life companies own over ¼ of quoted UK equity.

    The with-profits market is very fragmented, with over 30 companies, but the top 13 account for 84% of new sales.

    One third of the insurance market it accounted for by mutual companies (i.e. owned by the policyholders, rather than shareholders).

    98% of new business for life assurance companies is in products with at least some savings element.

    Single premium unitised with-profits policies were introduced in the 1980’s and now account for over 87% of new with-profits business.

    New with-profits bonds are usually ‘whole of life’ (i.e. mature on death) rather than ‘endowments’ (which mature at a fixed point in time).

    1995-2001, single premium life savings business grew by 21%, while regular premium business declined (especially affected by the decline in endowment policies, such as endowment mortgages).

    Less than half of all policies are held to maturity – 70% of endowment policies sold in the 1980’s have not been held to maturity.

    55% of life product sales by value come through IFA’s. This represents only 20% of sales by volume, due to the high concentration of IFA’s on the wealthier investors.

    Data on Advisers:

    There has been a sharp fall in numbers of Direct Sales Forces in the last decade. In 1991, there were 190,000 Direct Salespeople, but now there are only 20,000.

    There are 26,000 IFA’s in 11,000 firms. 37% of these are sole practitioners and 50% are in networks.

    The top 25 IFA firms account for71% of the market.

    10% of IFA income comes from fees. Fees typically range from £120-£250 per hour.

    Sales time per adviser has risen substantially from 1990-2000. For a Direct Salesperson, the average sales time has risen from 1 hour to 5.5 hours and for IFA’s from 2.5 hours to 6 hours.

    The ABI estimates that compliance for an IFA costs £6,400 per year.

    The ABI estimates that, unless a client can save over £70 per month or invest a lump sum of over £8,500, it is not profitable for an IFA to advise them due to the high compliance and administration costs.

    Data on charges:

    In 1999, 32% of regular premium personal pensions received a rebate of commission and this figure rose to 51% in 2001.

    20-30% of non-pensions life business receives rebates.

    Sandler on New Products

    The strong theme of the Review is ‘simplification’. It recommends introducing a set of simple, comprehensible, tightly-regulated products, with safeguards, so that they can be sold to low/middle income groups without advice. They should be more accessible, with a cheaper and shorter sales process. This process would start with a ‘warning’ (designed by the FSA) for the consumer to check ‘suitablitiy’ of the products for themselves. The warnings will explain that the salesman is not providing expert advice on the suitability of the product and that their value is related to the markets, so that it can fall. There will be no ‘know your customer’ requirements and people on low incomes, those will an occupational pension or over a certain age (50?) will be told to seek separate advice.

    These ‘simple’ products will be all be called ‘stakeholder’ products and the existing CAT and stakeholder products will need to be rolled into these. Three types are suggested:

    1. With profits product
    This will be run on a new model: it will be required to disclose underlying performance, will be designed to ensure that the smoothing account is neutral in the long term, will have an explicit management charge to a separate company, will pay 100% of the profits on the fund to the policyholders and will have standard charges.

    2. Pension
    This will be similar to today’s stakeholder pensions.

    3. Mutual fund product.
    This will be similar to today’s managed funds. Government will recommend limits on investment risk – restrictions on certain minimum amounts in fixed income, not more than x% in a particular equity market or sector, minimum levels of diversification, assets with low correlation, etc. In other words, the products will aim to diversify both market and specific risk, so they will need to be managed, rather than entirely passive (but the individual funds within the product could be passive). They will differ from current CAT or ISA products in their controls of financial market risk.

    They will all share standard features:

    – no initial charges
    – regular annual charges (starting with a 1%) cap
    – preferably no surrender charges preferred
    – no lock in (at least not for long)
    – not high risk.

    CAT standards were introduced in 1999 for ISA’s and have been extended to mortgages and stakeholder pensions. They are designed to ensure good value for money and the intention is that consumers can buy them with little or no advice. They have low charges, low penalties, are clear, easy to understand and provide access for small sums of money. Stakeholder pensions require a 1% cap on charges (although individual advice and annuity purchase can be charged additionally) and this means that most firms cannot make money on the product unless they offer passive funds. Margins are very narrow and stakeholder pensions also suffer from complexities of the tax regime, partial concurrency rules etc. Both CAT marked products and stakeholder pensions are subject to two levels of regulation – on the product and on the sales process. Perhaps because of this, the products have not been widely taken up and have, therefore, not achieved their aim of reaching a wide audience. They have had the beneficial effect of lowering charges on pensions generally, but the industry seems to have just switched to selling investment bonds, on which charges and commissions are higher.


    I wonder what track record Government has in product design? Who will decide which optimiser to use?
    People will still need advice on suitability. If a product is not suitable (for example, if a person should buy an ISA rather than a pension) then a simple, cheap product should still not be bought!
    The products should be designed to be appropriate for different age groups – different asset allocations will suit different age groups.
    These may be seen as ‘poor man’s products’.
    It is difficult to see how smaller players will be able to compete in this market, and they are, therefore bound to lose market share to larger players. If these are sold through banks, supermarkets and stores too, the market share will erode further.
    The warning process may put people off buying them altogether.
    Will the 1% cap on charges be high enough to get people in?
    If firms cannot hide the costs of developing and running these products in their with profits funds, they may not be willing to offer them.
    These products could be useful for starting off the Child Trust Fund policy, if it is introduced.

    Sandler on Pensions

    Sandler recommends a radical simplification of pensions, with one regime for all schemes. He discusses some of the complexities of the current system. For example that we have 4 regimes for approved occupational pension schemes (before 1970, 1970-1987, 1987-1989, post-1989) and various regimes for personal pensions, all with different variables, different tax rules, complicated limits on contributions and benefits. He questions the need for complex rules – why can’t they be simple?!

    The Review discusses the various types of small pension schemes that are available.

    He discusses small insured occupational pension schemes, which still form the majority of occupational pension schemes. These typically have about 8 members and around £1million in assets and all aspects of the pension fund are run by an insurance company (administration, investment and payment of pensions). They were popular in the past, after contracting out started, but as the NI rebates declined, so popularity of small schemes fell and they now account for only about 10% of sales (more money is going into GPP’s or stakeholder). Unlike GPP’s or stakeholders, employers can promote these schemes to their employees. Also, insured schemes are not obliged to tell members their charges, whereas GPP’s are. This is anomalous, because they are run in a manner similar to GPP’s and can be a source of confusion. In general, employers are on the Trustee Board of the scheme, they usually use an IFA (typically on a fee basis) to recommend a provider and the employers often select the funds, range of funds and/or default funds for the scheme. Some small schemes only offer one fund for investment of pension contributions. Thus, the employers can influence the investment decisions even with very little knowledge. In addition, the Review shows that these small insured schemes tend not to be closely monitored and they do not change providers very often. The inertia involved in these schemes could mean that providers have little incentive to ensure good performance. To improve this, the Review recommends a short set of investment principles (modelled on the Myners principles for institutional investors) that trustees of these insured pension schemes should follow:

    quantify the investment objectives of the funds
    measure and report fund performance regularly
    compare an assess the quality of the managers used
    ensure the scheme allows exit at fixed periods

    The Review also discusses Group Personal Pensions (GPP’s), which comprise about 9% of private company schemes, mostly in medium size firms. In such schemes, there is no trustee, but the employer chooses the provider (usually on the advice of an IFA, who is paid by commission). These are effectively a collection of personal pensions, grouped with one provider (larger firms occasionally have more than one), to ease administration. The employer is not permitted to promote these schemes (because they are regulated by the FSA under the FSMA) and the employee chooses the investment funds. A GPP also has to disclose its charges, whereas a small insured scheme does not. These schemes look like occupational pensions, but are taxed as personal pensions. It is disappointing that the Review does not pick up on the confusion of this for employees. Many will think this is an occupational DC scheme, but it is not.

    Sandler also mentions personal pensions. These have grown significantly since the rise in self-employment in the 1980’s and the big boost they received from the Thatcher government in 1988. He highlights the complications of the regulations imposed by the DWP (which also apply to occupational pensions). The three areas he particularly discusses are:

    1. contracting out – this has requirements to mirror state benefits, with age-related rebates to encourage older workers to stay contracted out (Pickering suggests these rebates are no longer high enough to make it worthwhile to stay contracted out). The contracting out rules revolve around the ‘Reference Scheme Test’, which specifies minimum benefit levels, mandatory spouse cover and replicating the state scheme. For most personal pensions, the annuity purchased must be unisex, indexed, joint-life (even if there is no spouse) and cannot generate any tax free cash.
    2. transfers – he points out that, since 1985, people are allowed to transfer out of their pension scheme, but the rules for calculating transfer values are very complex
    3. preservation of pension benefits – he identifies the increasingly stringent preservation requirements that have been introduced. Before 1975, there was no requirement to preserve benefits, but now there is the requirement for full revaluation plus statutory treatment of contracted out rights for all scheme members after 2 years.

    As regards stakeholder pensions, the Review highlights that there are complexities in the tax regime, that partial concurrency will still mean people need advice and that advisers are reluctant to sell 1% products.

    He suggests that pensions tax rules create artificial barriers to non-life companies who want to enter the pensions market. He believes these barriers have caused the failure, so far, of the IPA (Individual Pension Accounts) system. IPA’s were introduced to try to encourage more non-life companies to compete for pension business. However, the rules appeared to suggest that it was still easier to run an IPA within a conventional pension structure and non-life companies were subject to less favourable tax treatment, so that the IPA never really took off. The Review recommends removing some of the taxation anomalies on this product.

    The Review also discusses the situation of IPA’s (Individual Pension Accounts) They were originally introduced as a means of enabling non-life companies to offer pensions. However, the rules have been so complex that companies believe it is still better to set up a life subsidiary to offer the IPA. The administration of tax relief is harder in an I{PA, pension fund management fees are only exempt from VAT for life companies, investment trusts must still pay stamp duty on trades and the Review recommends the playing field should be ‘levelled’ in order to help more companies offer IPA’s.


    Still no mention of the fact that pensions are currently ‘unsuitable’ for many people.
    No real addressing of the issue of how to better incentivise the target group to put money into a pension –i.e., if tax incentives are not best, why not recommend a proper matching scheme, taking incentives outside the tax system.

    Sandler on the FSA

    The Review looks at the regulatory regime, because this impacts on the competitiveness of the industry. The regime is really a response to consumer weakness and regulation does seem to have improved the quality of advice, somewhat, but at a high cost. The costs of compliance with FSA regulations have increased substantially in the last 10 years or so. There has been huge rise in the costs of advising and selling, much longer and more expensive processes are in place. Compliance officers or departments, training/competence/CPD requirements, ‘fact finds’, form filling and so on have all led to a dramatic increase in sales time per client (from 1-2 hours in 1990, to 5-6 hours now). If higher compliance costs lead to better advice and increased consumer confidence, this might be acceptable, but this has not been the case. In fact, the increase in regulatory costs has resulted in an increasing focus on selling financial products to higher income groups, because it is not economic to advise small capital sums. Thus, the regulations which were designed to protect consumers may have resulted in locking out many middle and lower income groups from the advice process and from financial products altogether. The FSA has apparently been unable to calculate the extra costs of the regulatory burdens imposed on the industry. Sandler suggests they should try harder to do so!

    The FSA’s ‘Conduct of Business’ rules are based on two principles – ‘know your customer’ and ‘suitability’. The Review urges the Regulator to make compliance easier. It criticises the Regulator for not giving the industry enough guidance. For example, there is no definition of ‘suitability’ and the FSA is urged to issue clarification on this. There is also not enough guidance to assist advisers to design their ‘fact find’ questionnaires. The focus of the Regulator appears to be on documentation (for example, the investigations of pensions mis-selling focussed on records and documents to show whether the fact finds had been thorough, but did not try to identify whether the facts gathered had been sensibly used.

    The FSA is urged to publicise that it will be willing to give guidance to firms in advance, about plans for new processes or IT changes. A lack of guidance will inhibit innovation.

    The FSA regulations have aimed to help consumers by

    1. information disclosure, by issuing the ‘Key Features Document’ to consumers. But this is said to be too long and cannot be used to compare products. It should be shortened and focus on the important features of the products, in language that people can understand. Firms are frightened of not complying in some way with rules that have not been clarified, therefore they err on the side of disclosing everything. Apparently, the FSA will consult on this later in the year.
    2. consumer education – but less than 5% of the FSA budget is devoted to this and Sandler recommends that this level needs to be raised.

    The FSA is also looking at using more decision trees, with a lower level of advice, to help low/middle income groups access financial products more easily.

    Some of the anomalies in the regulatory system, which work in favour of insurance companies, are discussed. For example an adviser must disclose charges and commission for designation investment business in advance, but, for a life policy, there is simply a requirement to hand over the Key Features Document and commission does not need to be disclosed until 5 days after the transaction.

    The Review commends the forthcoming changes in FSA operations, which will focus on ‘risk-based’ regulation, looking at ‘outcomes’ more than documentation and spending most time monitoring ‘higher risk’ firms, advisers and products. The PIA personnel are currently being re-trained to cope with this new approach.


    If the FSA is to be required to issue guidance in advance to help companies know whether their plans for business process or IT changes will be compliant, there should probably be a time limit within which such guidance must be given (perhaps 3-6 months?) otherwise, the plans may become outdated.
    Will consumers be willing to pay for advice, even if they negotiate in advance.
    Why shouldn’t government incentivise financial advice?

    Sandler on Tax

    There are two aspects of tax which relate to this Review. Firstly, the taxation of savings products and secondly the use of tax relief to encourage savings. The Review suggests that the over-riding goal should be to reduce the complexity and distortions in the taxation of saving.

    1. Taxation of savings and products.

    The rules on taxation of savings are extremely confusing and complex.
    Taxation of unit trusts is different from taxation of investment trusts and this is different from taxation of life policies. The most favoured tax treatment is for life policies, and the least favoured is for investment trusts. Different savings products are subject to very different tax regimes, giving unfair advantages to life products and to higher rate tax payers. Tax and regulatory differences can make identical products look different. Investment trust management fees are not exempt from VAT within an IPA and transactions are not exempt from Stamp Duty, whereas unit trusts and oiecssare exempt. The Review recommends removing stamp duty for investment trust trades and removing VAT from investment trust management fees.

    Tax is levied on the investment income and gains from investment of premiums and reserves, but not on the profits from life insurance, therefore, life products are taxed within the fund, not on withdrawal. There are two types of policy – ‘qualifying’ and ‘non-qualifying’ policies. To be a qualifying’ policy, the following features are required: the premiums must be payable for more than 10 years, at least annually, evenly spread and the fund must provide protection with a sum assured of more than 75% of total premiums payable. There is also the ‘5% rule’, introduced in 1975, under which 5% of the total premium paid so far can be withdrawn tax free every year (or accumulated over a number of years) and tax will only be paid on final maturity. This benefits higher rate taxpayers in various ways. First of all, they can withdraw some tax free income. Secondly, if the policy matures after retirement and they are in a lower tax band, they will pay less tax and thirdly, the 5% tax-free withdrawal is not taken into account for calculations of the ‘age allowance’ in the tax system for over 65’s. As the Review rightly points out, there are no obvious public policy advantages of allowing the 5% rule or ‘qualifying’ status, and the suggestion is that these rules should be removed to ensure fairer treatment of all savings providers.

    The Review recommends that Government should look to remove the distinction between mini and maxi ISA’s.

    2. Tax incentives for saving:

    The Review suggests that the use of tax to increase saving levels is undesirable and ineffective and that using a system of matching payments would be fairer and more effective. The Review of the literature on the effects of tax incentives on aggregate savings levels is rather cursory and many studies do, indeed, show that tax incentives increase the overall level of saving. For example, Blundell suggests that tax relief on TESSA’s resulted in 15% extra saving and studies on 401(K)’s in the US suggest they have led to up to 30% new saving. The experience of New Zealand also suggests the power of tax incentives on pension saving. In the late 1980’s, New Zealand removed pension tax incentives and this led to a dramatic fall in savings. Similarly, the removal of Life Assurance Premium Relief in the UK in 1984, resulted in a sharp fall in the proportion of households with life assurance cover.

    Some commentators suggest that the positive effects of changing tax incentives are due to the marketing and publicity surrounding the changes. This indicates that any program to increase awareness of savings incentives should have positive effects.

    Surveys show that low income groups do not understand tax related issues, in fact some thought that ‘tax relief’ had a negative connotation (in some way that they were ‘taxed’ on the savings!) The Review argues that the complexity of tax puts people off pensions, makes advisers’ jobs more difficult and more time-consuming and gives an unfair advantage to particular groups. It increases consumer confusion, makes it more difficult to compare products and increases the cost of buying the products.

    The above factors suggest that it would be beneficial for Government to take the savings incentive system outside the tax arena and introduce a system of standard monetary top-ups to pension or savings contributions for everyone.


    I would argue that, in order to encourage people to save more, especially the lower/middle income groups, we need to do three things:

    1. remove the disincentives to saving which currently exist (such as pension credit)

    2. improve the incentives offered by Government (use monetary payments, rather than tax relief, which disproportionately benefits the better off)

    3. ensure more people are advised about how much they might need to save to achieve a desired level of income from their savings.

    Sandler on Advice

    The Review’s analysis of the way the advice process currently works is excellent. The emphasis on higher value clients, commission bias, the lack of understanding of the costs of advice are all correct. The Review suggests the need


    It is disappointing that the Review does not more fully explore what elements advice should cover. The increased expertise in asset allocation is excellent, but there also needs to be more emphasis on explaining to people how much they need to save to achieve a particular level of income.

    It is disappointing that the Review does not recommend incentivising employers to give financial advice as a benefit to the workforce. The rationale for this is said to be that it would have an inconsistent impact and be a burden on small firms. But, it would be a voluntary benefit to provide, so it is not clear how this would be a burden.

    Leave a Reply