We need more competition – not a full frontal assault on the pensions industry
The policy instrument of price controls seems to be the flavour of the month with politicians of all parties. In the last three months, they have been proposed for energy, consumer credit, rents and wages. Politicians may like them, but economists regard price controls as the worst form of regulation.
So what could go wrong with the government’s pensions proposals? The first problem would be with small funds and small employers. A price cap defined as a percentage of a fund could make the provision of pensions to small employers and low earners unprofitable. We have already seen the advice market to the low-paid dry up because of the fixed costs of regulation. Will we see the pensions market dry up too? Small employers and the low-paid might be left with no option but to join the government’s own pension fund management arm – the National Employer Savings Trust (NEST). This would be ironic because, for many savers, NEST will not be compliant with the proposed regulation. Presumably, the government will give itself an exemption.
A price cap will also inhibit competition and innovation. The pensions market will end up with the same structure the energy market has today, with a few big providers offering the same form of passive fund management. New entrants – even if they are providing innovative products that consumers want – will not enter the market because the charges they are allowed to levy will not cover the startup costs.
It is likely that fund managers will design ways of avoiding the cap, some of which will be necessary and legitimate. For example, it is impossible to imagine a directly-managed real estate fund meeting the cap. However, the fund manager could invest in a real estate investment trust (REIT), which itself invests directly in real estate. The charges will therefore be incurred by the REIT, not by the real estate fund manager, and the cap will be avoided.
Webb also proposes banning firms from incentivising persistent savings behaviour. He should look at the energy markets. Here a similar policy of banning discretionary discounts has been followed. The result is that charges have risen for the minority, but not fallen for the majority.
Pensions is a market that needs looking at. It should be easier for small schemes to combine to create bigger schemes. It would not be unreasonable for employers to have to explain to employees if they offer a scheme that is significantly more expensive than NEST. However, the story of the regulation of consumer financial products since 1986 is that every intervention has made things worse, not better. Perhaps the minister needs to go back to first principles, and focus on competition rather than on control.
Philip Booth is editorial and programme director at the Institute of Economic Affairs, and professor of insurance and risk management at Cass Business School, City University.
This article originally appear in City AM.