"Choice adds complexity, which adds to cost," says Aries' Ian Neale as he looks at the connection between cost, complexity and choice in pension schemes.
Having a choice seems to be widely regarded as highly desirable, if not essential in all aspects of life in a democratic society. 'Choice is good' is one of those motherhood-and-apple-pie sentiments which is hardly ever questioned: indeed the more choice, the better, many marketing campaigns imply.
It's time we did question it. Choice adds complexity, which adds to cost. Henry Ford knew this when he said: "The customer can have any colour he wants, so long as it's black [it can take up to 8 hours to change colour on a production line]." In defined contribution (DC) pensions, cost is built in as a result of perceived pressure to offer a range of funds, although it's not clear how much this amounts to.
The recent Office of Fair Trading (OFT) study of the DC workplace pension market considered, among other things, how transparency of costs and charges might be improved. Requiring a breakdown of charges might be an advance on the single 'bundled' figure usually quoted (especially if, as I argued here a couple of months ago, we could see how much resulted from the compliance burden imposed by politicians and regulators).
The OFT also looked at the benefits of scale, but did they miss a trick in apparently failing to examine the connection between cost, complexity and choice? Do most people actually need or even really want to exercise choices about pension saving?
Research in behavioural finance a decade ago found that people may feel overwhelmed by too much choice and abdicate from making a decision. A California grocery store offered 250 different varieties of jam. Two tasting tables were set up, one with six and the other with 24 different jams. 60% of passers-by went to the one with more extensive choice, but only 3% of them bought. Contrastingly, of the rest who were more attracted by the limited selection, 30% made a purchase.
In the auto-enrolment market, one provider has gone out on a limb and basically offers only one fund (Sharia-compliant funds are available too, on request). NOW: Pensions, run by Danish giant ATP, has recognised not only that this enables it to offer a highly competitive investment management charge, but also the fact that elsewhere, overwhelmingly members are opting to invest into the default fund.
People are rejecting the burden of choice. Many would really rather somebody else (preferably an 'expert') made retirement saving decisions for them. Apparently small barriers can cause employees to abandon interest.
An additional threat to the success of auto-enrolment is the compliance cost all employers face, increased by the choices they have to make between complex alternative propositions on entering a market in which they are weak and ill-informed (as the OFT found). Most smaller employers - who have yet to engage with auto-enrolment - probably will opt for the least-cost route to compliance; but will this necessarily be in the best interests of their employees?
As we all know, the challenge is how to simplify pensions and promote engagement by individuals and employers. One strategy is to focus on cutting costs, making compliance easier and charges more transparent. Personally, I believe it would serve us well to streamline the pension saving process by eliminating unnecessary decision points and elsewhere making choice optional, for those willing to pay extra for the privilege.
Written by Ian Neale, director, Aries Pension & Insurance Systems Ltd
ian@ariespensions.co.uk
