Life companies provide DC portal
In the UK the defined contribution (DC) revolution looks like finally taking off, though it has been very slow in coming. Mike Wadsworth, a partner at Watson Wyatt describes progress to date as ‘glacial’. It was in anticipation of a pronounced shift in emphasis from defined benefits (DB) to DC that many asset managers established life assurance companies as vehicles for this business.
A life company is an attractive wrapper for pensions. Avoiding the inflexibility of an investment fund, it conveniently bundles investment management with member-level administration. It exploits the freedoms in the Financial Services Authority’s ‘permitted links rules’ that specify the assets to which a life company can link its unit-linked business; these allow a wider range of investment options than are available through other investment vehicles. The tax treatment of life companies is favourable. And lastly, the life company route offers cost advantages through pooling clients’ funds under one umbrella.
Despite these benefits not all investment managers have been tempted to set up life assurance subsidiaries. Some are clearly happy that their investment strategies and product offerings are sufficiently competitive without the additional legal and regulatory framework of a life company. Frank Russell, for example, regards itself as a specialist investment manager and has no life subsidiary. But the firm has an arrangement with Scottish Widows who provide a life assurance wrapper where required. Roger Whittaker, its UK sales director says, “We are not in the market for bundled schemes. We feel confident that we are well equipped to deal with the DC revolution when it comes.”
Robert Hall, a partner at Watson Wyatt believes there are other reasons for investment houses not having gone the life company route. “It’s probably true to say that cultural factors come into play,” he says. “Some investment managers have a tendency rather to look down on insurance companies, and the problems of the retail life and pensions industry in recent years – mis-selling and suchlike – have reinforced that view. But, of course, the asset manager life subsidiaries are far removed from the retail business. These companies are simply legal entities acting as very effective tools for transacting certain types of pensions business.”
Hall’s colleague Wadsworth points out, too, that there is a need to get to grips with an unfamiliar regulatory regime. That means having dedicated team with a first-rate understanding of how to manage the operation for optimal performance in the pensions environment. Such expertise does not lie naturally within asset managers’ core business and thus needs to be imported. Apparently some firms have been reluctant to do this. A further deterrent has been the substantial capital required up-front to establish the life operation. That, and the scale required to maximise the financial advantages, have meant that the larger investment managers predominate.
The league table of asset manager life companies (see panel) reveals pretty impressive volumes of assets, or funds under management, by the key players given the timescale of their development. Nevertheless, given the slow transition to DC business, build-up of assets has not been as rapid as the investment houses would have wished. As a result, much of the funds under management consists of unitised DB money. The two years’ figures shown reveal considerable fluctuation, as might be expected in a business where mandates are switched, resulting in loss or acquisition of sizeable volumes of funds.
In the table, Barclays Global Investors is way out in front, with assets of £38.5bn (E60.4bn) thanks to its focus on and reputation in tracker funds. For the same reason, Legal & General (Pensions Management) which, with its massive £62bn of assets, leads the group of specialist pensions life companies owned by insurers, have been included in the table for completeness. The scale economies resulting from its tracker strategy enable L&G to be highly competitive on charges, which represent the main differentiator for this class of business. The life retailer companies have been set up to compete alongside the specialist fund managers for pensions business, a strategy driven by the trend towards open architecture of pensions investment management, characterised by demand for choice, flexibility and consistently high performance.
But having a life subsidiary is not necessarily a reason to keep it. Schroders is in the process of disposing of both Schroder Pensions and Schroder Hermes. “We regard fund management as our core competence and therefore our core business. We aim to be highly focused,” says Robert Noach, director at Schroders. Thus the firm is transferring to Alexander Forbes Group its Schroder Pensions clients (to whom Schroder funds are still available), and selling Schroder Hermes (originally set up to allow Schroder customers access to Hermes funds) to Hermes itself.
Naturally, Hermes is happy to take the operation under its wing. But Charlie Metcalfe, deputy chief executive and head of sales at Hermes, echoes the mild concerns about the popular image of life companies. “Pension trustees may be wary about dealing with a life company,” he says. “But it’s important to remember that this sort of company is merely a legal tool acting as a means to an end. Even so, when we re-name the company we may just omit the word ‘life’ altogether.”
Where are asset manager life companies headed? Industry authorities generally agree that these operations are here to stay and that their prospects are good. They should remain a flexible, cost-effective way of managing a diversified and well controlled portfolio of mandates. Moreover, legislative change will see them used as vehicles for arrangements for clients throughout the EU, not just in the UK.
At the moment the life company has no serious rivals. The Treasury has come up with the individual pension arrangement (IPA) as a wrapper but this has proved to be no great threat to an arrangement written through a life company, although IPAS do put unit trusts and life funds on an even footing as regards stamp duty. Wadsworth of Watson’s believes there should be other options and that the pensions industry should be trying harder to devise them and get them approved. “It’s up to trade bodies to look for alternatives, but so far they haven’t succeeded – despite trying for 10 years or more.” It looks as though the industry is content with what it has now.
So life companies as legal instruments for pensions seem to have an assured future, especially in a market in which DC schemes figure more prominently. But the growing importance of transparency, flexibility and choice means they have to adapt to changing demands. Whittaker at Frank Russell sounds a note of warning: “In future trustees will need to give more thought to investment management and to think twice about single-manager strategies.”