A key reform, under which the Government has planned to slash the cost of regulation by putting "kitemarks" on cheap pensions, would put an entire swathe of pension providers outside the law.
Life insurers, which provide nearly a third of all private pensions to date, this week warned they could not sell "stakeholder pensions", a central plank of the Government's welfare reforms, if they were kitemarked.
The European Union's "Third Life directive" makes it illegal for insurance companies to offer products that are pre-approved by the Government, or kitemarked, because it would supposedly kill off competition.
According to the insurers, the law could also block the Government from cutting the cost of regulating Individual Savings Accounts by using a kitemark.
This means a widely touted method of reducing the cost of long-term savings products, backed by the Association of British Insurers and investment houses such as M&G, is in effect no longer an option for the Government.
As the Government looks to expand the availability of investment products to the less well paid, one of its primary concerns has been to keep costs to an absolute minimum.
Kitemarking would be one means of doing so because it cut out large costs to the consumer. The idea was that the Government would authorise certain products as approved for sale to anyone. This would eliminate much of the cost of sales regulation as well as reducing the cost of financial advice.
In its submission to the Government on pensions reform, Standard Life says the overall costs of creating, selling and advising on a pension worked out at 18 per cent of all the money put in. Of this, 8.5 per cent consisted of the cost of advice, be it through a financial adviser or direct sales force.
Ironically, the relevant elements in Europe's Third Life directive, which make it illegal for insurance products to be kitemarked, were introduced by the British in an attempt to open up the German market to external competition.
But not all sellers of pensions and investment products will be affected. Unit trusts are not subject to the European life directives and so could slot in to any kitemarking or pre-approval regime for either ISAs or pensions.
Virgin Direct, which has been a keen advocate of kitemarking for stakeholder pensions, has its own pension set up through unit trusts, not through a life company.
Martin Campbell, product development manager at Virgin Direct, says: "We understand there would be a number of problems with the Third Life directive and we hope there is a way round this. We would certainly not want only a small segment of the market to be eligible for kitemarking."
Virgin says it wants a kitemark to be awarded to clear, transparent and flexible products to help attract the 6 million people who currently do not save.
Mr Campbell said: "We would like to have kitemarking extended to all financial products. This would not tell the customers the product is the best for them but it would mean they would avoid all sorts of hidden nasties."
The unit trust industry's own trade body has come down against the need for kitemarks.
Philip Warland, director of Autif, said, "The first problem with kitemarking is moral hazard. People could see it as a recommendation to purchase and if that happens and the product does not work in some sense, the Government will eventually foot the bill.
"Secondly, if some products are kitemarked what does this say about products which are not, even if some of them would be more suitable for some individuals than the kitemarked version? Finally there is a difference between cost and value, not all low-cost products offer good value.
"I imagine the Government is seeking a product that is accessible, safe, flexible and has clear charging structures and above all is one that is recognised and authorised by a regulator. This is exactly what a unit trust is."
However, the unit trust industry faces its own problem down the line with pensions. There is a move among investment groups to convert unit trusts into a more recent investment vehicle, the open-ended investment company or Oeic. As yet there is no legislation in place to allow Oeics to be used as pensions vehicles.
The insurance industry is fighting back by trying to find a formula which is as close as possible to kitemarking without having to resort to pre- approval of life products.
So far, the Third Life directive has not had a big impact because no one on the Continent has complained about pre-approval in the UK.
Paul Grace, who heads the Association of British Insurers' tax committee, said: "The UK Government said three years ago it was looking to remove pre-certification on qualifying policies issued by life assurance companies. While it is still a requirement of UK law it is outlawed by European law. If there were any objections on the Continent, the UK government would have to move swiftly."Reuse content