Jeremy Warner's Outlook: British insurance faces up to challenge of delivering the right product at the right price

Pension reform: a charging matter
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The Independent Online

There are only three topics of general discussion in the UK insurance industry these days - one is how Lord Turner's proposals for a National Pensions Savings Scheme might be implemented, the others are the burgeoning claims cost of personal injury and employment protection insurance.

Norwich Union has this week attempted to address the second of these issues by jacking up the cost of motor insurance an average of 16 per cent per policy - (high-risk customers, such as young, single men, will see much bigger increases; those with clean records, much less). As No 2 in the motor insurance market, Norwich Union's hope is that rival insurers will follow its lead. The gamble may or may not pay off, though the company is perfectly prepared to cede market share should that be the price that has to be paid.

Few companies make much money out of motor insurance. The business is perennially loss-making. Yet the traditional reason for this, the cost of bashing the car back into shape after an accident, has given way to a new one, the cost of personal injury, and particularly whiplash, which is easy to fake and tends to come in at a minimum of £3,000 a pop. Insurers have managed to get to grips with the spiralling costs of metal bashing by forging relationships with particular garages where they have some degree of control and can limit the scope for rip-off insurance jobs. These methods have also hugely reduced the costs of assessment.

Personal injury is something else. Unless seriously injured, few people used to bother with it, even going back only 10 years. Now it is seen almost as a blessing if someone rams into the back of you while parked at the lights. I don't want to belittle these claims, most of which are entirely genuine, but much of what was once seen as just the rough and tumble of life is now routinely regarded as a money-making opportunity, even though it is ultimately the consumer who pays through higher insurance premiums.

Employers' liability insurance is following a similar pattern, though here the main issue is about legal fees. According to the Association of British Insurers, the claimant's legal bills are typically costing 40p for every pound paid out in compensation. This is plainly a monumental waste of money, laid bare by the fact that successful claims pursued without the benefit of lawyers nearly always pay out more than similar cases with the active involvement of lawyers. Again, it is the consumer who ultimately pays.

The ABI has put forward some sensible proposals for reform. A single tariff for each injury is one approach, a regularised system and timescale for claims that are disputed is another. Yet for the time being, insurers are addressing the problem in the only way they know how - by jacking up the prices.

There are two rates of inflation in Britain at the moment. One is for discretionary spending, where prices are subdued or in some cases even declining.

The other is for unavoidable spending - utility bills, fuel, college fees, council taxes, house prices, rents, parking penalties and other disguised forms of taxation, insurance and more recently even food prices. This one seems to be rising like topsy. The targeted rate of inflation still looks tolerable, even though it is rising back towards levels not seen since the mid-1990s. Yet rightly or wrongly the perception is of much more serious rates of inflation in the things we have no option but to buy.

The cost of many forms of discretionary spending in the service sector is rising strongly too. This helps to make the perception of more generalised high rates of inflation a predominantly middle class one. Yet, perhaps regrettably, it is the chattering classes who tend to dictate public opinion. Wherever these pricing pressure are coming from, it all adds up to quite a challenge for the Bank of England, the main guardian of our economic stability.

Pension reform: a charging matter

With the Government due to issue a second White Paper in November on the Turner proposals, the debate over the National Pensions Savings Scheme is again coming to a head. Don't necessarily expect anything quite as bold as a decision from ministers quite yet.

It could be that all this "technical" paper does is suggest the establishment of a "delivery authority". Putting off difficult decisions for another day has become the defining characteristic of government pensions policy, so it is to be hoped that ministers can be persuaded to be braver.

The basic principle of Lord Turner's recommendations - that a national scheme be established that employees and employers are obliged to pay into unless the employee deliberately opts out - has already been accepted by the Government.

Parts of the business lobby, in particular the hospitality industry, have asked for a qualifying period of up to a year in employment before employers are obliged to offer the pensions benefit, yet there is little prospect of the Government accepting these demands. To do so would undermine much of the purpose of the NPSS - to provide a private pension to the millions who at present make no provision because of poorly paid or promiscuous working habits.

Even so, the most important issue - whether the scheme is public or private sector-administered - is not yet settled. Lord Turner has insisted that the economies of scale that would be possible in a single, state-administered system might make possible an annual management charge of as little as 0.3 per cent.

The savings thereby delivered would make a significant difference to the size of the pension in retirement, helping to counter claims that it is not worth the low paid saving because the amounts are so small that they get eaten up in fees.

In a detailed submission to the White Paper, the insurance industry is next week expected to condemn the figure as completely unrealistic. Its own research shows that the scope for economies of scale in the delivery of personal pensions is quite limited. The marginal cost of administering a relatively small number of pensions is not much different from a larger number. In fund management, economies of scale are better, but they tend to flatline after the first £500m.

Instead, the industry suggests an open access approach, where insurers are allowed to bid for the business in much the same way as they do at the moment among companies that offer pension benefits. Ideally the charge would be uncapped, with competition doing the work of keeping charges as low as possible.

The administrative cost and hassle for companies being forced to deal with several different pensions providers because of labour mobility would be dealt with through a central clearing house, or "carousel", which would collect and apportion the money. As proposed, then, the industry's scheme would share some common ground with Turner. The idea of the clearing house makes it more of a hybrid than a different species altogether.

Even five years ago, I doubt it would have passed muster with a Government deeply suspicious of an industry which has given us high charges and repeated mis-selling scandals. Things may now be different. The industry has largely cleaned up its act: ministers are more willing to listen. The last thing they want is a repeat of the costly fiasco of the National Health Service's new IT system, all too likely with a state-administered personal pension scheme.

Yet there is one key question the industry has not so far been able to answer convincingly. It is all very well relying on competition to keep charges low. However, the market failure which has long been apparent in the savings industry is that the proliferation of cost involved in marketing and sales makes it impossible to deliver the product at a charge low enough for worthwhile saving by the low or even averagely paid worker. By stripping away all that cost, Turner's NPSS could in theory deliver the desired result. Whether it can in practice is another matter. No wonder the Government is dithering.

j.warner@independent.co.uk

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