The Future at Stake.

U.K. insurers are vying for positions in the new stakeholder pension market, where competition promises to be fierce and margins are paper-thin.

In April, the British life insurance industry launched the government backed stakeholder pension, designed to extend protection to millions of low- and middle-income people who now lack any form of private coverage.

"Stakeholder pensions will change the face of how people save for their future," said Alistair Darling, the government's social security secretary. "Because they are flexible and value for money, they are a good deal for lots of consumers who do not have other pension options available to them."

Stakeholder pensions, which will be targeted at people earning between [pound]9,000 and [pound]18,000 a year (about $12,900 to $25,900), has been greeted with mixed emotions by insurers, employers and independent financial advisers. "It is too early to tell how the launch has gone," said Mike Smith, business communications manager at Legal & General in London. But Smith added that L&G is "very optimistic from the early signs that we have seen."

The potential market for stakeholder pensions is large. There are an estimated 5 million low earners in the United Kingdom who don't belong to employee pension plans. Stakeholder plans are open to the self-employed and the unemployed. The insurance industry expects stakeholder plans to give a boost to the entire pensions market, even as the new product pushes prices downward.

Mandatory Fee Cap

There have been complaints from within the insurance industry that the government-mandated fee cap--of 1% of the total value of the fund each year--is too low to allow for reasonable profits. By comparison, fees on traditional pension products average between 1.5% and 3%. And many businesses, particularly smaller ones, are unhappy at the requirement that all employers with five or more employees must offer access to stakeholder plans by October. Those organizations that fail to comply could be fined as much as [pound]50,000. Employers aren't required to contribute to the stakeholder pensions they set up on behalf of their workers.

"Quite a lot of employers even now are not aware of" the deadline, said Roman Cizdyn, an analyst at Merrill Lynch in London.

More than 40 organizations have registered as stakeholder providers, and larger life insurers are expressing confidence about their prospects in the market. These organizations tend to have recognizable brands, extensive delivery channels and the strength to operate on lower profit margins. Companies that have welcomed stakeholder plans include Norwich Union Life, Legal & General, Prudential, Standard Life and AMP of Australia, which owns Pearl Assurance.

Iain Buckle, head of individual pensions at Norwich Union Life, said Norwich Union, which is part of CGNU Group, hopes to capture 20% of the stakeholder pensions market. Buckle said that a company such as Norwich Union, with large funds under management, stands to do well in the market, even if the early years may not be all that easy. "If you can attract lots of single contributions and keep hold of business once it's written, then you can turn around to profit reasonably quickly," Buckle said.

Graham Storrie, assistant general manager at Standard Life in Edinburgh, Scotland, also discerned peripheral benefits from stakeholder plans. "As we see it, the overall pensions market in the U.K. is going to grow significantly over the next few years," he said. "And stakeholder will be a very important product within the pensions marketplace."

Chasing Market Share

Smith said Legal & General is hoping for a 10% share of the stakeholder market. "But what we aim to do from year one is to provide shareholders with a double-digit return on capital," he said.

Buckle said the 1% fee cap represents the first time the government has prescribed basic product terms in the pension market. Previously, he said, the government, through the watchdog Financial Services Authority, had been content merely to lay down the rules under which providers would be allowed to operate.

The determination of the government of Labor Prime Minister Tony Blair to create an easily understood product at a reasonable price grows out of its concern that many of Britain's lower-paid workers are heading toward retirement on only the relatively modest state pension. The stakeholder plan, which will qualify for tax deductions, is in line with a long-term shift by Western European governments away from the welfare state.

The U.K. government also wants to overcome any bad memories of the pension mis-selling scandal of the late 1980s and early 1990s, when many people were sold unsuitable private pensions. A more recent marketing problem came with the collapse of Equitable Life after the company lost a court battle with policyholders over its decision to reduce payouts on its guaranteed annuities.

Stakeholder plans' low fee structure is likely to accelerate the existing trend within the industry toward consolidation by putting a premium on market share. Already, Prudential and Britannic have each eliminated 2,000 jobs through cuts in their sales forces. Insurers have begun to pursue distribution agreements with banks to lower their costs and tap into wider retail markets. Norwich Union is cooperating with the Royal Bank of Scotland, and Legal & General has announced an alliance with Barclays Bank.

Cizdyn, of Merrill Lynch, said planning for stakeholder plans over the past two years has altered the shape of the overall U.K. pensions market. "The whole pensions market is now on a stakeholder-type basis," he said.

Buckle noted that a number of providers, including Norwich Union, have launched products in anticipation of the stakeholder market. He described these as "personal pensions with stakeholder features."

Smith said Legal & General also has its sights on the entire "defined-contribution marketplace."

Michael Hooton, senior financial analyst at A.M. Best Europe Ltd. in London, said the 1% cap would put a heavy emphasis on the comparative investment performance of the various providers. He suggested that insurers would have to market their investment expertise to attract stakeholder business. Hooton noted that some companies will be offering multimanaged funds, as well as their own.

Cizdyn said the issue of market hare would solve itself as providers without the necessary muscle pull out of the sector. He noted that many companies remain wary of stakeholder pension plans. And he said the list of providers includes sister companies under the same corporate umbrella.

Barriers to Success

Cizdyn predicted that memories of pension mis-selling wouldn't dissuade people from buying stakeholder pensions. The big barriers, he argued, are lack of affordability and low awareness among the target market. There are some expectations that the government eventually will require employers to make contributions to the stakeholder plans that they sponsor.

Stakeholder plans contain a default mechanism for customers who don't specify an investment strategy. Smith said this feature would make the product easier to market to many customers who, faced with a seemingly daunting choice of investments, might otherwise simply put off the entire purchase. There has been some concern that passively managed, index-linked default funds, which will be relatively inexpensive for insurers to operate, will produce lower returns than funds that are actively managed. Once invested, the money must remain until the customer reaches age 50.

Hooton noted that default money is likely to wind up in an insurer's with-profit fund, which is held on behalf of customers with participating life insurance policies. "And there has been a lot of fuss recently about the lack of transparency of with-profit Funds," he said.

Some independent financial advisers fear that the 1% cap will reduce the revenues they earn from insurers. IFAs also worry that stakeholder will bring in a lot of single-product customers who will drive up administrative costs and resist cross-selling efforts. Stakeholder customers will enjoy flexibility on their contributions. They can choose to contribute is little as [pound]20 a month and as much is [pound]3,600 a year. They will also be able o stop payments and start again, and hey will be able to switch provider without penalty.

Robert O'Connor is a London-based correspondent.