PensionsMar 27 2013

Sipp capital adequacy paper: Capital inadequacies

twitter-iconfacebook-iconlinkedin-iconmail-iconprint-icon
Search supported by

Setting up shop as a self-invested personal pension (Sipp) provider is not that difficult. Despite being available since 1989, Sipps were not regulated until 2006. Regulation did little to raise the entry-level requirements of operators and it is thought that more than 170 Sipp providers are or have been in business since. FSA sales data suggests around two-thirds remain active and accept new business.

Repeated attempts by the regulator to nudge Sipp operators towards better practices appear to have been ignored by many. The findings of the thematic review of providers, published in October 2012, pulled no punches: the FSA said Sipp providers risk causing “significant consumer detriment” through a “failure to adequately control their business”. In highlighting a number of other systematic failures, the regulator felt that some providers in themselves were at risk of failure.

The FSA’s proposed solution – CP12/33, a new capital regime for Sipp operators – was published just a month later. Only days after the initial headlines died down, such as “£20,000 minimum capital requirement”, the industry realised that these proposals signalled the biggest ever shake-up of Sipps.

Before and after

Sipp operators can fall under different regulatory regimes, but in broad terms they are required to hold a minimum of capital equal to six weeks of business expenses. That amount should be sufficient to wind up the business and transfer out all plans and investments. Due to the fact that Sipps can hold a wide variety of investments, including some that are highly illiquid, the regulator has proposed to increase this minimum capital requirement and amend the calculation.

The proposed formula no longer takes business expenses into account and instead calculates capital requirements through two different formulae. Both take into account the value of the total assets under administration (AUA) and one reflects a capital premium for the amount of complex – or “non-standard” – assets held.

Table 1 demonstrates the financial change needed by a theoretical but typical Sipp operator with 2,000 plans.

A number of different scenarios can be modelled but the financial shock is clear. Using this example, the Sipp operator will need to find 942 per cent more capital just to keep running the same business it has always done.

The impact can be more clearly modelled on a smaller Sipp operator with just 500 plans. As shown in Chart 1, required capital could conceivably rise from just £41,000 to more than £1m. It appears unlikely that Dragons’ Den will see any pitches from Sipp operators in coming years.

Market impact

The immediate impact for Sipp providers is clear: more money in the bank is needed to continue operating. But that’s not all. The FSA’s thematic review also puts pressure on operators to introduce the necessary systems, controls and processes to bring their business up to a more acceptable level. These additional costs seem likely to force some Sipp operators to close. During 2012 a handful of high-profile acquisitions made the headlines, a trend looking set to accelerate in 2013.

Advisers will still need to undertake due diligence on their chosen Sipp providers – there are still too many smaller firms for the requirement for in-depth analysis to lessen. But over the short to medium term advisers will soon see the benefits. Choice of providers will inevitably be reduced but choice of features, flexibility and access to investments will hopefully not. Access to some of the more esoteric unregulated schemes may reduce, however, as the wider Sipp market considers whether they represent good, sustainable business.

The ideal scenario is that the remaining providers will be stronger, invest more in their systems and ultimately drive better service to advisers. Some will inevitably try to diversify into SSASs or platforms.

The end consumer looks set to benefit most from the proposals. The regulator will deserve credit if this takes place, although some will argue that the crisis averted may never have happened. The regulator considers parts of the Sipp industry to be fragile to the extent of posing serious risk of consumer detriment. Right or wrong, an industry that was buoyant just five years ago has been rocked by closures, failures, investment scandals and firms forced to close to new business. Should that spiral continue, consumer confidence in Sipps as an effective retirement vehicle could be severely shaken as better providers risk being tainted by the failures surrounding them.

Instead consumers should have greater confidence that their chosen Sipp provider can deliver a safe environment for them to invest to their retirement and beyond. The current situation, where there is uncertainty as to whether a Sipp provider will even exist in five years, is simply unacceptable. It is unthinkable that consumers would risk their other monies – such as bank accounts or Isas – in such an environment. A potential outcome of the regulator’s actions could be a slight elevation of cost to the consumer, a fact that must be balanced with the increased level of protection should things go wrong.

Justifying the means

Whatever the outcome of the proposals, few businesses that fail to put customers’ needs at the forefront of thinking survive in the longer term. With more than one million Sipps now in force, the industry is no longer afforded the luxury of being inward-looking. If it continued that way it would risk being viewed as self-serving and losing sight of on whose behalf it exists. In the not-too-distant future it will beggar belief that virtually anyone could put £5,000 in the bank and take on responsibility for administering the retirement plans of hundreds of investors.

The FSA has nudged and cajoled for several years without the desired outcome. Now it has legislated. Providing a Sipp is no longer part of a cottage industry; it is no longer acceptable to take on board any investments without understanding the risks they pose. Providers cannot simply send money to third-party investment managers and lose track of where it is invested. With the planned changes, they will not be able to operate on resources so limited that there is little hope of protecting their investors should their business fail. Providers may disagree on the intricacies of the FSA’s proposals, but no one can argue with an aim of a safer environment for investors.

Those Sipp providers that survive have the potential to thrive. Tomorrow’s ‘good’ providers will take responsibility for putting the controls in place to know where investors’ money is and in which assets it is invested. They will understand the risks of the investments they accept. And, should things go wrong, they will have sufficient resources to ensure every investor will be afforded safe transfer out from their business to another provider.

Rigid, inflexible retirement options gave birth to Sipps. They thrived by putting flexibility and the customer at the centre. More than 20 years later sharper oversight and robust controls will ensure Sipps continue to deliver for the next 20 years and beyond.

Those who do not embrace it should not seek to continue beyond this point.

Greg Kingston is head of marketing at Suffolk Life