Acceptable Premiums

When I was in New York last September I had occasion to go diamond-shopping with a friend. He reckoned the best deals in the city could be found in a particular street (it might have been 47th, I don’t remember). Anyway, we went to this street with dozens and dozens of diamond shops each selling thousands of the things. Where to begin?

We went into one shop that didn’t look too dodgy and a chap with a kippah and a white shirt introduced himself as Ruben and pointed to his brother Saul behind the counter. He waved his hand over the displays containing a few hundred diamonds and brought some out for us to look at. He assured us these were the very best diamonds at the very best price, but they could have been fragments of a Corona bottle for all I knew. We thanked him and moved to another place where an almost identical chap with an identical brother greeted us and showed us yet more diamonds. After the third or fourth time it was clear that we knew nothing whatsoever about diamonds, the blokes in the shop could tell this as soon as we walked in the door, and we stood a good chance of being fleeced. I have no doubt this street was the best place in New York city to buy diamonds, but you had to know what you were doing and we didn’t.

The solution was to go to Tiffany’s on 5th Avenue and buy the diamonds there. Sure, they’d be a lot more expensive and the same money could probably get you bigger diamonds and better elsewhere, but at least at Tiffany’s you could absolutely guarantee that the diamonds you were buying were legitimate.

I was reminded of this the other day when I met with a financial adviser. Years ago I set up a pension scheme with Friends Provident and it’s still running. The financial adviser took a look and told me it was expensive, the fees were high, and the savings vehicle was not the most flexible and efficient of all those out there. He showed me one that was cheaper, run by an outfit neither you or I have ever heard of.

There was a reason why I’d picked Friends Provident all those years ago: they were a household name. If a pension company has been around 100+ years you can be fairly sure they’re not some fly-by-night outfit. More importantly, a company of that size ought to have enough liquidity behind them to rescue themselves should they screw up somewhere. But most importantly of all, if they are about to go bankrupt they are big enough that the story will be splashed across all the newspapers and enough people will be affected that the government will come under considerable pressure to intervene, either with a bailout or by arranging a takeover. We saw this with the banks: they were well known and too big to fail, so the ones we’d all heard of got rescued. Had a startup internet bank been clobbered by the global financial crisis, it would have gone to the wall and nobody would have noticed – except the handful of unfortunate depositors. Similarly, if a pension vehicle set up by three city whizz kids in 2012 goes tits-up, nobody will care. If Friend’s Provident starts wobbling, people will.

Like buying diamonds from Tiffany’s instead of Ruben, you might not be getting the best deal with a Friend’s Provident pension, but there’s often a good reason why you pay a premium.

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22 thoughts on “Acceptable Premiums

  1. Good choice, although you should beware of any false notion that you would see it coming just because of their longevity.

    Most of the times that I have tried to beat the market I got a kicking.

  2. Mind you, people thought that about Equitable Life. (Friends Provident was taken over by Resolution in 2009 and in 2011 changed its name to Friends Life.)

  3. You’ll be covered by the FSCS compensation scheme, but the reason the banks were bailed out was to prevent contagion. This isn’t really an issue with life insurance firms, so I wouldn’t rely on the govt to bail them out – see the comment above about Equitable.

  4. I often visit the MSE website where the forums discuss personal finance. I’m struck by the number of people who see no merit in diversifying their pensions across several providers. Nor do they seem to see merit in diversifying their investments rather than using just one preferred firm – say Vanguard.

  5. I’m struck by the number of people who see no merit in diversifying their pensions across several providers.

    Trying to avoid multiple sets of fees, I suspect.

  6. Mind you, people thought that about Equitable Life.

    True, but I wasn’t suggesting publicity and government intervention is a guarantee, just that it’s an extra safeguard. The government did intervene with Equitable from what I remember, and raised a stink, and did whatever they could to ensure the pensioners were not left with nothing. Had they been a small company with a few hundred pensioners, we’d not have heard a peep.

  7. Just out of interest, could you let us know the name of the outfit your financial adviser told you about?

  8. “I had occasion to go diamond-shopping”

    In case anyone wonders, I can safely assure all my friends, family and various hangers-on — including government agencies watching my every more — that I have no memory of nor plans to ever have occasion to use those words.

    In other words, some of us are poor dirt people who know no one with money and others are, well, clearly up there at the top.

  9. You’re well wide of the mark with this one, Tim. Life companies use the “it’s well known, therefore safe” argument to sell horrifically expensive products with absolutely no possibilty of providing you with decent investment returns. There is no comparison with Tiffany whatsoever.
    People with little knowledge of investment can easily create their own pension through a self invested personal pension (SIPP) investing in the extensive range of investment trusts trading on the LSE, managed by reputable groups which have often been running for over a hundred years. Unlike life companies, they do not have mountains of liabilities which can often lead to unanticipated problems, as with Equitable. And the fees are a tiny fraction of those charged by life companies. I hope you give this some further thought.

  10. Life companies use the “it’s well known, therefore safe” argument to sell horrifically expensive products with absolutely no possibilty of providing you with decent investment returns.

    I don’t know what product you’re referring to, but that doesn’t sound much like mine. The days of pension providers being able to stiff you with hidden charges and make it impossible to get any returns are long gone, the regulators saw to that.

    easily create their own pension through a self invested personal pension (SIPP) investing in the extensive range of investment trusts trading on the LSE, managed by reputable groups which have often been running for over a hundred years.

    That sounds more like mine, albeit through a Friends Provident vehicle which I’m paying for, and I get to choose the (mirror) funds and change them as and when I see fit. There was an up-front fee (sunk costs now), and a charge of around 1.8%. The guy I spoke to could offer 0.8% if I jumped in with him. Hardly a major saving.

  11. In other words, some of us are poor dirt people who know no one with money and others are, well, clearly up there at the top.

    I’ll flick you some crumbs should I pass you begging on the streets. Yeah, I know some wealthy guys. Good lads, though.

  12. David
    You’re right in principle. Wrong in practice.
    The govt has been trying for ages to get more competition even for current accounts, but people just stay with the bank they’ve got.
    Pensions are an even more file-and-forget proposition.

    Maybe the govt should lower their guarantee. Good luck with that, a surefire way of losing the next election.

  13. A lot of these funds do rely on inertia as a means of keeping clients.

    Following twenty five years of utilizing plain vanilla pension funds and at one stage having my own self manged one (too much paperwork, compliance and annual audit fees) I have landed with a pretty versatile flexible product that gives me oodles of choice as if I was directly investing. At the moment I have about 2/3rds in various fund and 1/3 directly invested in shares that I purchase and sell. New funds coming in are directly invested in shares by me and as the funds drop I can cash up some funds and directly invest in shares. I find that I can safely dispatch with my hunter killer yearnings by buying and selling shares in either $5k or $10K packages and my results are at least on par with the funds and I think that I will overtake them given that I have only started this this year.

    Regardless of the fund type you should really invest in uniform with whatever stage of your life cycle that you are at. A young person should invest for growth but once you reach 50 then you are on the dash for cash stage of your life where higher yielding investment may be more suited to provide you with the necessary cash flow to fund your lifestyle in retirement.

    I prefer Aston Martins to diamonds.

  14. It’s quite complicated but …
    (1) Friends Private became Friends Life which was taken over by Aviva, which is quite a large company
    (2) being a large company is no guarantee of safety
    (3) Insurance firms have capital in case something goes wrong, not liquidity, although they do need liquidity as well but insurance regulation focuses on capital. That isn’t to say the regulator doesn’t look at liquidity by the way just that much much more effort is spent on capital.
    (4) a personal pension should be held in trust. Even if the firm operating it goes bang your money is separate and legally not theirs to use. This is quite important.
    (5) compounding matters a lot over a long period. A 1% saving per year will compound up over 20 years to be a big difference in performance. Interim will cost you
    (6) investment choice matters a lot over the long run. diversification is fine but can cost significant returns, especially when cash and bond funds return marginally less than the annual management charge, so effectively zero return there,

    Watch for the lifetime allowance though. They keep reducing it. If you have a final salary scheme with one of your prior employers that can be a huge chunk taken away. The buggers reduced the annual allowance as well but if you live abroad that isn’t relevant.

  15. being a large company is no guarantee of safety

    I’d rather hope none of my readers think I’m so stupid to believe it is.

    But somebody like Friends Provident will at the very least be concerned about public image and whatever stupid decisions they may make, the directors are unlikely to disappear in the middle of the night. If the choice is between somebody like FP and an outfit you’ve never heard of being presented by a bloke who’s cold-called you having cribbed your info from LinkedIn, which would you go for? Sure, there will be a hundred companies out there which are better than FP – but there are also hundreds of diamond shops better than Tiffany’s. The problem is knowing which one, and unless you have an adviser you trust 100% or you’ve done the research and are able to make an sound decision, you go with the company you’ve heard of.

    Sorry, but I’ve not been reading news reports of hundreds of thousands of British retirees over the past 10 years being left high and dry with no money at all because FP has fleeced them completely. Stuff like endowment mortgages made the papers and the government put a stop to them, wholesale misselling and fraud would be reported if a company like FP was actively engaged in it.

    compounding matters a lot over a long period. A 1% saving per year will compound up over 20 years to be a big difference in performance. Interim will cost you

    That’s a good point. But does the saving come with additional risk? It probably does, but I don’t know what it is.

  16. Tim

    Your charge of 1.8% would absorb over 25% of the real investment return taking the midpoint of a range of 6-8%. You don’t say if FP charge for contributions or on the underlying funds you invest in but that compares with under 10% for my SIPP because investment trusts have very reasonable fees. If I used trackers like you the charges would be under 3%. I would consider this a major saving especially when compounded over 40 years.

  17. Apologies if you took my “large company” comment as an indication of any lack of intelligence on your part. Far from it. I was trying to highlight a weakness in my own point above that.
    Capital and the ability to recover if something goes wrong matters for insurers. Big companies, generally, have deeper pockets and can recover better as they have more options. Big companies can also bet big. Pensions are special as they are segregated (almost almost always) so even if the Aviva board decide to blow the company’s capital on cocaine, call girls and casinos before the day is out your money won’t be affected.

    The topic is dry and there are most people don’t take an active interest until it is too late. Polyamory is much more interesting, or so I hear….

  18. Your charge of 1.8% would absorb over 25% of the real investment return taking the midpoint of a range of 6-8%.

    That’s a good point. I wish the guy I’d spoken to had pointed this out.

  19. Apologies if you took my “large company” comment as an indication of any lack of intelligence on your part. Far from it. I was trying to highlight a weakness in my own point above that.

    Ah okay, I’m sorry too. Jumped in all grumpy for a minute there, I did.

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