Personal finance: A Direct Line to cheaper pension provision?

Direct Line, the bargain basement insurer, this week presented itself as the new saviour of the nation's retirement incomes as it launched a no-nonsense pension. Such is its clout that it was immediately attacked by the other pretender to that role, Virgin Direct. Andrew Verity reports.

It very nearly goes without saying: none of us saves enough to be comfortable in retirement. Nevertheless, Direct Line, the downmarket direct insurer, has commissioned a survey to tell us why. The sobering facts are worth repeating.

According to the Mori survey of more than 1,000 adults, over half of us are honest enough to admit we have no idea how much money is in our pension fund. On average, we reckon we will get a pension income of pounds 852 a month. In fact, if things stay as they are, we will get an average of just pounds 200, perilously close to the poverty line.

Direct Line's life insurance wing accuses the bewildered British public of being in a state of "guilty inertia", knowing what is needed but constantly procrastinating because of other financial pressures. The company's chief executive, Duncan MacKechnie, says: "There is a real need to bridge the gap between people's expectations for their retirement and the pessimism which currently exists about the state of current pension provision."

The state of pension saving is dire, says the survey, and we're all a bit ignorant about it. But should we follow the next conclusion, that Direct Line can provide the solution?

The company is famous for its shake-up of motor insurance. Because motor insurance is compulsory, costs can be cut by eliminating the "middle-man", the insurance broker, and appealing straight to the public through friendly TV ads. In the early 1990s, the company was able to undercut other insurers to such an extent that the whole market was forced to follow. Few companies now take a big profit from motor insurance.

Direct Line evidently believes the same can be done to the pensions market. The Government wants low-cost, private schemes for everyone. Personal pensions have, it says, been much too expensive, with charges eating up as much as a third of contributions. This is because the provider has to cover commissions to the sales people in the middle who sell them (which have risen by up to 60 per cent in the past five years).

Direct Line believes it can overcome our inertia by bringing out a straightforward, no-nonsense pension. By appealing directly to consumers, it does not have to pay commission. So its products will be cheaper.

The rhetoric has a familiar ring: very similar to that of Tesco's, Virgin, Legal & General, Marks & Spencer, Eagle Star and Scottish Widows, who have all launched "direct" pensions in the last two years. Is Direct Line doing anything new?

At first it looks very cheap. Direct Line's new customers get charged 1 per cent of their fund per year. They can invest in a fund that tracks the FTSE 100 - or just put their money on deposit. Payments can be by cheque or direct debit. Easy.

Well, not quite. Sensing heavyweight competition, rivals such as Virgin and Legal & General have rushed out statements insisting their pensions are cheaper. Virgin seizes on an extra fee. Only 98 per cent of every pound at First Direct will, in effect, be invested (a common practice known as "reduced allocation"). Virgin's pounds 2 a month is easier to understand. Not only that, says Virgin. "Direct Line's limits are restrictive. You have to invest at least pounds 75 a month. With Virgin, invest what you like, when you like as long as it's pounds 50 or more," a statement from Virgin said.

Are Virgin being, as the slogan says, Virgin Direct? Well, not quite. If pounds 50 was invested with Virgin, its charges would be pounds 2 plus a 1 per cent fund management charge - or 5 per cent of your investment. Considering Virgin says it is appealing to people with all levels of income, this is not all that cheap.

Because it charges by percentage, Direct Line's pension is cheaper for smaller contributions. At pounds 75 a month, its charges amount to 3 per cent. Virgin's are a fifth higher, at 3.7 per cent.

The bickering over cheaper pensions also masks a more important debate. Virgin and Direct Line are cheap partly because they offer a cheap way of investing their customers' pension savings. Just stick it in a fund which tracks the FTSE 100 index, they say. Over the long term, active fund managers never do as well as the index - and they are more expensive, so the charge is bigger.

Unfortunately, some of these arguments may be wearing thin. Customers have validly protested in the past that a 1.5 per cent charge on their savings, much of which goes to the extravagant salaries paid to fund managers, is not value for money. Between October 1995 and September 1997, less than one third of UK unit trusts got more from their investments than a fund tracking the FTSE 100. But in the last quarter of last year, nearly half did just as well, according to figures from HSBC Asset Management.

According to received wisdom, active fund managers will do better than tracker funds in a bear market. And over the long term, investment performance can have a much greater effect on the size of a pension fund than charges will. Cheaper, in other words, may not always mean better.

`The Independent' has published a free 26-page guide to pension planning, written by Nic Cicutti, personal finance editor. The guide, sponsored by Eagle Star, discusses what kind of pension you may need, and how to find it. It is available by calling 0800 776666. Or fill in the coupon on page 6.