@Marc: I realize that actors in the Irish financial services industry incur high compliance and operational costs. Every machine has its friction, and the small size and fragmented nature of the Irish retail market doesn’t help. I’ve read pieces in the

*Sunday Business Post,* the

*Irish Times,* and the

*Irish Independent* over the years in which you were interviewed, and I’m grateful to you for fighting for lower costs and more transparency. I guess that many people—not without reason—mistrust the financial services industry, and so even the good guys often get tarred with the same brush. Of course you’re entitled to get paid for your services; I explicitly said as much in an earlier post. And if you can significantly reduce ongoing charges for investors, then presumably some of that benefit should accrue to you too.

So, to your question “what would be a reasonable upfront cost to pay to set up a pension with lower ongoing charges?” It’s an interesting question, and the short answer is that for several reasons that I’ll do my best to spell out, I don’t know.

Firstly, there is an asymmetric information problem that creates an imbalance of power between industry insiders and their retail clients, and a consequent atmosphere of suspicion. I have only a fuzzy idea of the costs to the provider of setting up a pension, and so it’s hard to say what would be a fair retail price to pay.

In the abstract, the question of how to divide fairly the savings from reduced ongoing charges between the adviser and their client could be framed as a variant of the ultimatum game from behavioural economics, with which I’m sure you and many of the forum members are familiar. The proposer is given a sum of money (say one hundred euros) to divide with another player, the responder, who can choose to accept or reject the proposed division. If the responder accepts, then the money is shared as per the proposal; if they reject the offer, then neither player gets anything. Narrow economic rationality would suggest that the responder should accept any amount down to as little as a single cent, since any amount of money is better than none, but although experimental results vary widely, responders often reject proposals of under 30%, since they don’t like to feel they’re being exploited.

So perhaps the economically rational investor should be prepared to pay any amount up to one cent less than the reduction in charges (plus some small sum for the inconvenience of switching) to move to a lower cost provider.

Or, perhaps one could frame the question in terms of a fair distribution of spoils between capital and labour. Arguably, since the investor, in putting up the capital, is taking all of the risk, they should be the one who receives most of the reward.

Suppose, for the sake of argument, that a 50/50 division is fair. If investor X is paying company A €1,000 a year to manage their portfolio, when it only costs €500 a year to keep the lights on and the salaries paid, then in theory, company B could do the same job for €500. Company B could then offer to manage X’s portfolio for €750 a year, effectively splitting the savings 50/50. But there is still €250 of profit left on the table, so in a competitive market, company B would be undercut by company C, who could again offer to split these profits 50/50 with investor X, charging them €625, spending €500 on overheads and payroll, and making a profit of €125. And so on until in theory all the savings accrue to the investor in a perfectly competitive market...

I’m sorry if it seems like I’m podding through toy examples from Econ 101; I’m just trying to formulate a genuine response to the question you posed by thinking through simplified—but hopefully clear—cases, and going back to first principles to do so. From one angle, the provider should get almost all of the savings; from another, it should be the investor. But in a highly

*uncompetitive* market like Ireland’s, the situation more closely resembles the ultimatum game: the pension providers and intermediaries hold most of the cards, and thus end up with most of the loot, which may explain the frustration of many posters on this forum.

More narrowly, the question of how much it would be worth to the client to pay upfront to reduce ongoing charges is a difficult one, because an accurate answer involves several variables, only one of which is known. It depends on (1) the initial balance, (2) the size of subsequent contributions, (3) the period over which those contributions are made and the associated ongoing charges reduced, (4) the rate of return on the balance invested and (5) the future availability of other options owing to regulatory changes and new entrants to the market.

As a first pass through, if one takes a somewhat arbitrary break even point of ten years out, then one might think it would be worth paying anything under €1,000 upfront to save €100 a year for ten years, but the future savings need to be discounted to allow for the time value of money.

So, if we fix (1), plug in guesstimates for (2), (3), and (4), and handle (5) by assuming that the regulatory and market environment will not change during the given period then the mathematical formula that should be used to answer the question would be that for the present value of a growing annuity. Let me try a worked example:

Suppose somebody on the median Irish salary of €37,775 has been investing for 15% of their salary for 14 years and has accrued a pension balance of €100,000. If they contribute €5,666.25 or 15% again this year and earn a 6% nominal return, then at the end of the year they’ll have €112,006, and with a Davy PRSA they’d pay a 0.75% dealing charge of €840.05. (The charge is on the average, not the year-end balance, but I’m using the year-end balance to keep things simpler.) Assume that their salary grows at a nominal rate of 3.75% per annum, and that they continue to contribute 15%, and make a nominal annual return of 6%. (I arrived at the salary growth rate as follows. Assume that a person at the end of a 40 year career earns double what they did in inflation adjusted terms when they started out. The rate at which a sum of money doubles over 40 years is 1.734%, so rounding up and adding back inflation of 2% gives 3.75%.). Then their pension balance, and thus their annual dealing charges will increase at a rate of approximately 10% a year. Plugging this in to the present value of a growing annuity formula, one gets:

PV = (P / (r - g)) x (1 - (((1 + g) / (1 + r)) ^ n)), where

P = first payment

r = rate of return per period (discount rate)

g = growth rate of annuity

n = number of periods

In the case above PV = (840.05 / (0.06 - 0.10) x (1 - (1.10 / 1.06) ^ 10) = €9,416

Strictly speaking, since the rate at which the pension fund balance—and thus the annual dealing charges—increases is not exactly constant, the present value of an annuity formula answer is only an approximation. To see this, imagine somebody who is just starting to save €5,000 a year. At the end of year 1, they have €5,000, at the end of year 2, €10,000, and at the end of year 3, €15,000. So the rate of increase from year 1 to year 2 is 100%, but from year 2 to year 3 it’s only 50% etc. But after a few years, when the ratio of the balance to the contributions is high, this effect is rather minor, so the approximation is quite close. I worked out the exact figure using a spreadsheet, and the present value came to €10,276.

So, for somebody on €37,775 with a pension balance of €100,000 who intends to keep contributing 15% of a salary that they expect to grow at a nominal rate of 3.75% making a nominal return of 6% on their investments and paying 0.75% in annual dealing charges, the present value of those future charges over the next 10 years is about €10,000.

Suppose a provider or an intermediary can offer a comparable selection of investment options (low cost broad index based funds) and can reduce the dealing charge by 50% to 0.375%. They’d save about €5,000 in charges over the following 10 years. If the professional and their client were to divine those savings equally between them, the professional could charge €2,500 to set up the pension into which the €100,000 balance was to be transferred, which is in the ballpark of what an expensive solicitor here might charge in conveyancing fees for handling a property purchase.

I’m not suggesting that this figure of €2,500 is reasonable or fair, or that a 0.375% dealing charge represents good value for money, and there are multiple assumptions I’ve made that could be challenged. I also agree strongly with

@Qwerty22 ’s excellent points that people shouldn’t have to pay for what they don’t need, that there are too many intermediaries in the Irish system that are extracting rents rather than adding value, and that the Pan-European Pension Product can’t come quickly enough. But I just wanted to work through a possible scenario quantitatively in order to anchor the discussion in some actual numbers. I’d be interested to know what you think of my analysis

@Marc...