Saving for retirement - can startups solve the pain points?
Fees are the first thing you should look at before choosing a pension manager and fund. Buy cheap and you have a significantly better chance of making money than if you buy expensive. The growth of roboadvisors and their success in attracting client assets shows that retail investors are recognising this. However, while roboadvisors have kept absolute fees very low, there are other areas in which they have not innovated.
The first is the industry’s antiquated fee structure, which is not properly aligned with customer interests. The worst fee structure for investors is one that pays the manager either a flat percentage of the assets under management, or a flat percentage plus a performance fee. It’s a classic “Heads We Win, Tails You Lose” design.
The optimal approach, according to a recent study by Cass Business School in the UK, is a symmetric fee, in which both fund manager and investor share in the upside and downside of the investment manager’s performance. Funds that charge symmetric fees, rare in Europe but more common in places like the US, deliver better results to investors.
Pricing innovation alone is not a compelling enough proposition, but it is about time that a next-generation pension product launched with this type of fee structure.
The current crop of roboadvisors has so far failed to help individuals who are shouldering more risk than ever of providing for retirement. Governments across Europe are encouraging individuals to save to fund their own retirement, rather than relying on the state. Meanwhile, companies have stopped guaranteeing retirement income through defined benefit plans. Yet individuals rarely have the financial know-how or even basic maths skills to make good decisions, as the Bank of England’s Chief Economist pointed out recently. For example, with long-term government bonds yielding 2%, one needs to save three times as much for the same retirement income as when rates are 5%.
This is an ideal opportunity for intuitive software and expert algorithms, particularly since the majority of financial advisers are not equipped with the right tools or training, and consumers are generally unwilling to pay the fees.
As a result of these missed opportunities, the first generation of automated investment and roboadvisor services are underwhelming from an investor’s perspective. Building the technology is relatively easy but creating a compelling user interaction layer is hard, particularly since consumers lack education and excitement for financial products.
Additionally, customer acquisition cost (CAC) is expensive, which can result in payback periods of 2–3 years. With annual contributions of €10,000, fees of 15–75bps per year, and CACs of €200–400, venture capital returns are difficult to achieve. CAC might come down as consumer awareness grows and the market develops but there may also be more competition from incumbents; Schwab and Vanguard have already entered the U.S. fray.
Retirement and pension products are more interesting businesses because the tax advantages relative to other forms of saving mean that take-up rates are higher. Also, due to the higher complexity, we expect switching costs will be high, leading to higher lifetime value (LTV) for each customer. Solving the distribution and CAC challenge remains paramount, but both enterprise and SME-focused products could offer solutions, as might other innovations such as pension consolidation.
The vast majority of the trillions of euros of assets in private European pension accounts are administered today through corporations rather than personal pension accounts, and most are in defined benefit plans. However, trends such as more incentives for private pension saving, the growth of SMEs and the expanding “gig economy” will create a bigger market for startups that can help people plan and save effectively for retirement.
And even with the large corporate pension schemes, the fees charged are far in excess of today’s low-cost, index-tracking options, creating an opening for an affordable, transparent service that includes great, interactive, retirement planning tools. As an employee at one of the FTSE 100 or Euro Stoxx 50 companies, your pension plan is administered by one of the large European insurers such as Allianz or Aviva, whose more modest management fees are usually eclipsed by hidden trading and FX costs.
If you can navigate through their online portal (forget using your phone), then you deserve a medal. European corporates are starting to re-evaluate their provision. There are multiple stakeholders to navigate, from the CFO and HR to pension trustees and IT, but any startup that signs up a BP, Siemens or Unilever, with their thousands of employee accounts, gets a big win.
The SME sector also offers a low cost customer acquisition opportunity. In Germany, for example, pension provision at Mittelstand companies is relatively unsophisticated and companies inherit all of their employees’ former pension plans, creating a tremendous administrative headache. Startups like Vaamo and Fairr are operating in this space.
In the UK, government regulation is forcing every small business to provide an employee pension. Most large pension managers have high costs that do not work for this market, creating an opening for startups like HiBob and Smart Pension in the UK and ForUsAll in the U.S.. A simplified, low cost pension offering could provide tremendous benefits and cost savings to small business owners and their employees. The same is true across the rest of Europe.
Pension Bee, a UK startup, has an interesting take on the pension space. It aggregates existing pension accounts from prior employers — it’s a smart model because you can start with a sizeable AUM figure per customer rather than building it over time with contributions. The CAC may be high, but payback drops below a year when you start with an account of €50,000.
Retirement saving tax benefits make pensions one of the most attractive ways to save for the future and there are tremendous opportunities for startups to disrupt the old dinosaurs serving savers today. Savers face a major pain point in figuring out how to maximise the tax benefits and invest wisely for their retirement needs. Fees should be low and structurally aligned with customers. Private savings accounts and pensions provided through large corporates and SME’s are all desperate for better, mobile-centric products. With negative interest rates and uncertain economic growth, the savers of the world need some help.
Given ageing demographics and the increasing risks of relying on the state or a company defined benefit scheme to look after us in our old age, building private pensions is an important problem to be addressed. We’d love to find a challenger to back in this space.