Filling a Giant Hole in Israel's Banking Reform
Pension counseling has never taken off, leaving ordinary savers to fend for themselves.
Here is the conventional wisdom: The much-maligned Bachar committee banking reforms of 2005 forced the banks to divest their mutual and provident fund operations, but ended up putting those operations mostly in the hands of insurance companies. This means the reforms are to blame for almost all the ailments of the capital and pension markets, especially the high concentration of pension savings in insurance companies.
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According to this approach, the Bachar reforms were damaging and exacerbated the lack of competition in the markets.
The problem with this argument is that it suffers from all the typical Israeli diseases: It is superficial, shallow, uninformed and, most of all, suffers from long-term memory loss.
Even the critics acknowledge that the Bachar reforms reduced the banks’ power and hedged their financial risk by distancing them from the capital market, increased competition in the credit markets, and ended the conflicts of interest that made the banks financial advisers as well as the managers of the financial instruments about which they were giving advice.
But critics of the Bachar reforms typically take all these achievements for granted.
This shallow approach prevents us from focusing on the few missed opportunities left in the reforms’ wake, and on what can be done to attempt to correct them.
One of the less discussed missed opportunities concerns pension counseling. It seems as if the committee had done everything needed to lay the foundation for an extensive pension advice industry in Israel by eliminating the conflict of interest with the banks.
This incredible conflict of interest that pervaded before the reforms took effect, in which bank customers would regularly invest most of their savings in mutual funds managed by the same bank, has been fixed.
Now the banks only give financial advice about financial instruments in which they have no interest. The Bachar recommendations have successfully resolved the conflict over bank advice on securities and mutual funds.
Hopes dashed
The problem is that this is not what happened with pension advice. The great hope that separating the provident funds from the banks would allow the banks to serve as the public’s pension advisers have been dashed. Pension counseling never took off. The little advice the banks provide is given mostly to the clients who have the most money to put in.
In a country in which pension decisions are completely up to the savers and the only explanations they receive are provided by insurance agents – biased salespeople, since they receive their salaries from the insurance companies – the lack of pension counseling is a major economic and social failure.
Why did the banks fail to offer pension advice?
One reason is the serious operational difficulties, in lieu of any technological interfaces between the banks and companies that manage the pension and provident funds. Another reason has to do with the difficulty banks face in marketing such services; most people make their pension decisions through their employers or the insurance agents who work with their employers, but the Bachar reforms banned banks from making one service conditional on another – for example, by offering loans to business owners who send in all their employees for pension advice.
The third explanation is the lack of profitability. Pension counseling is a complex and prolonged process, but the banks are entitled to charge what they regard as too low a fee for the work. The payment is usually in the form of a portion of the management fees paid to the pension or provident funds – generally 0.25% of the total savings.
Ten years have passed since the changes were instituted, and now the commissioner of the Finance Ministry’s capital markets, insurance and savings division is trying to revive pension counseling.
The pension information clearing house, which aims to solve the problems of the interface between the banks and pension funds, was completed this year, though it is too early to judge whether it will fulfil its goal.
Last week, the insurance commissioner announced changes in the pension advice fees banks may charge, which should make it more worthwhile for the banks to get involved in the business.
For now, the commissioner has avoided the historic decision of a decade ago not to allow the banks access to employees through their employers. But there is reason to believe that if pension counseling fails to take off, the commissioner will have to reconsider her position on this issue too.
In any case, the payment model for pension advice has been changed. Instead of fees of 0.25% of the total funds saved, the banks will now receive 0.2% plus 1.6% of the annual savings deposited – almost a third of the total management fees for pension funds, adding up to tens of thousands of shekels over the lifetime of the fund.
Right direction
This change in the fee model is a move in the right direction, but there is reason to doubt it will be enough to create a dramatic change. The operational and marketing problems have still not been solved, and it is not clear whether the new fee model will satisfy either the banks or the savers.
Given that it’s taken 10 years to change the compensation model for pension counseling, the change should have been more far-reaching. But it’s not so simple to cut the links between the banks and the pension funds, so the bank fee does not come out of the pension funds’ management fees. The banks could charge savers – say, 1,500 shekels (about $430) – for advice once every five years, paid by the saver directly, or out of his or her pension savings, in addition to the regular management fees.
So far, however, the Israeli public has never shown much enthusiasm for pension counseling, even the seemingly free service given by the banks. That is why the proposal for the banks to charge clients directly is doomed to fail, unless the banks convince the public that it is worth it because their management fees will go down.
In such a scenario, the banks would compete among themselves to see which will offer the largest discounts in management fees. For the price of a few thousand shekels, the public could enjoy a large discount in management fees, which would save it tens of thousands of shekels over the years.
Such a step, if it succeeds, could finally give pension counseling the push it needs to take off in Israel – and, along the way, reduce inequality in pension savings.
In other words, everyone could receive discounts in management fees, not just the strongest unions or most well-compensated employees.
