RegulationAug 21 2014

Cap to cause pension providers to pull out: Deloitte

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Deloitte warns that providers may withdraw from the workplace pension market if the cost of provision is greater than the defined contribution charge cap and additional charges cannot be levied outside it.

The warning from Deloitte comes as several insurance companies reveal how much they have put aside to cover expected losses in long term income.

In March, the Department of Work and Pensions revealed that workplace pensions will be subject to a management charging cap of 0.75 per cent from April 2015.

Yesterday (20 August), Royal London revealed the cap will cost it £61m on an ‘assumption change’ exceptional item and has negatively impacted its results ending the first six months of this year down 45 per cent at £139m.

Phil Loney, group chief executive at Royal London, also warned that while the pensions minister Steve Webb told Parliament that pensions companies’ total revenue would be reduced by £200m over a 10-year period, Royal London estimates it to be £1bn.

He said: “This seems to me to be an unacceptable margin for error in the government’s understanding of the impact of its actions and the size of the impact is driving many insurers to introduce employer fee arrangements to mitigate against the impact of further reductions in the price cap.”

However, a spokesperson for the DWP told FTAdviser: “We’re taking action to ensure workers have access to good quality pension schemes, protected from high and unfair charges.

“According to the government’s green-rated impact assessment, the default fund charge cap will transfer around £200m from the pensions industry to savers over the next 10 years.

“Of course, the impact on individual providers will vary, depending on their own current charge levels.”

Andrew Power, partner at Deloitte, explained that the difference between the DWP figure and what providers have suggested is that the latter is on an accounting basis which takes into account the legacy book and the former is on a forward-looking basis which does not take account of the legacy book.

“The impact in terms of the large and medium sized companies will not be that significant, as the majority of pension schemes are now below the charge cap, and the costs are only really above it for those companies with 10 employees or less.

“For those small companies it could be that providers don’t offer anything in that market because they can’t make it economically viable.

“There are some other charges not part of the charge cap that will be levied in order to make a profit, I’m sure the DWP will be very alert to that and it will end up being more difficult for the providers to do it that way.”

Mr Power added: “Definitely if the cost of provision is greater than the charge cap and additional charges cannot be levied outside it, then providers will withdraw from the market.”

Malcolm Kerr, senior adviser to Ernst and Young, told FTAdviser that the £200m seemed a bit low, although the £1bn number is also off the mark.

“I’ve got some misgivings about the fact that the government can step in an insist that contracts have been agreed between employers and product providers have to be changed.

“I understand the Treasury’s approach, the fees were high, but it’s a bit of a worry that the contracts can just be ripped up, I’m not sure that establishes the right precedent.”

Debbie Falvey, senior DC consultant at Aon Hewitt, told FTAdviser that the firm warned of unintended consequences during its response to the consultation and there is now evidence of some providers taking the opportunity to pass costs on to members, employers and advisers.

She outlined some examples, such as Standard Life looking to equalise annual management charges between current charges and active member discounts, meaning costs will go up for active members.

“If a scheme is repriced from 1 January 2015 and is currently charged at 25 basis points for active members and 50bps for inactive members, the standard mono charge across the scheme would be 37bps.

“Therefore active members will see an increase in charges, even though the scheme had an [active member discount] well below the charge cap. Any leavers before the January 2015 reprice would remain on 50bps and would not be affected by the change.”

Some providers are repricing down to the active member rate, but will reserve the right to charge employers a fee for services that are received as part of the package before the changes, citing Aviva’s approach as an example. Others, like Scottish Widows, will drop to the active price, plus a fixed fee, Ms Falvey said.

Tom McPhail, head of pensions research at Hargreaves Lansdown, pointed out that the original charge cap consultation was deemed not fit for purpose by the Regulatory Policy Committee, yet was passed into law anyway.

He stated that the possible consequences of this could be that pension schemes simply reduce the quality of member services.

Mr McPhail said: “It is a great shame that the DWP lacks the necessary evidence to prove that its decision in this matter was well founded.”

In May, Aegon UK warned the charge cap posed a real threat, estimating an impact on underlying earnings of £20m to £25m a year, equating to more than half of the profits for this year at its current run rate.

Scottish Widows’ parent company Lloyds Banking Group disclosed a £100m one-off charge in its first quarter interim management statement.