Personal PensionOct 16 2013

Lessons of yesteryear

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In the mid-1980s and early 1990s I worked for a couple of leading employee benefit consultants.

At the time we were administering the last of the big defined benefit schemes and engineering the switch to defined contribution for both big companies and for smaller employers.

King

At the time, the DC market was rapidly developing – previously DB had been king, whereas money purchase, (then rebranded as DC) was very much the poor cousin. The aim seemed to be to replicate the good bits of the legal and governance frameworks of DB schemes with the focus moved to investment choice and member communication.

At the same time, the personal pension regime was developing and, in a parallel universe, the investment choice and communication were even more to the fore as individuals had the investment choice (and as is the case with DC – the investment risk).

So roll on a few years, with the stakeholder experience now behind us and with the auto-enrolment focus now switched on – we now like to call them all workplace pensions.

The OFT has produced a study to look at the DC pension market and whether competition alone could produce value for money and the required “good outcomes” for scheme members. The broad conclusions of the OFT fall into two categories:

- The complexity of pensions in general and how difficult it is to make the right choices.

- The failures of employers, where it appears they have lacked the knowledge or inclination to know what is best for their employees, to provide a scheme that gives value for money and those ever-elusive “good outcomes”.

At this stage the report acknowledges that as the auto-enrolment procedure continues and we reach the staging dates for smaller and even “micro” employers that this situation could get worse. In many cases we will be getting into unknown territory with companies facing pensions for the very first time. Indeed this is surely a nightmare scenario – if the employers who have had some inclination to be involved have failed then what chance do those employers with no inclination or even an active disinclination for pensions have?

The two main findings by the OFT concern some of the issues regarding old, seemingly by analogy, higher-charging schemes.

- The findings suggest that there is around £30bn of savings in old or high-charging contracts, of which many bundled trust schemes may not be value for money.

The report suggests that the AMC on pre-2001 schemes can be up to 26 per cent higher on average than schemes set up post-2001, and, in addition, schemes sold before 2001 are more likely to have other charges in addition.

- The findings also suggest there is an issue with small trust-based schemes where there are around £10bn of savings at risk of delivering poor value for money, due to low levels of trustee engagement and capability.

So, this is the past – but what of the future?

The OFT has concerns that the past could be repeated if there is no intervention with better governance and scrutiny of pension schemes on behalf of savers together with relevant information disclosure to the parties involved.

Route

It is revealed in the report that the OFT has agreed with the industry and The Pensions Regulator, that the following route map will be undertaken to seek to address the issues they have raised:

- Old or high-charging schemes: the concern on old and high-charging contracts and bundled-trust schemes will be picked up by the Association of British Insurers with an immediate audit to look at value-for-money issues.

- Small trust-based schemes: TPR has agreed to consider which smaller trust-based schemes are not delivering value for money and the department for work and pensions will consider the powers of TPR to make sure it can act accordingly.

- Governance issues: the ABI has agreed that its members will establish independent governance committees to recommend changes to providers and escalate issues to regulators where they see risks of poor outcomes for savers. The OFT recommends that the key elements of this governance solution should be embedded by the government in a minimum governance standard that will apply to all pension schemes.

- Information disclosure: the OFT recommends the DWP consult on improving transparency making it possible to compare schemes and therefore possibly assisting employers in the choice of schemes available to offer to their employees.

- The future: finally, the OFT recommends that the DWP consult on preventing schemes being used for auto-enrolment that contain built-in adviser commissions or that penalise members with higher charges when they stop contributing into their pensions.

In summary, some fairly strong findings and a lot of work to be done.

It is always easy to view such issues in a bit of a vacuum, so I do think it is important to add a bit of context.

The report itself sees 1981 as a bit of a watershed – the introduction of stakeholder pensions and the original introduction of a charge cap of 1 per cent (increasing to 1.5 per cent).

I remember that at the time the whole pricing of small schemes changed (rather than a prescribed set of product charges) the data would often have to go to the actuaries to calculate an AMC. At the time, we had significant discussions about the investment funds that could be included in the package due to the charging cap and the issue of price versus value was prominent.

In hindsight, it is very easy to look back to say that what went on pre-1981 was expensive and poor practice. I think it is generally accepted that stakeholder has been instrumental in bringing pension charges down.

When chosen, I can only speculate that such schemes assumed that the scheme sponsor, the employer and the scheme members would be interested enough in the details of the scheme to never let it become uncompetitive and high-charging. So what we see as we look back is quite possibly a failure of engagement.

For the member, this is an important failing as ultimately the proceeds from the scheme are what will provide an income in retirement, and even more if part of it is made up of personal contributions.

For an employer, this is a more difficult point to address as employers are very keen to get on with what they do, particularly small employers, and for many the administration and cost of a pension scheme will be seen as an immediate cost in time and money that they do not wish to incur.

Larger employers with good human resources departments and even pension departments are perhaps used to promoting a scheme and engaging the membership (early low opt-out rates perhaps reflect this) where a smaller scheme may well tell a different story.

Anything that can be done to assist employers I am sure will be welcome, and guidance as to what makes a good scheme and causes the “good outcomes” for scheme members will be very useful. In the end, however, the more an employer identifies with the scheme and the members understand and value the scheme, then the real pressure for good governance and competitive charging will come from within.

Mike Morrison is head of platform marketing of AJ Bell

Key points

- The OFT has produced a study of the DC pension market and whether competition alone could produce value for money.

- As the auto-enrolment procedure continues, the situation could get worse.

- Anything that can be done to assist employers and guidance as to what makes a good scheme and causes the “good outcomes” for scheme members will be very useful.