Perhaps surprisingly, at least to some, the government decided not to reduce the level of the charge cap, or to increase the scope of the cap to include more types of costs, such as transaction fees.
Whether or not the cap should change has become an increasingly polarised debate. On one side of the argument there is concern about the impact of the disclosed charges on the value of members’ pensions, and the potentially larger impact of undisclosed charges. On the other side there is concern that a more restrictive cap could affect the range of investments open to be used, again leading to worse outcomes for members. So who is right?
Background
Before considering that thorny question, it is worth reminding ourselves of what the charge cap is for and what it covers, as well as examining the marketplace into which it has been introduced.
The charge cap, equivalent to an annual management charge of 0.75 per cent a year, was introduced in April 2015. The cap applies to all scheme and investment administration fees, excluding transaction costs and a small number of other specified costs and charges.
The rationale behind the charge cap is to ensure that members’ funds are not eroded by excessive charges, as part of series of measures designed to increase minimum standards and improve the governance of the default funds used within automatic-enrolment pension schemes. The level of charge can have a significant impact on final outcomes for members.
All things being equal, a 0.1 per cent reduction in charges could increase the value of the final pension for a typical median-earning woman (including some career breaks) by around 2.5 per cent.
Key points
- Last month, the government decided not to reduce the level of the charge cap on default DC funds.
- The charge cap is to ensure that members' funds are not eroded by excessive charges.
- The charge cap only covers some, not all, costs.
It is also worth remembering that the charge cap applies only to the default investment funds offered within auto-enrolment. So there are plenty of other investment funds offered to members of schemes in which they have been automatically enrolled that can have charges higher than the cap.
However, in reality the vast majority of people who have been automatically enrolled are in the default fund. In master trusts, more than 99 per cent of automatically enrolled members remain in the default fund, as do 94 per cent of group personal DC arrangements. Therefore, most individuals’ investments are covered by the charge cap.
It is also the case that in master trusts, in particular, the charge levels faced by members are already significantly lower than the 0.75 per cent cap. The Pensions and Lifetime Savings Association reports the average charge of the DC schemes in its membership as 0.4 per cent.
The announcement does suggest that small schemes might be more at risk of facing higher charges, and references the recent proposals to make consolidation of small schemes easier. But in reality, the vast majority of those automatically enrolled are already facing charges below the cap. So do we need it?
Some might even argue that a cap has the potential to become a floor, with charges clustering around the cap as the acceptable level of charges.
One obvious response is that, in master trusts at least, it has not become a floor. But that is not to say the cap has not had an impact. Some schemes do have charges at the level of the cap, and without the cap it is possible that some below it might have charged more without the relative benchmark that the cap provides.
The cap also means some investment strategies might be less likely to be used in default funds, in particular strategies that traditionally have higher associated cost, such as diversified and actively managed funds. Does this matter?
Well it depends as to whether the aim of the charge cap is to reduce costs or improve retirement outcomes. Charges are only one of the factors that determine how much an individual might accumulate in their pension fund. The most important factor is how much money goes in. Another is the investment return on the fund.
Trade-off
As pointed out earlier, all things being equal, a lower-charging pension provides a better outcome than a higher-charging pension. But generally not all things are equal. For example, there is a potential trade-off between the costs of an investment strategy and what it is expected to deliver – not necessarily just in terms of the returns, but also in other variables that members might value, such as volatility.
Some assets that can be associated with better long-term performance – such as infrastructure – might also be associated with higher costs and charges. That is not to say that all higher-cost funds have better performances – far from it. But there are different combinations of cost and performance to match different member preferences.
There might also be additional costs involved with improving governance, which could increase the security of the pension, or with communication and engagement that might lead to higher contributions.
What is really important is the overall member outcome – something often described as value for money – and the charge faced is only one factor among a number than can affect outcomes.
Lack of transparency
None of this means there is no need to review the charge cap, or indeed to have one at all. The announcement is very clear that the focus of the review was to “protect members from unreasonable and unfair charges”. There is still a lack of transparency of costs that means it is difficult to tell whether or not the charges are fair and reasonable.
The charge cap only covers some, not all, costs. Some of these are specified in the current regulations as not being covered, but there are also undisclosed charges that can further reduce the value of outcomes for members, where the size and net impact of the costs is either not known or not reported.
But until there is more evidence – more transparency – it is hard to tell where the balance is between protecting members from unfair charges and allowing them to access different types of investments and schemes. Both the Department for Work and Pensions and the Financial Conduct Authority are developing legislation and rules to increase transparency.
This announcement is not an end to the matter – more a deferral to the next review in 2020 when hopefully there will be more transparency and better evidence on which to make an informed decision. For someone who believes in evidence-based policy making, that is probably the best possible outcome.
Chris Curry is director of the Pensions Policy Institute
