Issues

OFT workplace pensions study focuses on lack of level playing field for DC scheme charges comparisons

23rd September 2013

This week’s big news in pensions disclosure was publication of the Office of Fair Trading’s Defined Contribution Workplace Pensions Market Study: The 175-page study http://www.oft.gov.uk/OFTwork/markets-work/pensions/#.UjxUfHxwZMs focused hard on an investigation of Annual Management Charges (AMCs) as stated by pension providers. As a charges comparison tool The OFT found AMCs wanting.

Although the media focus fell on speculation about a 1% cap on all charges being imposed, the real focus of the OFT’s ire seemed to be on pre-2001 (pre-stakeholder) legacy pensions because they generally seem to levy higher charges and include less of the overall ‘final’ charges bill within the AMC. They also levy:

Initial or contribution-based charges – these charges involve deductions form the contributions that is actually invested into their pension fund.

On-going fixed charges – levied on an on-going basis – often monthly for each member

Early surrender or discontinuance penalties – normally a one-off penalty if members stop regular contributions or prematurely withdraw funds. If they change jobs and want to transfer savings to another provider they will again charge a transfer fee

Other one-off charges for certain events like switching funds or even changing the level of contributions. Providers justify these charges by explaining that the legacy schemes often offer specific benefits which make them better value for money for many. These include:

Guaranteed annuity options or rates

Guaranteed rates of return or fund value at selected dates

Bundled insurance benefits such as incapacity insurance so that in certain circumstances (illness or incapacity) the scheme provider will pay the contributions when the member in incapacitated

Loyalty bonuses – when the member has reached a milestone of years or amount of funds held.

The OFT’s point of view is that it is difficult to quantify some of these benefits, which also exist in many post-2001 schemes, and therefore benchmarking becomes difficult.

The OFT also levels its fire at specific types of charging systems in occupational schemes. It hates the so-called ‘AMD’ which is the removal of a discount which active members get (when they are employed with the company contributing to the pension) as they become ‘deferred members’. They estimate that deferred members (most of us have been one as we flit from job to job early in our careers) are on average paying 0.47% higher charges per year as a result.

They also hate the fact that AMCs generally fail to include investment management transaction costs (bid/offer spread costs etc.). About a third of the providers they investigated add charges on top of AMC still today, a practice that reduced considerably post-2001 but has clearly not disappeared. Eight out of 13 providers charge a separate TER (Total Expense Ratio) based on total investment management charges incurred by the fund during the previous year. The IMA has a separate initiative on-going to demand that its members disclose policies and procedures for monitoring transactions costs and assessing their impact on overall performance. However despite all this flagrant over-charging and multi-charging that seems to be going on, one interestingly underwhelming finding we spotted from the study was that the difference in charges impact (pre versus post-2001 schemes) were not exactly ‘gob-smacking’. A pre-2001 scheme had a median average AMC of 0.82% whereas a post-2001 schemes has 0.63%. AMC gripes aside, the OFT’s chief demand is for a better level playing field for scheme charges from which tables can be drawn up so that employers running pension schemes can judge whether their existing scheme provider is delivering value for money.

This has become all the more important with Auto Enrolment. AE is set to deliver 9 million new members into workplace DC schemes over the next five years and the risk is that most schemes still employing poor charges practice are open to offer AE schemes. They worry particularly about SME businesses not being able to scrutinise the small number of product providers offering stripped-down default investment strategies in their quest to live in the 0.5% AMC world demanded by NEST.

Investment management quality (difficult to assess at the best of times) will be driven out of the market and with the absence of a decent financial adviser or clear charges comparison tables - employers will find it difficult to know what to select for the best. The OFT’s argument is that neither the employers not the (largely disinterested) employees will place sufficient pressure on providers to select best value default funds and deliver quality service and support. The market will not be efficient because competition will not operate properly.

The OFT has added yet more pressure on providers to deliver total transparency on all charges in a way in which scheme members, trustees and employers can judge whether they are getting value for money from their workplace scheme.

This mirrors what is already going on as a result of RDR across the DC world as a whole. We all want more transparency but we also need to be make sure in our quest for value for money we don’t squeeze all quality and differentiation out of the market. A value for money world can easily become a poor performing, lowest common dominator one where no one wants to operate and returns naturally slide. Value for money needs to be in the eye of the beholder – different segments of the market surely want different quality and are prepared to pay higher charges for perceived value. That is how a healthy market should operate surely?

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