"The implications are clear: firms need to act quickly to review at-risk portfolios and governance processes - the jaws of the FCA are ready to take their first bite."
PA financial services Expert
On Wednesday 30th October, pensions minister Steve Webb announced a wide-ranging review of charges for auto-enrolment pensions. This action has been given impetus by the report from the Office of Fair Trading (OFT) on charges for workplace pensions. There has also been significant pressure from the Opposition who have been tabling amendments to the Pensions Bill 2013-14 and highlighting issues regarding transparency and competition in the pensions market.
On Thursday 31st October, the Department for Work and Pensions (DWP) launched its one-month consultation. This seeks views on a range of measures, including absolute caps on charges for qualifying schemes, improved disclosure for members and retrospective action on legacy schemes with active member discounts and higher charges for deferred members.
The focus on charges and disclosure is inevitable. We have been here before with the Sandler review, charge caps for stakeholder pensions and the Retail Distribution Review (RDR), all of which focused on making charges clearer to consumers. There is nothing wrong with this, and the challenge that consumers are at an information disadvantage in the pensions market is a valid one.
Providing schemes at low cost should be possible. Providers can mitigate the impact of charge caps by increasing the number of members that join the scheme, the contribution rate that they pay and the value that they see from their contributions so they are more likely to raise them in future. The challenge in the market is that many scheme providers are not in a position to provide the low-cost, engaging customer experience that will make this happen. This needs to change.
How can pension scheme providers meet the challenge of operating in a low-cost environment while ensuring that their propositions deliver long-term value to scheme members?
First of all, pension scheme providers need to correct the sins of the past. The recent OFT study highlighted that schemes set up before 2001 have charges that are 26% higher on average than schemes established during 2012 under the new auto-enrolment regime. In addition, it estimated that approximately 10,000 schemes have active member discounts in place which can significantly disadvantage members who move employer. These schemes have charges that are, on average, 0.5% higher for deferred members. This is a substantial cost on large pension pots. Many providers who offer new schemes with competitive charges still have schemes with higher charges for deferred members in their portfolio. They should come clean now and take action to introduce charges designed to benefit all members rather than using higher charges for deferred members to subsidise consultancy charging (the cost of advice to employers). The current consultation forces this issue with various proposals to cap charges at 0.75% together with a ‘comply or explain’ option included for those employers who feel they can justify a higher charge to The Pensions Regulator. It also proposes a ban on active member discounts, which could extend to charges when moving paid-up members into individual personal pensions. This would deal effectively with legacy issues and level the playing field for all pension contributors.
Secondly, many providers, and particularly those with large legacy-scheme portfolios, need to change their whole commercial outlook on the economics of pension scheme provision. The capability of new entrants to the auto-enrolment market is clear evidence that there is change ahead. These providers use digitally enabled propositions to deliver value for money and engage members through lower costs and better communication. Constantly tweaking existing propositions will no longer deliver what consumers require, nor will it provide a sustainable long-term business model for providers. Providers must reduce costs, and technology needs to work harder and smarter. Developing platforms capable of delivering a transparent and engaging customer experience across multiple product wrappers and investments, not just pensions, will be critical. The average charge for defined contribution pension schemes set up in 2012 was 0.51%. While there are some outliers, many providers are already meeting the apparent cost challenge.
Thirdly, providers must wean themselves off the commission model. Consultancy charging, the last vestige of commission payments on pensions allowed post RDR, was a controversial concession to allow employers to continue to pay advisers from contributions to the pension scheme and thus avoid paying a fee. But if employers do not value the services provided by the adviser enough to pay a fee for them, this model only benefits the employer and the adviser, not the member. The OFT agrees. It has raised considerable concerns regarding the negative impact of consultancy charging on overall charges and proposes extending the charge cap to cover these qualifying schemes too.
Finally, pension firms will need to make more realistic future estimates on profitability. The introduction of stakeholder charging was marred by a land grab on the part of providers displaying irrational charging behaviour to acquire volume. Breakeven points of 10+ years were not uncommon (15 years in some cases!).
Current pricing models will need to make realistic estimates for attrition and future costs. If they don’t, capital requirements will rise rapidly under a new charge cap. Hopefully, firms already pricing at below the potential cap of 0.75% have already taken a realistic stance. If they haven’t, there will be considerable concern from insurers at the prospect of having to set aside yet more capital because of unrealistic future assumptions.
The DWP consultation ends on 28 November. In the meantime, while firms are preparing their lobbying positions, our advice is that they also conduct a future-proofing review of their proposition based upon a compelling customer experience and supported by a sustainable commercial model.
Firms that do not do this will rapidly become irrelevant to their customers at a speed that will give them little opportunity to recover. Those that do can expect to reap the benefits in a better-informed market.