We are now in the third week of January and the first great spike in enrolments this summer is but three months away (see chart above). We are reaching a critical juncture- the first capacity crunch, and we are reaching it with no certainty about what can be considered a (good) qualifying workplace pension scheme (QWPS).
It is critical that we get a set of rules from Government which employers, advisers and those governing the workplace pensions we use, all work to.
In this article I discuss the rules I would like to see, which we called for in our consultation response in early November and which we hope will be part of primary or secondary legislation, or at the very least the basis of a comply or explain code of best practice.
We must be clear, the purpose of auto-enrolment is not to occupy payroll and middleware consultants or deliver profits to providers, the purpose is to improve the retirements of working people in the UK. Specifically, this consultation is about making the rules clear about what makes for a good pension and ensuring that is what people get.
Currently , all that is required is that the scheme is able to receive contributions paid compliant to the Auto-Enrolment regulations and that the various disclosures are made to members in a timely way. There has to be a default investment option but otherwise, the rest is left to the market.
And as the OFT pointed out, this is a badly functioning market where the purchasing decisions taken by employers relating to the investment of member funds is taken by employers with little guidance as to “what makes for a good pension”.
The purpose of the charges consultation, as laid out in its “”, was to reach consensus as to what protections should be in place , to ensure that members and indeed employers , were able to determine good from bad and ensure that what people got, by way of the investment of their money was good.
The debate on charges seems to have lost this focus. All I hear from providers is concern that Government intervention will throw them off course from delivering on the auto-enrolment promise. What I hear from employers is that if they cannot charge members through commissions and higher fees, they will not be able to afford to enrol (and pursue their growth plans) and I’m not hearing much from members or consumer groups lobbying on behalf of better value for their pension contributions.
The lack of engagement of this issue may stem from a failure to understand the impact of compound interest over time. I will not labour the point here, but will point to the excellent work done by the Pension Institute to show in words and charts just how corrosive high charges to member pots and how important it is that people aggregate their savings in pensions that offer value for money.
Apologists for the status quo, including John Lawson of Aviva (who I respect very much) argue that the debate on charges is overcooked and we should move on to something more interesting. I hear the same from Hargreaves Lansdowne (and the excellent Tom McPhail).
The status quo has served the insurance and funds industry well – and still does- but auto-enrolment is not business as usual, and we cannot duck the tough questions that the OFT posed and the charges consultation seeks to answer. We simply need better workplace pensions and that means looking at costs at investment costs and provider charges.
As David Blake and Debbie Harrison demonstrate, statistical evidence demonstrates that the majority of successful investment charges are low cost and that while high cost strategies can deliver tremendous returns, they are more likely to produce lower net returns (because of the yield drag).
Put simply, the use of high cost funds is risky and if we are trying to provide a low-risk solution as the default, it is hard to justify higher charges.
Hard but not impossible. The Pension PlayPen metrics currently rates the higher cost Standard Life default with the same mark as the lower cost L&G default. This recognises that the active component of the Standard Life fund is likely to deliver added returns that compensate for the extra risk taken.
Nowhere in the current debate, do I see arguments of this kind. The debate is being hi-jacked by the Government’s growth agenda, or the sustainability of insurers as workplace pension providers or the political implications of a capacity crunch and the breakdown of confidence in the Auto-enrolment staging process.
While all of these things are important, they are not as important as getting the investment of member funds right.
I am firmly in the Pension Institute camp on this, while we cannot control the markets, we can control the costs of investing in them. What we cannot allow to happen is to cap the costs of investment in a way that restricts investment managers from carrying out their job. But an analysis of how most funds are managed , suggests that there are substantial amounts of a funds value “left on the table” due to inefficient execution that are given away to third parties with no skin in the game. Dr Chris Spier has written eloquently on this on this blog.
The impact of investment costs – the hidden charges – is analysed by large pension funds (I know as I market the services of a company that does this work). The analysis requires minute analysis of costs and rigorous benchmarking so that negotiations on restitution and reparations for bad execution can be concluded.
But as the Swiss colleagues with whom I work are the first to point out. An obsession with reducing costs to zero can and is self-defeating. The obsession must be in reducing waste to zero.
Unfortunately, this debate about investment efficiency has itself been hi-jacked by a secondary agenda, the obsession we have with communicating this minutiae to ordinary people. As I write, I am looking at a discussion paper, produced by my Swiss colleagues that runs to three pages and takes the form of “Pension Fund cost report for members”, it’s a great document. But it is of little use to members. It is a great report for trustees and for an independent governance committee as it allows them to see at a glance how the costs of investment are divided up and how their direction of travel (up or down).
Here is the frightening thing. The problem with this report is not in its production. This information is available and with only a handful of workplace pensions actively marketing themselves it is feasible for it to be commissioned by all QWPS.
The frightening thing is that I reckon only a tiny fraction of DC trustees or those lined up for IGCs would be able to understand the simple methodology employed and be able to determine whether their fund was getting value for the costs incurred.
As the OFT has said, we need a better buy side, a properly educated buy-side and buyers who have good information with which to take decisions. Currently they do not have that information.
Employers struggle to understand the price they are buying services at (the TER is not a complete or adequate measure) and even trustees and those that govern GPPs are woefully under-educated in these matters.
Instead of obsessing with disclosing this complex information to members, we need to concentrate on educating fiduciaries in how to use it to make things better for members. If fiduciaries can stand up and promise members their interests are being looked after, and if trust is created, then we have a working model
But before we do that, we need to be absolutely clear what the rules are. The rules need to be consistently applied. What is good for master trusts must be good for GPPs.
I think we can all sign up to certain things.
High charges are hard to explain but no impossible (which suggests a comply and explain regime for total costs of more than 0.75% of the fund.
Members should not be picking up the costs of auto-enrolment (which should be kept to a minimum but billed to the employer)
Members should not pay for advice unless they opt-in to that payment, advice should not be charged for through the AMC
The only justification for AMDs is when the non-discounted charge is still acceptable
The implementation of any regime needs to be managed sensitively so that it doesn’t do more harm than good.
I hope that employers contemplating auto-enrolment will be able to make decisions about the workplace pension that they use with the clarity of these rules and whether these rules come into force today or in a years time- or even if they are simply enshrined in a code of good practice, the focus of regulations and of governance is on improving the pension of those relying on these workplace pensions