Historically pension costs were none of the savers’ business.
One of the things people find hardest to understand is what they’re paying for when they put money into a workplace pension.
Historically , the answer is a promise of an income paid according to a formula which lasts the rest of your life. That was the DB covenant and it holds good for those in public sector schemes and for a few people still accruing in private sector DB schemes. In these cases all the costs of paying the promise are taken care of by the scheme itself. The only worry consumers have about costs relate to the employer’s capacity to fund the balance of costs needed to meet the promise. For this reason costs and charges have not historically been a member issue.
I suspect that many savers thought that they got a free ride when paying into a defined contribution plan. Indeed some munificent employers have historically picked up the charges of employer sponsored DC plans, as an extension of the DB pledge. But for the most part, the members of workplace pensions have been expected to pay for their own costs, the employer being on the hook only for the contribution paid into the scheme. This has contributed to the acceptance of the provision of workplace pensions as BAU for UK employers.
In the early years of workplace pensions , there was no charge cap and practices such as active member discounts allowed advisers to take a chunk out of workplace pensions through what was briefly known as consultancy charging. This practice was knocked on the head by then pensions minister Steve Webb who levied a charge cap on default funds of 0.75% pa.
This 0.75% was originally thought to include all costs (what is now known as the total cost of ownership to the saver). But the Government stepped back from this allowing some of the management costs of a workplace pension to be disclosed and some to be hidden (and impact the performance of the fund in a clandestine way).
This ‘partial disclosure’ of the costs of workplace pensions was considered pragmatic at a time when there was no proper way of reporting on the hidden charging. But lately there have been advances in reporting that mean that these hidden costs and the disclosed costs could be reported on in one single charge.
But this has been resisted by pension providers , who see that it could easily become a single charge under the existing price cap, with the provider’s margin picking up the strain of the hidden charges where in aggregate costs exceeded the cap.
But there is another confusion amongst the public about what the annual charge they pay on their fund actually pays for. Understandably, because the AMC is charged against the investment fund, it is thought of as an investment charge – the cost of managing the money.
But it is not an investment charge, most of the money raised from a workplace pension AMC doesn’t go to the fund manager but stays with the pension provider, to meet the cost of supporting the member. Sometimes the amount paid to fund managers is negligible.
We know that fund managers can manage our money at no cost to the investor, so long as the investor gives the manager rights on the investment that make the manager money. For instance, investment managers can make money by lending stock out to third parties and there are all kinds of side-deals going on that mitigate fund management expenses.
The trouble is that the more ways that fund managers find to reduce the cost of their fund managers to workplace pension providers, the more the temptation is to transfer costs onto members through hidden charges.
Full disclosure of cost and charges is only just beginning
Last week, CACEIS published a startling number
It suggested that hidden costs are on the rise (though this may be just because CACEIS are getting better at reporting them).
The worry is that as workplace pension providers try to squeeze better deals out of fund managers, fund managers just bury more and more of their charge into the hidden charges which – falling outside the cap, means that members end up paying more while providers pay less.
This is why vigilance amongst trustees and IGCs is so important. They should be able to see the Investment Management Agreements between the pension providers and the fund managers and check what is going into the AMC and what is being buried in hidden charges and they should be able to make sure that providers are properly disclosing all the costs of managing funds, including the costs they trigger by moving money from fund to fund (life-styling).
Who watches the watchers?
Just how much access fiduciaries like IGCs and Trustees get to these investment agreements seems to vary, I suspect the amount of close attention to the detail of these agreements also varies. The agreements tend to be long and the bits which allow hidden costs to be passed on to savers – tend to be hidden.
And IGCs and Trustees tend not to want to antagonize providers by probing too deeply into the revenue sources of the fund managers and the providers themselves.
And because the general public are often not aware of what they are actually paying for, when they pay into a workplace pension, there is very little pressure on workplace pension providers not to let the hidden costs creep up.
If the IGCs and Trustees aren’t pushing back on hidden costs, who will?
We may know the answer to this question this summer when the FCA publishes its review of IGC performance. I would like it to cover this question of cost disclosure as the FCA is the organization that watches the watchers.
What further disclosure do we need?
In the past I have pushed for proper disclosure of what pension providers are paying for fund management. This information is detailed in the Investment Management Agreement but this is subject to non disclosure agreements that prevent savers working things out for themselves.
I’ve wanted this figure to be in the public domain so that savers can see that most of the money they pay by way of AMC and other overt charges, does not pay for fund management.
It would also have the benefit of showing just how much of the cost of investment management is hidden and how much is disclosed. If CACEIS are right and the hidden costs are just over a third of the total cost, then the situation is manageable.
But look at this extract from the Fidelity IGC’s 2020 report. It shows that transaction costs for those in the Fidelity default fund are running at 0.31% pa. That is as much again as the cost to members of being in the Diversified Markets Fund. Here the transaction costs are not 37% but 100% of the fund management cost.
I have urged the Fidelity IGC to push back on what appears to be an unacceptably high level of non-disclosed costs (the saver only gets to see this in the IGC report – which are seldom distributed to savers).
The advantage of full disclosure
Savers into workplace pensions are not good buyers, nor for the most part are employers buying workplace pensions on behalf of staff. That was the finding of the 2014 OFT report on workplace pensions and their findings remain true today.
IGCs and Trustees have the powers to escalate matters to the FCA where they see poor practice. They seldom declare they have done this in their reports and I suspect that most issues are sorted out without escalation.
But I am also sure that many trustees and IGCs are simply unaware of the problems highlighted in this blog, They may not be aware that fund managers can offer better deals (IMAs) to pension providers, without sacrificing margin, by adding extra costs to the hidden charges . They may not be aware that these hidden costs are not capped and can mean savers pay more than 0.75% for a default. Finally , they may not be aware that the choice of fund manager may be influenced by a complicity between fund manager and provider to pass costs on to members through hidden charges.
So the more disclosure IGCs and Trustees can get on IMAs the better. I have given up on being able to see these IMAs myself but I very much hope that the FCA are checking that the IGCs and GAAs they oversee, are making it their business to be very nosey indeed!