Our response to "Better workplace pensions- a public consultation on charging"
Pension PlayPen response to the DWP consultation
"Better Workplace Pensions; a public consultation on charging".
Pension PlayPen Ltd trades as www.pensionplaypen.com and is the leading portal through which employers access information to stage auto-enrolment. The site allows employers to assess their workforce, determine a contribution structure, apply to workplace pension providers for terms and choose the most suitable provider.
This response has been written by Henry Tapper, Founding Editor of Pension PlayPen. Pension PlayPen has a significant shareholder in First Actuarial, a company of which Henry is also a Director.
This response is on behalf of Pension Play Pen though it will make reference to First Actuarial whose ethos and principles underpin what Pension PlayPen does. It contains input from a number of partners, contractors and suppliers to both the Pension PlayPen and First Actuarial.
We are very impressed with this paper which is clear, concise and well-informed. We think it addresses the principal issues full-on and does not shy away from difficult questions such as how to treat transaction charges.
Our detailed responses to your 23 questions are set out below.
For further information please contact Henry Tapper at firstname.lastname@example.org
1. We would welcome views and evidence on the effectiveness of these initiatives and the extent to which the industry discloses charges upfront, in a consistent manner, to members and employers.
Disclosure has been targeted at the member (the worst buyer). In our experience trustees and employers with <250 employees are little better equipped than the members to analyse complex data. There is heavy reliance on advisers who have often been conflicted (they create costs within AMC). This is why disclosure has been dysfunctional.
The joint industry initiative on charges was ineffective because larger employers had no need of this assistance, while smaller employers have relied on what has often been conflicted advice from advisers rewarded from member charges.
The ABI initiative is yet to show its outputs but we understand it is finding it hard to disclose charges on its more complex fund structures. We warmly commend the ABI for its work and hope it will be rewarded with good outputs. So long as the fund structures analysed are relatively simple, we expect the ABI initiative to yield good results though not in time for April 2014 (your proposed timeline for the introduction of full disclosure).
Here for instance is the comment of John Lawson of Aviva on our PlayPen discussion board. This does not suggest that life companies are geared to reporting on anything but the simplest fund structures.
As for disclosing trading expenses we have no objection to doing that, but life companies will have to build new accounting systems to capture those. Unlike OEICs we don't account at individual fund level. When we execute a trade, that might relate to the money in several funds, and whilst we capture trading expense at the level of the life company, we have not traditionally split that down by fund. We will be reporting these transaction costs to the Independent Governance Committees overseeing contract-based schemes, so we will have to build those systems to capture these costs. I see no reason why we wouldn't put those costs on the fund fact sheets once we have them.
We are pleased the IMA is at last tackling the issues with its members but have concerns that it is being asked to provide its own SORP and have written to the Financial Reporting Council expressing our reservations concerning possible conflicts (
click here). As with the ABI initiative, the proof will be in the eating.
Disclosure of charges still focusses on the AMC but the AMC is a poor proxy for what the member pays; it is also inconsistent in what it contains. Some AMCs are TERs – we have yet to find an AMC that covers all charges earned.
2. Is further action required by the Government to improve disclosure and if so which of the options should be introduced? Are there any other options?
Further action is required. Consumers are uncomfortable with pensions and employers and trustees will privately admit they don’t know "good" from "bad". There is too little good advice about. The answer is, as the OFT suggest, to shift fund governance away from members, bypass most employees and trustees and place the responsibility on those who run the platforms on which the defaults and supplementary funds sit. We mean the insurers, the operators of mastertrusts and (where there is resource) the pension managers and trustees of large employers.
Our favoured option is a 0.75% charge (to include the total charges earned – see below). We favour a "comply and explain" option for schemes operating total member costs of 0.75-1%. We have conviction about this approach and, in view of timescales, cannot recommend any alternative.
3. How might the total cost of scheme membership including transaction costs be captured, what would be reasonable and practical to ask providers and investment managers to report on and to whom (members, employers and governance committees/ trustee boards)?
For investment managers, we propose a practical and philosophically sensible approach that we call "total charges earned"
The picture below gives a holistic view of the costs and charges that reduce the gross returns on an investment portfolio
Note: © novarca; not to scale
"Total charges earned" covers all costs for which the manager or third parties receives a direct payment. This in effect gives you the total cash earned along the way by the investment manager and the third parties servicing the investment portfolio.
Using the chart above, this means capturing management costs, brokerage, mark-ups, fees to underlying managers and custodians, and certain spreads (in particular, forex spreads). It excludes "other costs" (by which we mean potential un-reclaimed taxes, poor hedging and similar instances of poor execution), which are not deliberately captured by any service provider.
In terms of transaction costs, this means capturing all elements of transaction costs that are directly billable, such as brokerage, custodian handling costs and stamp duty, but not attempting to capture other costs inherent in transactions but which are not invoiced to the investment manager. Such costs include market impact and certain spreads. In our view, these also tend to be examples of "poor execution" - even if they can be meaningful costs, where they occur, they are mostly examples of weak processes rather than over-charging.
There is a practical reason for adopting this formulation
To measure these implicit or "unearned" costs properly takes time and costs money; to apply an average penalises the good practice that the DWP wants to encourage.
If we take "total charges earned" then we can be fast, accurate and transparent. If we start getting into discussions with fund managers about whether a trade was worthwhile or not, we will lose sight of the aim which is high quality at lower cost.
Now, this does not mean that these types of implicit costs should not be considered and that pressure should not be put on the managers and their brokers to be as good as possible. So establishing a benchmark and a standard definition and periodically checking providers against it is certainly a good idea. The DWP should also consider commissioning a peer group study like those emerging on the Continent.
This gives an objective measure of "best practice" and that in itself tends to raise the bar. We are a long way from having a standard definition of transaction costs that can be unequivocally used in the cap, but the approach we are proposing is one that can be implemented within the proposed timescales.
There is a philosophical as well as a practical reason to adopt this formulation.
Here is a contribution from one novarca – a firm that works closely with First Actuarial and Pension Playpen.
What is the purpose of the cap? To compensate for and protect a weak buy side
What do the buy side need? Fairly priced, well-managed pension investments
Do transaction costs relate to the fairness of the price or the quality of the strategy: yes and no
So we should only include in the cap the "yes" bits, not the "no" bits
Why? Because if you start controlling market impact etc, you are interfering with investment policy - sometimes a manager needs to trade no matter what, e.g. if Bernanke is assassinated, and you have a derivatives portfolio, you might just need to take the hit for the good of the clients. Market impact is linked to manager behaviour and while I would expect that most default funds are fairly standardised, we should not be telling managers how to manage their portfolios. You will end up dictating their investment strategy and implementation style and that is not a good idea,
WHO NEEDS THIS INFORMATION
The short answer is those who can reasonably act upon this information. We need to be clear that the detailed breakdown of these costs is of no interest to anyone outside of a small coterie of experts. However, the cumulative impact of total billing is of interest to everyone and a single number demonstrating total costs for each provider is useful to employers and to the more interested employee.
So we suggest that the detailed reporting is restricted to those deciding on the funds that go on the fund platforms - the insurance companies’ newly created Independent Governance Committees, the investment committees of mastertrusts and large occupational schemes that select their own default investment options.
So, we think that extending the scope of the cap is valid. But the cap needs to be rock solid in terms of what it captures. Capturing total charges earned gets you very close to total cost, is unequivocal in its measurement and makes transparent just who is making the money out there (and therefore who is expected to stop billing quite so much).
We would be happy to meet with the DWP (and representatives to discuss this proposal).
4. Do the proposed implementation dates for a cap provide sufficient time for employers to review and put in place compliant arrangements? The dates are:
April 2014, for all employers staging from April 2014 onwards.
April 2015, for all employers who staged between October 2012 and March 2014.
So long as the only fund to which this work applies is the Default Fund, then we see no problem with these timeframes. Assuming the consultation ends at the end of November, fund managers would have three months to get their number to the platform manager.
Where it becomes clear that a fund is non-compliant, then an adjustment to the annual management charge will need to be made to accommodate the overrun above 1%. Where no satisfactory explanation for an overrun is forthcoming, the adjustment should be made to take the charge to 0.75%. The Pension Regulator has not got the resource to adjudicate on thousands of "explanations" and we are suggesting elsewhere in this document that the 1% limit can only be used where the workplace pension is funded by employer above the minimum level.
We do not think that any mainstream workplace pension provider is currently operating a default fund that cannot be accommodated within a 0.75% cap.
The difficulties will surround the use of existing arrangements which are staging at or soon after April 2014. Many of the funds currently being used will not be considered by the providers as Auto-enrolment ready, the providers will then have to insist on the use of a pre-packed "Auto-enrolment ready alternative". This will not be popular but if this is indeed a "full-frontal assault on charges", then this will be necessary enforcement
5. Which of the three options for a cap is the most appropriate?
Our favoured option is a 0.75% charge (to include all costs borne within the fund price). We favour a comply and explain option for schemes operating total member costs of 0.75-1%.
6. Under option 3, what conditions would you expect for schemes levying a higher charge between 0.75 per cent and 1 per cent?
One large employer-Whitbread- has gone public on having a member charge that might not fit within a 0.75% cap. Its argument is that the use of a relatively expensive diversified growth fund provides smoothing that would not be available within a capped charge.
We think that there is a merit in the argument but only where the employer is demonstrating a commensurate commitment to workplace pensions in other areas.
Unless the employer is consistently applying a superior benefit, we cannot see a workforce considering the employer’s position credible.
So we suggest that a minimum contribution level be required to levy a higher investment charge. Unless such a real commitment in place, the 1% concession will simply be used by lazy schemes to avoid a more rigorous approach.
Only where the employer is adopting on an enhanced contribution basis should a "comply and explain" approach be considered
Without such a restriction, the Pension Regulator could be open to an avalanche of "special pleading".
7. How will employers and pension providers respond to a cap on charges and what evidence is there that charges will be ‘levelled-up’ in response to a cap?
The stakeholder pension (SHP) experiment informs; initially SHPs were sold at 1% AMC (which became a 1%TER for responsible insurers). Large consultancies drove this price down to current levels (c0.5%)
Commission based advisers drove this down and absorbed the saving in sales commissions (e.g. 70+30). Some advisers took to passing on some of the savings to employers (50 +30).
The direct market has taken fees still lower. BT and Logica members now can access Standard Life funds using its GPP at c0.1% TER
The evidence is that there is competition on charges. We expect, so long as NEST is in the market, for the market price for workplace pensions to stabilise at 0.5%. For new business there is no compelling argument for a charge cap.
Legal & General’s recently stated intent of absorbing its legacy book into its flagship workplace savings product with a stated charge of 0.5% sets a good precedent. We hope it will be followed by other progressive insurers.
The legacy book of those insurers no longer actively marketing themselves in the workplace is a different matter. The £30bn of DC assets the OFT have identified as poor value is testament to the number of schemes that could be used for workplace pensions which would not get under either the 0.75 or 1.0% charge cap.
Because auto-enrolment requires every UK employer to take a decision on what scheme to use for auto-enrolment, this is a vital issue. We have no reason to doubt the DWP’s or the OFT’s numbers on existing poor value workplace schemes and suspect that if a cap is not implemented, these schemes will be used going forward. This is the worry – rather than a worry that providers will level up charges to the cap.
We suspect that rather than trying to limbo-dance under an impossible cap, many smaller schemes will admit defeat and not attempt to be admitted as auto-enrolment qualifying schemes. This is in the long-term interests of their members and in line with the DWP’s stated aim of rationalising the numbers of small schemes.
Similarly we hope that many employers with workplace pensions from uncommitted providers will vote with their feet and switch to mastertrusts or progressive insurers with durable propositions. This is what First Actuarial has done for its staff.
8. What evidence is there on the link between scheme charges and scheme quality or investment returns?
We do not subscribe to the view that you get what you pay for in fund management. In our experience there is considerable waste and inefficiency in many fund managers –especially active fund managers.
We accept that some high priced funds (Standard Life’s GARS fund for instance) have delivered smoothed returns without compromising on performance. This example is one where schemes have benefited from paying higher fees.
However the benefit of smoothing- so important to defined benefit schemes – is less important to those in defined contribution schemes, where there is no need to provide a mark to market valuation to key stakeholders.
The evidence, such as it is, suggests that the more a member pays, the less the retirement pay-out. This underpins our support for a charge cap.
9. If a cap is introduced, what if any changes should the Government consider in respect of the stakeholder charge cap?
The stakeholder charge cap should be brought in line with the Auto-Enrolment cap- we need simple consistent solutions
10. Are there any alternative options to capping charges that would provide protection for scheme members?
The obvious alternative would be to move to a total "comply or explain" basis. We do not think that this would work. The public would distrust the explanations of those with high charges and the system would be hard to police. On the other hand, it avoids market intervention and might appeal to a non-interventionist Government.
Some commentators suggest that full disclosure would do away with the need for a charge cap. Frankly this is naïve, witness Wonga adverts.
The OFT report, which stopped short of calling for an overt cap, has placed a lot of trust in the ABI and other trade bodies to do the right thing. There remains a lot of scepticism within and without the industry that we can put our house in order. The Minister has recently said that when he came into the job he was surprised that there was no clear framework in which DC could operate and we agree with him.
We think that there is no workable alternative to this intervention.
11. What impact will a charge cap have on the capital reserves pension providers need to hold under:
A 0.75 per cent or equivalent cap?
A 1 per cent or equivalent cap?
We do not feel qualified to make helpful comment.
12. Should transaction costs be included within a charge cap?
As mentioned above, we see scope for a "total charges earned" formulation. There is a need to manage these costs which is not being met by fund managers. In practice, only the fund managers can ensure these costs are minimised. The super-Fiduciaries, the insurers who govern what funds sit on their platforms and the trustees of large occupational schemes (especially mastertrusts) have failed to exert any control in these areas. We cite a recent e-mail received from Mike Smaje who worked for some years advising such funds while in one of the largest investment consultancies
Most funds over-trade. There should be a fee structure that dissuades fund managers from trading unnecessarily. Where I am really uncertain is in the murky world of broking. We never get involved with that side of the industry. Are they (brokers) any good? Are their fees sensible/reasonable? Is competition effective in that area? …..Why do fund managers bother taking their research – shouldn’t they be doing their own?
The failure to manage transactional cost at the fund level, to Govern the fund managers and even to provide consultancy so that the Governors are properly informed;-provides a compelling case for Government intervention.
By adopting our formulation of "total charges earned" within the charge cap, only funds with well-managed transaction costs (by which we mean not just low turnover but well-executed turnover) will be used as defaults.
13. Would requiring the disclosure of transaction costs to trustees and the independent governance committees to be set up for contract-based schemes help to manage any potential avoidance risks associated with a charge cap?
Requiring the disclosure of total charges earned would not in itself reduce avoidance. There would need to be a clear statement from Government that the total cost to members using the default fund cannot exceed the cap.
By applying the simple formulation of total charges earned, Fiduciaries would have clearly defined options.
If the charges fall within the cap, they can continue business as usual. Should the total charges earned formulation exceed the cap, the Fiduciaries can require the fund manager to reduce fees or get a new fund.
If all charges earned are not included in the charges cap, it is easy to see fund managers using alternative sources of revenue (referred to as soft commissions) as well as stock-lending to replace the fees lost from a reducing AMC and it will be hard for Fiduciaries to either see this going on or do much about it.
It is difficult to underestimate the ingenuity of the financial services industry. Any opportunity for a loophole will be taken so it is important that a "cover-all" clause is inserted in legislation that addresses both the spirit as well as the specifics of the legislation.
14. Are there any specific services that may need to be excluded from the cap to avoid constraining innovation, for example, in respect of annuity broking services?
We are pleased to see the specific mention of annuity broking services. Are view is that in the absence of any better means of decumulation, annuities will remain the main means to draw a pension from workplace schemes.
The variations in annuity types and annuity rates makes it vital that people at retirement get good value and we would like all DC beneficiaries to use at the very least the open market option.
The cost of doing so can be picked up by an employer and we encourage employers to do so as part of a good employee benefits package. But this should not be an employer duty- there are enough of these in auto-enrolment.
Instead, we favour a "carve-out" to allow the fund to pay for annuity broking services and/or advice up to a certain monetary limit (say £1,000). Should the deduction of any amount from a member’s fund mean that the fund is charged more than the cap in that year, we would deem this as an acceptable charge
If this charge is at the member’s instigation, then it will be regarded as "adviser charging" which we understand to be acceptable. But if the charge is for a flat broking fee (which should be a lot less than £1000) and is compulsory, then it should not be deemed to fall within the cap.
This is a hypothetical example. We have no objection to carve-outs such as this provided they are clearly for the benefit of the member and exceptional.
15. What would the impact be of a ban on Active Member discounts and other arrangements where deferred members pay an increased charge in qualifying schemes, would providers need to increase charges for active members and if so, by how many percentage points?
By and large this is a good policy. AMDs do little good and are a long-term recipe for disaster- especially when applied in industry sectors and with employers where there is high staff turnover.
We do know of one or two schemes where AMDs have been negotiated where the deferred member charge is under 0.75% (indeed on one scheme under 0.5%). If the policy intention is to remove AMDs for philosophical reason then we say "just do it". If the intention is to limit opportunities for funds to avoid the cap (by having active members below 0.75% and deferreds above) then simply including deferreds in the equation will do the trick.
To level the charges on schemes with AMDs , active member charges would typically have to increase by 0.25%
16. What, if any, transitional arrangements might be needed for those schemes already set up?
Assuming this means transitioning to a single charge, nothing could be simpler, the insurers who operate differential charging would have quoted the single charge as an alternative, the scheme would normally revert to the single charge.
17. Can you provide more information about the scenario whereby employees who leave their job are converted into an individual personal pension? Does this require the member’s consent and is this practice disclosed to employers when they choose the scheme?
We know of only one instance of an occupational pension being allowed to convert deferred members to personal pensions (the Kingfisher Retirement Trust). This has now been discontinued.
Members of group personal pensions are already in personal pensions when in the GPP and the only change when they leave service is that the personal pension becomes unfunded.
Where an AMD applies, the charge on the members fund (however taken) increases. This is without member consent and it is disclosed at point of sale (e.g. when they join). The practice is explained to employers who are typically given the choice of single terms or of an AMD.
Typically the insurer or adviser or both will contact a leaver to give them a continuation option where- providing they pay a smaller contribution (typically £20pm) the active member terms are maintained.
18. How are the existing regulations working in practice and how are services now being delivered and paid for?
The market is currently best described as febrile. Commission based advisers are struggling to advise on workplace pensions and have reverted to other ways to create annuity business, typically through levying per capita charges to employers assessing their workforces for auto-enrolment.
This is increasingly leaving an advice gap for smaller firms setting up workplace pensions from next year. The market has been slow to build alternative sources of guidance and support to allow the SMEs and micro employers to "stage themselves" with good quality workplace schemes.
While regulations have developed to provide clear guidelines on auto-enrolment, workplace pensions have not been subject to any intervention. We believe that the absence of clear guidelines as to what makes for a good workplace pension has contributed to the exodus of advisers in this space.
19. How are charges for blended funds structured, their level set and what disclosure is in place for members and employers?
We feel inadequately equipped to add value. We do not get involved in active member discounts, blending funds – nor do we take commission. We cannot understand how any of these practices can be in the long-term interest of members
20. What impact would extending these regulations to qualifying schemes have on providers, employers, advisers and any other third parties, and what if any transitional arrangements would be appropriate?
We would support the extension of these regulations to all qualifying schemes. We expect to see this happen as part of the reviews set in place by the OFT through tPR and ABI.
The impact on existing schemes and their various stakeholders would be severe and we would suggest that a phased timetable be established which dealt with the legacy in an orderly way.
21. What would be the impact of a ban on commissions in qualifying schemes and does commission present a barrier to switching?
The impact on advisers reliant on commission would be severe. Much future commissions is already baked into business projections, if not into the balance sheet. A ban on commission would materially impact the corporate advisory market and drive many commission based advisory firms into administration
Commission does represent a barrier to switching as advisers still have a strong influence on their clients. Advisers tell us that employers like commissions; this is a weak argument as commissions simply allow a pass-on of advisory fees from employer to employee. This practice has recently been extended to fund the administrative costs of auto-enrolment (where the normal charge levied by the adviser is offset against future commissions).
The net impact of a ban on commissions would be to increase costs to the employer and reduce charges to the employee (provided the commission element of the AMC was recognised in a reduction in AMC by the insurer after they cease to be paid to the advisor.
22. What evidence is there of an increase in sales of DC schemes with commission in 2012?
The obvious place to look is in the accounts of the corporate advisors active in the market. We cannot comment as we have not taken commissions on any schemes we established. Anecdotally we have heard some advisers talk of "filling their boots".
23. How much (on average) has commission on these schemes increased the AMC in percentage points?
Typically by around 0.3%.
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