Introduction
The new régime of automatic enrolment (AE) is bringing many people who have not previously saved for a pension into the scope of workplace pensions. The OFT notes therefore that it is important to ensure that pension arrangements being used for AE, which will be predominantly defined contribution, deliver the best possible value for money and so has conducted a study into the market for defined contribution workplace pensions.
The study aimed to examine whether competition on its own is likely to deliver value for money and good outcomes for scheme members and has concluded that it is not. The OFT attributes this finding both to pension products being complex and to a lack of engagement among the buyers of pension arrangements.
The OFT’s focus has been on the key elements of a pension scheme that determine whether that scheme offers value for money:
- the charges the scheme member has to pay,
- the design and execution of the investment strategy,
- the administration of the scheme and communication with the members and
- the governance of the scheme.
Charges
The OFT finds that charges can be difficult to understand and that they vary in structure between schemes, making them hard to compare. In addition, charges are borne by the scheme members but the scheme is chosen by the employer, who has no obvious incentive to choose the best value scheme for his employees.
The OFT reports that charges have fallen since 2001. However, scheme members can benefit from lower charges only if employers or trustees regularly switch to lower-charging schemes. If employers and trustees are not aware of the better terms available they are unlikely to switch provider.
A further concern identified relates to “active member discounts” (AMDs) – the practice of increasing members’ charges when they stop contributing to a pension scheme. On average, members of these schemes can expect annual charges to increase by 0.47% if they stop contributing. This is hard to justify given that less work should be involved in servicing a contract with no ongoing contributions.
Quality and governance
The OFT has found little evidence of competition between providers on scheme quality, which may be because quality can be difficult to assess. Larger employers may be equipped to implement good governance arrangements to supplement the services provided by the pension scheme. However, this is unlikely to be the case for the majority of employers who are having to provide a pension arrangement for the first time under the AE regime.
The OFT is concerned also that the governance put in place by providers of contract-based schemes is often not sufficiently independent. While multi-employer master trusts have the potential to offer independent trustee governance combined with economies of scale, the OFT is concerned that some trustee boards may not be sufficiently independent of the master trust provider to avoid potential conflicts of interest. It notes also that there may be too many new master trusts for the size of the market, meaning that some master trust providers may have to increase their charges in order to make a profit.
Other potential risks associated with AE
The OFT notes the risk of workers being automatically enrolled into schemes with charges that include in-built adviser commissions. Setting up such schemes was banned in January 2013 but new workers can still be enrolled into schemes set up prior to that date. This risk is exacerbated by employers wishing to minimise the cost of AE.
It is possible also that employers comparing the schemes available for AE may not understand the differences in the financial protection that apply to the assets of master trust scheme members, compared with those for contract-based scheme members.
Recommendations
The OFT would like to see:
- minimum governance standards for all pension schemes in order to ensure a consistent degree of ongoing scrutiny and assessment of value for money now and into the future,
- all costs and charges associated with pension schemes being disclosed in a manner that will allow employers to compare a single, consistent charge,
- the DWP requiring information about the key elements of scheme quality – such as administration standards, past investment performance and the quality of providers’ governance standards – to be provided to employers in a consistent format, by all providers of AE schemes where no adviser is involved,
- guidance from the Pensions Regulator (TPR) for the trustees of smaller trust-based schemes (fewer than 100 members) on how to assess the key elements of value for money of their schemes and require each of those schemes to report the results of their assessment.
Ending the current risks of consumer detriment
The insurance industry has agreed that each provider of contract-based pensions and bundled trust-based schemes will establish an Independent Governance Committee during 2014. The OFT expects governance committees to be able to identify situations where scheme members are getting poor value for money and implement changes to the pension product accordingly.
Additionally, insurers will carry out an audit of “at risk” schemes – covering all workplace pension products sold prior to 2001 and those post-2001 workplace pension products with AMCs greater than 1% – during 2014. The audit will establish the charges applicable to these products and the extent of any associated benefits. An independent board will then determine what action needs to be taken in response to the findings of the audit. The OFT prefers this approach to imposing a cap on charges.
Preventing risks of consumer detriment in the future
In relation to schemes that are to be used for automatic enrolment, the OFT recommends that the Government consider introducing the following standards for such schemes:
- no AMDs to be applied and
- existing schemes containing adviser commissions should not be used for AE in the future.
In relation to master trust schemes the OFT recommends that:
- they be required to demonstrate to TPR that they can deliver ongoing value for money for members on the basis of realistic growth plans and contingencies and
- Government and regulators should aim to ensure an equivalent level of protection between master-trust products and contract-based products.
Longer term principles
Finally, the OFT has looked further into the future and urges government and regulators to ensure that future policy and regulatory initiatives are informed by longer-term principles for how the DC workplace pension market should evolve. Specifically, these principles would be:
- scale, so that members can benefit from the consequent economies in the purchase of administration, investment and governance.
- the alignment of incentives of employers, trustees, advisers, providers and investment managers with those of scheme members,
- robust independent governance and
- the flexibility to move assets and administration services between providers.