DC pension scheme charges, more change to your pension scheme? It’s always tempting to start any article on work place pensions as "dull but worthy" but right now, how best to pension workers is something sexy in government and for good reason.
With Auto Enrolment (AE) in full swing, resulting in around 20 million people collectively contributing around £20bn a year by 2017, defined contribution (DC) pension schemes are being subjected to unprecedented scrutiny. There is barely a corner of DC that hasn't or isn’t in the process of being unpicked, criticised, improved and repacked to some extent or another. The area most subject to this is charges.
The Department of Work and Pensions (DWP) recently announced a delay in its plans to cap pension charges but what was missed, beneath the headline, is that it is also pressing ahead with a review of existing DC schemes that could result in a majority of them having to change. The review covers both trust based schemes and group personal pension plans.
Last year the DWP asked the Office of Fair Trading (OFT) to review the operation of the work place pension market. Their report, published in September, was damning.
They reached a number of conclusions including that the demand side of the DC market is very weak and in a complex market that can result in members not benefiting from price competition. They also concluded that the worst excesses of poor price competition (i.e. the highest prices) could be found in so called "legacy pension schemes".
Before publishing the report and perhaps with the insurers sensing the carnage that could follow, a deal was brokered: an Independent Project Board (IPB) would be established to audit and drive change in those legacy schemes.
What’s a "legacy pension scheme"?
A legacy scheme probably isn’t what you think. The phrase, itself, is misleading in two respects.
Firstly, a legacy scheme need not be an old scheme or a closed scheme. The IPB will have jurisdiction over any scheme set up before 2001 and any scheme set up since, where the total charges are more than 1% of funds. In other words, a "legacy scheme" is any scheme set up some years ago or with high charges whether or not contributions are still being paid to it.
Importantly the 1% charge test isn’t a measure of the headline Annual Management Charge (AMC) that is often quoted by insurers. It is the Total Expense Ratio (TER). This is a number that takes into account costs that can only be accurately measured retrospectively, for example dealing costs. A TER will always be higher than an AMC, sometimes by a significant margin.
Secondly, the name is misleading as the "scheme" may not even be a scheme in the legal sense of the word. The review will include group personal pension plans.
The audit will not take in final salary schemes, unbundled DC schemes (i.e. those that are not written under an insurance contract), Additional Voluntary Contribution (AVC) policies or certain small insured schemes.
What will the IPB audit?
The IPB will be looking to see if there is value for money. They have made clear that this is a comparison of costs verses benefits. In other words, this isn’t, simply, a way of bringing a charge cap in by the back door.
The IPB will determine how it tests value for money although the benefits it measures are unlikely to include the cost of any advice given, investment performance or any "soft" benefits like communication and branding. Instead it will focus on hard financial benefits like guarantees. These could exist in the investment process or in the annuity price offered at retirement.
What’s the time scale for this process?
The timescale is aggressive. The aim is that the audit will be completed during 2014 although there are, already, early hints at slippage.
The IPB was to be formed and to meet for the first time in January (neither had happened at the time of writing, in the dying days of January), during February theyare to agree their framework, during March the insurers will start to gather data, during May an interim report will be published, during October/November the last of the insurers data will be submitted and during December the final reports will be finished. In between times, the IPB, which is scheduled to meet six times during the year, will monitor progress.
The final reports will set out the remedial action needed. These reports will be sent to individual insurers, although these won’t be published, and the regulators (The Pensions Regulator (TPR) and the Financial Conduct Authority (FCA)). The regulators’ report, setting out remedial action at an industry level, will be published.
It’s envisaged that some of the spin off remedial work will be dealt with while the audit progresses, the rest will be left to TPR and the FCA to consider and pursue in 2015 and beyond.
How will this impact on companies?
At the moment, it’s very hard to tell. The IPB will determine what standards are to be applied to the legacy schemes and, until they do, it’s impossible to know what impact those standards will have. That said, the point is that legacy schemes, and so the companies paying contributions to them, are going to be subject to scrutiny during 2014.
What do companies need to do?
Right now, nothing – unless you want to get ahead of the game.
The Government is determined to improve the lot of UK workers pension provision. The consequences of them failing are horrific: more people working to much older ages and/or more people retiring in abject poverty. Definitely not dull.