DC charge capping has been around since 1997, when they were applied to Stakeholder pensions. It re-emerged as an idea in the 2013 study of the DC market by the Office of Fair Trading (OFT), albeit in the context of legacy pension schemes, where it was rejected due to the risk of unintended consequences. Despite that the concept was picked up by the 2013 Department of Work and Pensions (DWP) consultation “Better Workplace Pensions”. The March 2014 DWP response to that consultation, known as the Command Paper, announced their intention to apply a cap to default funds in qualifying schemes from April 2015. Initially the cap will be set at 0.75% (or “75 basis points”) or one of a few equivalent value models, of funds under management excluding transaction costs – all to be reviewed in the future.
The principle seems reasonable. The buyer side in DC is weak so the consumer needs protection. A charge cap is that protection. So why do I contend it is wrong?
- Typically, currently DC schemes have charges lower than the cap. Those that don’t tend to be legacy schemes or schemes paying advisor commission. In the case of the first of these a review is currently underway by an Independent Project Board, appointed by the Minister, with a brief to cut charges if they can’t be justified. In the case of the second, commissions have now been abolished and are being phased out. Charges will, as a result, come down. So, if the charges aren’t higher than the cap anyway, what’s the problem in having one? As the OFT identified: unintended consequences.
- A cap will give a mirage of value for money – acting like a quality mark. The consumer will assume that because charges are lower than they might otherwise haver been they must be getting something good. This may not be the case. Value is a two sided equation: cost v benefit. A cap in isolation, putting pressure on costs, can also drive down benefit. In other words a cheap shoddy pension isn’t necessarily better than a more expensive quality pension.
- One of the benefits that could be driven out is a diversified investment strategy. Diversification, over a period of time, will usually improve returns for the majority of members. A cap will make investment diversification more difficult as in order to achieve it there needs to be some judgement (and so cost) on how and where to diversify.
- Another is investment in systems and or proposition. If a provider can’t recover the costs of improvement – it won’t make any. A cap could freeze the state of DC development for years to come. For the same reason, it could become anti competitive. A capped world will attract fewer new players to the market (which in itself may not be bad) and so will discourage competition (which is bad) on non-charge features (for example, the quality of administration)
- A third is the ability of the provider to provide additional added value services. At least one major insurer provides a 10 year pre retirement counselling service – free of charge to the consumer. Will they do this in the future if charges are squeezed?
- Finally a cap treats the symptom of high charges rather than the disease of poor governance. If governance was made to work properly then charges would always be appropriate and each pension scheme would be well run and delivering optimal outcomes. A charge cap leaves the poor governance decease to spread – detrimentally infecting all other parts of DC.
It’s not clear why a cap is being introduced, or is it?
A cap is an emotive response to a rational problem. As an emotive response it generates an emotive reaction. Is the charge cap about good member outcomes or is it is about good electoral outcomes?