The Office of Fair Trading (OFT) has recently published its findings following its market study into defined contribution workplace pensions, which includes occupational defined contribution schemes and contract-based schemes. The conclusions are not good news for consumers: the OFT says that savers are at risk of not getting value for money from their pension savings for two key reasons. First, the complexity of pensions and the market means that it is difficult to make the right choices. Second, employers may not have the capability or incentive to assess pension choices for value for money.
The OFT has provisionally decided not to refer the market to the Competition Commission for further investigation, on the condition that a number of recommendations are carried out.
Old and / or high-charging schemes
The OFT is concerned about old and high-charging contract-based schemes and highlighted the impact of a poor Annual Management Charge (AMC) – a 0.5 per cent charge could reduce a pension pot by 11 per cent over its lifetime and an AMC of one per cent would reduce it by 26 per cent. In response, the Association of British Insurers (the ABI) and its members have agreed to an immediate audit of schemes with old and / or high-charging structures, including those with an AMC of more than one per cent. The audit will be overseen by an independent project board made up of representatives from the Department for Work and Pensions (DWP), the Pensions Regulator (TPR) and industry.
Small trust-based schemes
TPR has agreed to assess which smaller trust-based schemes are not delivering value for money and the DWP has agreed to consider whether TPR needs new enforcement powers to tackle the problem.
The OFT recommends that providers of contract-based schemes should take their own steps to improve governance. The ABI has agreed that its members will establish independent governance committees by mid-2014 within each provider, which will recommend changes and escalate issues to regulators where they see risks of poor outcomes for savers. The OFT would like key elements of this governance solution to be embedded by the Government in a minimum governance standard that applies to all pension schemes.
Quality of information available on costs and charges
One of the major flaws that the OFT found was a lack of clarity over the costs and charges associated with different providers and schemes. It identified 18 different charging combinations, which makes it very difficult to understand the costs involved and compare the costs with other providers' offerings. The OFT recommends that the DWP consult on improving the transparency and comparability of information about these charges – including whether providers could disclose a single AMC and investment transaction costs – and quality of schemes, in order to make employers' initial choice of scheme easier.
Preventing future risks of detriment
The OFT recommends that the DWP consult on preventing schemes being used for auto-enrolment that contain built-in adviser commissions or that penalise deferred members with higher charges through the application of "active member discounts". These are given to members of workplace schemes that are still contributing. If a person no longer contributes then they lose their discount and their AMC goes up. Active member discounts are very popular but are arguably inherently unfair as those members with the lowest administration costs (deferred members) are subject to the highest charges and they create a two-tier system. The report revealed that deferred members paid on average 26 per cent more in charges than active members.
No charges cap
The OFT has not recommended a cap on the costs associated with schemes. This is on the basis that there are too many charging combinations in the market to make a cap feasible and because the increased volume of savers resulting from auto-enrolment should allow providers to reduce costs considerably. A cap may negate such a reduction in costs by tacitly giving providers the green light to opt for the maximum legal cost rather than what is commercially viable. However, the DWP has confirmed that it is still intending to consult on this issue and is considering a cap of one per cent on costs to incentivise those who have been or will be auto-enrolled to continue saving.
The OFT findings are pretty damning on the defined contribution workplace market. The extent of the problems within the market are so significant that the OFT was on the verge of referring it to the Competition Commission for further investigation. The key issues identified that are in need of improvement relate to costs and governance within schemes and providers. The OFT's recommendations to deal with these issues have generally been well received by the industry although there is some doubt regarding the effectiveness of the internal governance committees to be created by the ABI within contract-based schemes. There is an inherent conflict of interest here and only time will tell whether the committees can bring meaningful changes to the quality of governance.
It will be interesting to see how the Government reacts to the OFT's recommendations to develop a legal framework for these governance committees to work to along with obligations on disclosure and transparency to improve the confusion over costs and other quality standards associated with schemes and providers. The Investment Management Association has put forward a potential solution to the problem of inconsistent charges. It has pointed to EU fund regulation, which uses the concept of an Ongoing Charges Figure (ONS) to enable charges to be calculated and presented in a comparable way in collective investment schemes. The suggestion is that it may be possible to adapt this concept to establish a consistent charging structure for pensions.
A legal framework would be helpful to ensure basic standards are met and is critical to ensuring that providers take a consistent approach when disclosing details of their product / offering, including the associated costs. It is only if changes are made in the context of such a legislative backdrop that employers will be empowered to meaningfully compare the market products and make better and more informed decisions regarding their workplace pension offering.