Sometimes one or two words in a piece of legislation can stir up an entire industry. The catchily named Occupational Pension Schemes (Charges and Governance) Regulations 2015 have done just that with the new definition of “default arrangement”.
Under new UK legislation applying from 6 April 2015, money purchase “default arrangements” are required to cap their charges at 0.75% in qualifying pension plans used to satisfy employer duties under automatic enrolment. This is a government move to protect members and help to ensure good member outcomes from pension savings. So far so good. However, there is some ambiguity around the definition of default arrangements in the legislation. The regulations provide that a default arrangement includes “an arrangement under which the contributions of one or more workers are allocated to a fund or funds where those workers have not expressed a choice as to where those contributions are allocated”. So, the intention is to protect the less engaged savers who do not wish to make an investment choice.
Where a member has expressed a choice as to the arrangement he wants to pay into then the cap does not apply. But questions have been raised around what is an “arrangement” and what is a “choice”. Let’s pose some questions of our own. If a member has chosen a particular funding strategy or has elected to be in a fund with a particular “white-labelled” funding objective, what happens if there is a change of investment fund within that particular arrangement? Would this fund remain outside the charge cap? Has the member still chosen this fund even though the investment has changed? If this is not the case, then the legislation could have results which do not seem to be in line with the objective of securing good member outcomes.
For example, let’s say the trustees of a money purchase pension plan have offered a variety of funds to their membership alongside the “official” default fund (for members who don’t express a choice). Some members have chosen to be in a fund with a charge of, say, 1.25%. The trustees find a better alternative fund with broadly the same investment strategy but with charges of only 1%. This is still above the 0.75% cap but a move is clearly in the members’ best interests. However, if the new fund is classed as a “default arrangement” because the members haven’t actually chosen to move to it (even though the move was consistent with their original choice), the trustees would be left in a position where they would have to provide a true default fund with a 0.75% charge cap for contributions from 6 April 2015. Members who want to continue in the same fund following the move to the new alternative would need to give their written consent. Bearing in mind that these members made an active investment choice in the first place this does not seem to be a sensible outcome.
In another example, both trustees of occupational pension plans and insurance providers who offer contract based plans may offer funds which are “white labelled”. That is, funds which are offered to members as representing specific investment strategies but give access to more than one underlying fund, with a generic name such as the “XYZ UK Equities Fund”. If the word “arrangement” is read as meaning each of those individual funds then any decision to replace one underlying fund with another could mean the whole arrangement would become subject to the charge cap even if a change of fund is clearly in the member/customer’s best interests. This could potentially have the effect of the arrangement being withdrawn if it is not possible to offer it for 0.75% and the members (who had previously made a specific choice) being forced into a default arrangement. Again, this is surely not the best outcome.
The answers to our questions seem unsatisfactory and inconclusive at present. The regulations appear to operate so that even seemingly similar funds could end up with a different answer to the question of whether or not a change in investments means that the fund is a default arrangement – it depends on the precise documents sent to the members at the outset. If the member chose a specific investment strategy but not specific funds, then it may be argued that a change in investments does not result in the fund being caught by the “default arrangement” definition. But if the member elected for a particular strategy and the process involved selecting specific underlying funds, then it will not be possible for the member to continue to make contributions if the underlying funds are changed without giving his specific consent (unless the arrangement can comply with the 0.75% cap).
This is an example of well-intentioned legislation having difficult practical impacts. For large schemes and insurance providers the task of reviewing all members’ initial application forms and forming a view on the choice element will be immense.
To finish with a final question: is this perhaps an example of a situation where clear guidance from the Pensions Regulator and the FCA would be welcome?