Pensions Bill

Consumer Focus is the statutory consumer champion for England, Wales, Scotland and (for postal consumers) Northern Ireland. We operate across the whole of the economy, persuading businesses, public services and policy makers to put consumers at the heart of what they do.

Consumer Focus tackles the issues that matter to consumers, and aims to give people a stronger voice. We don’t just draw attention to problems – we work with consumers and with a range of organisations to champion creative solutions that make a difference to consumers’ lives.

1 Introduction

1.1 Consumer Focus strongly supports the creation of NEST as a low-cost scheme to help employees save for their retirement. There are provisions which can be included in the Pensions Bill which will make this low-cost savings vehicle more beneficial for people who need it.

1.2 In order to make the scheme more easily available to employees with small and fragmented

pension pots:

· NEST should accept transfers of funds into the scheme, subject to a ceiling, as soon as practical once the scheme is successfully established;

· the cap on annual contribution limits into NEST should be removed immediately.

At the moment, the Pensions Act, 2008 [1] require Government to appoint someone to review these issues, but not until 1 January 2017.

1.3 Consumer Focus is also concerned about deficiencies in the criteria defining qualifying non-NEST pension schemes [2] . Of particular concern is the fact that employers are free to select schemes with high management charges or administration costs. Additional criteria should be added to the definition of a qualifying scheme to ensure that employees and ex-employees are no worse off because their employer has chosen a non-NEST pension scheme. Employees and ex-employees should not bear the cost of being auto-enrolled into schemes where charges are higher than those in NEST.

1.4 The main quality requirement [3] used to define qualifying schemes is that the employer must, by 2017, contribute at least 3 per cent of the amount of the job-holders qualifying earnings. An additional criteria should be added to deter employers selecting schemes with consultancy charges (levied by the company’s pension adviser) or with annual and initial management charges (paid by employees and ex-employees) higher than those charged by NEST. Employers would have the freedom to select higher cost schemes so long as they, rather than the employee, bear the additional costs.

1.5 The practice of higher charges being imposed on ex-employees (so-called ‘deferred member penalties’) should also be restricted. These charges are effectively a penalty on former employees that is negotiated by the employer and, in effect, create unfair financial disincentives, by making it more expensive, for employees to change employer.

2 NEST scheme charges and fees

2.1 NEST’s charges for managing savers funds are much lower than the norm for pension

companies. In the course of our recent research into the Individual Personal Pension (IPP) market, industry has pointed out that higher charges do not necessarily mean that savers will be worse off. However, if all other things are equal, savers are best served by schemes that have lower charges.

· NEST’s annual management charge of 0.3 per cent per year is much lower than the average level of 2.2 per cent we found in the IPP contracts we reviewed;

· NEST’s initial charge of 1.8 per cent is lower than the standard in the industry. Our research revealed initial commissions of between 3 – 5 per cent.

3 The case for transfers in – up to a ceiling – to NEST funds

3.1 In 2009 there were around 23 million personal pensions [4] ‘in-force’ – which means they were open for further contributions – and savers have some £470 billion saved in such personal pension plans (and annuities). According to HMRC [5] around 7 million people were making payments. A large number of pension plans are no longer receiving contributions and often only contain small sums of money. See Annex for further information.

3.2 HMRC data indicates that 10 million individuals own personal pensions and annuities. Around 40 per cent of people have £10,000 or less saved in personal pension plans – an amount which is insufficient to buy a meaningful annuity.

3.3 In the Governments initial response to the Preparing for automatic enrolment call for evidence [6] , it was noted that respondents had commented that the cost of administering a pension pot of ex-employees did not vary much with the size of the pot (one respondee said administration costs £15/yr) and over time the cumulative cost could easily exceed the value of a small pot. Employees should have the option of allowing small pots to be transferred into NEST, without penalty, as soon as practical rather than waiting for the 2017 review. This will allow small pots to be amalgamated at low cost and avoid the punitive effect of administrative charges on small pots of savings.

3.4 Some may argue that if NEST were allowed to accept transfers-in, in an unrestricted fashion, there might be an exodus of funds out of insurance company run pension schemes, which could then have a detrimental impact on employees remaining within the non-NEST employer scheme. We would not wish to see this occur. However, we see much less danger to remaining employees if small pension pots are allowed to transfer out and be consolidated into NEST, up to a ceiling limit. This would allow savers to benefit from the low administration costs that NEST will operate with. This change would also place NEST schemes on an equal footing with other employer backed pension schemes.

4 Removal of NEST contribution caps

4.1 At present, NEST is permitted to accept contributions of up to £3600 [7] (in 2005-06 prices, equivalent to £4271 today) per year on behalf of any one employee. This was designed to ensure that NEST was focussed on low and medium income employees. The practical impact of this limit, initially designed to ensure NEST was focussed on low and medium-income employees, coupled with the minimum contribution of 8%, is to deny people on modest incomes access to NEST.

4.2 The existence of a hard limit of contributions means that employees whose qualifying earnings fluctuate and might exceed that limit will be auto-enrolled into an alternative scheme to avoid risk of non-compliance, even if the employee and employer would prefer to use NEST. The only option open would be to enrol the higher-earning employee into NEST and into a second top-up scheme for earnings above the NEST cap. This seems a highly bureaucratic approach with no obvious benefit for the employee.

5 Requirements of a ‘qualifying scheme’

5.1 We contend that the current scope of legislative requirements, and what we know of practices in the IPP market, could lead employers to select ‘qualifying schemes’ that are not necessarily in the best interests of employees and especially ex-employees.

5.2 Pension companies should compete in the auto-enrolment market by providing cost-effective pension schemes that are in the interests of employees. Unfortunately, our research into the IPP market shows that those customers who have "done the right thing" by putting money away are ill-served by an industry characterised by complex pricing and charges; unnecessary churn of products; and occurrences of mis-selling. In particular, high annual management charges can greatly erode the value of savings.

5.3 In our research, we reviewed correspondence between Independent Financial Advisers (IFAs) and savers. Despite RU 64 [1] requirements on the financial adviser to have to explain why the pension scheme being recommended was at least as good as a low-cost stakeholder pension, we found IFAs and pension companies malign low cost stakeholder schemes. Not one of the 22 sets of correspondence we reviewed contained a recommendation from the IFA to the saver to invest in a stakeholder pension. The following is typical from the correspondence we reviewed:

"I have recommended an Individual Personal Pension plan (IPP) rather than a Stakeholder Pension. In terms of cost the two are very similar. However the IPP gives you a wider range of funds to choose from. As your fund grows it may be beneficial for you to switch your pension fund into a variety of different fund managers to help diversify your investment. The Stakeholder Pension does not allow this facility however; it only offers a comparatively basic core range of funds."

5.4 The obvious incentives for employers, at present, are to select a qualifying pension scheme

that:

a) meets the criteria;

b) imposes fewest administrative costs upon them;

c) takes the least effort to set up;

d) can aid recruitment and retention of staff.

5.5 The Pensions Act, 2008, allows Government to establish further criteria on qualifying

schemes [2] :

"(3) The Secretary of State may by regulations provide that a scheme is not a qualifying scheme in relation to J if-

(a) while J is an active member, the payments that must be made to the scheme by, or on behalf or in respect of, J for purposes other than the provision of benefits exceed a prescribed amount, "

The explanatory note explicitly gives the example of high Annual Management Charges (AMCs) of non-NEST qualifying schemes as an issue that the Secretary of State might choose to address by regulation:

"...This can be where the payments and contributions – for example annual management charges – that must be made to the scheme exceed a prescribed amount..."

However, the above section of the 2008 Pensions Act specifically excludes the interests of ex-employees. It is also unclear which agency will be responsible for monitoring whether payments like AMCs are excessive and causing un-necessary detriment to savers.

5.6 Establishing provisions which would incentivise employers to take cognisance of scheme charges, for example by imposing responsibility for payment of scheme charges beyond a certain threshold on them, would help ensure that schemes chosen by employers were in the interests of their employees.

Annex

Size of the personal pensions market

Individuals had around £470 billion held in personal pensions [1] in 2009. This includes Individual Personal Pensions, group and stakeholder pensions [2] and pension annuities. Individually owned pensions are just part of the larger universe of pensions. People have £2,045 billion invested in pension saving and annuity products – this includes defined benefit products and also company-administered pension trust funds. shows the different sorts of pension products and how the value of assets in each has changed over time.

Table 1   : Total funds held in pension schemes in real terms (2004–09)

Source: ABI calculations, Office of National Statistics and Standards & Poor’s (FSA returns)

*Insurer-administered individual pensions include group, individual and stakeholder personal pensions and pension annuities. These policies can be arranged by an individual or through an employer, but in all cases the insurer and policyholder have a direct contractual relationship.

**Self-administered pensions not administered by insurers include any fund invested in a pension not administered by the insurance industry. This includes Defined Benefit schemes and SIPPs not administered by insurers.

Consumer Focus research

Consumer Focus reviewed 31 randomly selected cases of correspondence and contracts between IFAs and their clients. We found clients were often switched onto pension products with higher charges. The benefit to clients of these switches was often unclear to us.

One common practice is to recommend transfer into a pension plan which levies an AMC of around 1 per cent and then invests the savings in ‘externally’ managed or ‘multi-manager’ funds (some or all of which could be operated by the same pension company) which levy a second round of charges. This practice was not so common in the pension funds being transferred from. Each of these new funds will levy a different percentage charge and the client would have to calculate a weighted average of these fund charges. Then they need to add this to the pension provider’s AMC to obtain a like-for-like comparison with the old fund. In one such example the IFA’s justification is given below:

"I have not recommended switching funds internally due to the limited fund range. There are only eight funds available for investment with Firm 1. Firm 2 offers a range of 245 funds, which are both internally and externally managed. A wider fund range allows us to create a portfolio which is diversified, and matches your attitude to risk accurately."

Whether eight funds is an unduly restrictive number of funds is an important issue. The IFA selected three funds from Firm 2’s internally managed funds (Far East, defensive and Pacific). Firm 1 currently offers (the contract was taken out in 2008 so cannot be directly compared) international, defensive and adventurous life funds as well as a large number of pooled pension funds and external funds. Why transfer from Firm 1 to Firm 2?

Another common practice is to recommend transfer out of closed schemes because, as one IFA put it, "their with-profits fund is now a closed fund and likely to under perform in the future." The FSA have issued guidance on closed funds and have said that there is no reason to believe that closed funds will generate poorer returns than open funds. Interestingly, with-profits funds have slightly out-performed the average balanced managed fund in the periods to 2009.

More often than not the customer was moved to a more expensive product. We saw one example where a client specifically requested "a more cost effective contract with a transparent charging structure" but was moved onto a platform product with two sets of costs – the AMC and 'external' fund charges too.

In a different case a client moved from a pension with a 1 per cent AMC to actively managed funds with considerably higher charges and agreed to pay 1 per cent trail commission. This had the perverse result that the IFA ended up receiving the same level of remuneration for his advice to transfer as had been adequate to run the previous pension.

IFAs actively discourage people from saving in stakeholder pensions even though they will often have low charges  

In no case was the client advised to take out a stakeholder pension. Stakeholder pensions provide excellent value to many customers. However the pension provider is not allowed to make an initial charge (or allocate less than the entire contribution) and the management charge is restricted to 1.5 per cent in the first 10 years and to 1 per cent after that. This means it is hard for the provider to finance the payment of initial commission to the IFA for marketing of the product. Stakeholder funds are simple, flexible and have low charges. However, this is not how they are described in the correspondence between IFAs and their customers that we reviewed.

One firm of IFAs uses the same script to write-off stakeholder pensions to several of its clients in 2009 and 2010.

"I have recommended an Individual Personal Pension plan (IPP) rather than a Stakeholder Pension. In terms of cost the two are very similar. However the IPP gives you a wider range of funds to choose from. As your fund grows it may be beneficial for you to switch your pension fund into a variety of different fund managers to help diversify your investment. The Stakeholder Pension does not allow this facility however; it only offers a comparatively basic core range of funds."

Several of the clients who received this letter had simple investment needs and small pension pots. The advice they received was to invest or transfer all of their pension or to set up a regular saving into just one fund. The recommended funds differed between clients but generally charged an AMC of 2.20 per cent. This is 0.7 per cent above the maximum charge allowed in a stakeholder pension.

Given the low growth rates of many pension funds in recent years, the cost difference between a stakeholder pension and the recommended non-stakeholder pensions could have a material impact on the amount available to a customer at retirement.

July 2011