House of Commons - Automatic enrolment in workplace pensions and the National Employment Savings Trust

Automatic enrolment in workplace pensions and the National Employment Savings Trust - Work and Pensions Committee Contents

3 Ensuring pension schemes offer value for money

50. Employers will be responsible for choosing an auto-enrolment pension scheme on behalf of their employees. They can choose from a wide range of private providers or they can opt for a NEST scheme. Employers will therefore have an important role in comparing pension schemes and selecting a scheme in the best interests of their staff. This chapter considers the extent to which employers and employees can be assured that pension providers will operate with transparency and offer products that represent good value for money.

Criteria for auto-enrolment providers

51. Providers must meet certain criteria established by the Government and regulated by The Pensions Regulator (TPR) in order to offer an auto-enrolment pension scheme. For example, UK pension providers must be tax registered and must offer occupational or personal pension schemes. Non-UK pension schemes must meet additional qualifying criteria relating to regulation in their country. In addition, there are minimum requirements according to the type of pension scheme (for example, defined benefit (DB), defined contribution (DC) or hybrid schemes which combine elements of DB and DC schemes). For example, the requirements for DC occupational pension schemes require employers to make minimum contributions at a set rate.[62]

52. Although providers are required to meet these criteria, they will not be assessed against them by TPR as part of a registration process. Instead, it will be for the employer to satisfy themselves that the pension scheme they plan to use to fulfil their auto-enrolment duties meets the criteria.[63] TPR and the Financial Services Authority take a risk-based approach to regulation, whereby resources are concentrated on organisations where they identify the greatest risk to the security of members' benefits.[64]

53. It is useful to compare the UK criteria with the requirements on pension providers offering the KiwiSaver scheme in New Zealand. Organisations wanting to provide KiwiSaver schemes need to be certified by the NZ Inland Revenue and meet requirements set out by the Financial Markets Authority before they can register a scheme. These include meeting certain IT requirements, implementing a business continuity plan, providing data to the Government and taking part in annual review meetings with the Inland Revenue. All providers are required to sign a scheme provider agreement before they can provide a KiwiSaver scheme.[65] All KiwiSaver schemes are regulated by the Financial Markets Authority and schemes are required to have charges that are "not unreasonable".[66] Although the New Zealand Government has not defined a cap for charges, providers can only offer a KiwiSaver scheme if their charging structure has been assessed and considered to be reasonable.

54. The regulatory arrangements for providers under the KiwiSaver are significantly stronger than the requirements faced by providers wishing to offer auto-enrolment schemes in the UK. It is arguable that the New Zealand system offers a higher level of protection for savers that could increase their chances of receiving good value for money on their investment.

55. Employers will be responsible for ensuring that their pension provider meets the Government's criteria for auto-enrolment. Providers are not currently required to register with The Pensions Regulator to ensure that they are eligible. This may represent a regulatory gap, and we are concerned that some employers may unknowingly enrol their staff in schemes that do not meet the criteria. Equally, the criteria for providers appear relatively light compared with the New Zealand model. The Government must monitor this situation closely. It should act to strengthen the minimum criteria for providers, or require providers to register with The Pensions Regulator, if it becomes clear that some providers are not safeguarding the interests of pension scheme members.

Transparency of pension scheme charges

56. Comparing pension charges can be very complex due to the different types of fee that can be applied. These can include:

Contribution charges: investors are charged a percentage of each contribution they pay into their scheme.
Annual management charges: every year investors are charged a percentage of the total pension pot amount they have invested.
Fixed administration charges: investors pay a fixed monthly or annual fee, for example £2 a month or £20 a year, regardless of the size of their pot.
Trading charges: taxes and commissions incurred each time an asset is traded.
Active member discounts: increased charges once the employee ceases to contribute.

57. DWP research examining a sample of schemes found a current mean charge level, expressed as a percentage of funds under management, for defined contribution (DC) occupational schemes of 1.23% (with a median charge level of 1%), and charge levels for most contract-based workplace schemes at 1% or lower. The Department therefore expected that NEST's charges (broadly equivalent to a 0.5% annual management charge)[67] would act as a benchmark across the pensions industry which, combined with a competitive pensions market, should keep charges for auto-enrolment schemes low.[68] Otto Thoresen from ABI echoed the expectation that NEST's low charges would force other providers to keep their charges competitive: "the existence of NEST [...] is setting standards that will force the market to normalise at a level that I think we should be able to demonstrate is good value for money for the services provided."[69]

58. Lawrence Churchill, the Chair of NEST, highlighted the complexity of setting a single transparent measure for pension scheme charges, indicating that there could be variation in annual management charges (AMCs) within a single pension provider:

Joanne Segars from the NAPF highlighted the need for the industry to develop a common language around pension charges:

59. Due to the current complexity and lack of transparency around pension scheme charges, there is the potential for pension providers to misrepresent the fees applied by their competitors, even if they do so inadvertently. This may become an issue as providers compete increasingly against each other for auto-enrolment contracts. The Advertising Standards Council and the Financial Services Authority have powers to regulate product-related claims, and the increased transparency of charges would help reduce the risk of any miscommunication around competitors' fees, demystifying the industry, and therefore encouraging pension saving.

60. At its annual conference in October 2011, the NAPF announced that it planned to hold an industry summit on fee transparency. Its aim was to develop a code of practice for pension providers that would help customers understand and compare pension scheme charges. A working group has been established to explore the issues in depth and the NAPF proposed launching the code in spring 2012, ahead of the launch of auto-enrolment. A NAPF discussion paper put forward several ideas for fee transparency, including: ensuring fees are disclosed in a standard format to employers; providing annual information to employees about the cash amount they have paid in charges; ensuring transaction costs are disclosed; creating a comparison website for charges; and adopting a standardised method of comparing charges.[72]

61. If auto-enrolment is to be successful in convincing people to increase their retirement saving, it is essential that providers offer value for money for employees who are automatically enrolled and that they demonstrate that this is the case. A competitive market of providers should help promote this but it will only work if charges are clear, understandable and comparable. In the insurance industry, comparison websites are available to enable people to compare providers, and we believe that the pensions industry should aim to establish a similar model.

62. Current industry practice and regulation does not offer sufficient transparency for employers or savers. We welcome the work that the NAPF and the pensions industry are undertaking to develop transparency around pension scheme charges and look forward to the NAPF's code of practice.

63. We expect to see the industry make progress on improving transparency and will continue to monitor their actions in this regard. It is imperative that the pensions industry establishes a clear, accessible and universally-adopted model to allow the comparison of charges and that this is in place by the end of 2012. This would ensure that the model is available to all employers choosing schemes from 2013 onwards.

Regulation of fees and charges

64. The criteria for auto-enrolment pensions, as determined by the Government and published by The Pensions Regulator, currently do not restrict the level of charge that can be applied by a pension provider. DWP has stated that it will monitor charge levels across the market and emphasised that it has reserve powers in the Pensions Act 2008, which would allow a charge cap to be set should auto-enrolment charges reach inappropriately high levels.[73]

65. The Royal Society of Arts' (RSA) Tomorrow's Investor programme argued that the current consumer protection legislation that regulates workplace pensions is being "abandoned" alongside the introduction of auto-enrolment, increasing the risk of high charges: "There will be no restrictions on how much [providers] can charge, and we can expect that many will be sold pensions where 50% or more of their potential pension disappears in charges. Some of these fees will be hidden from customers."[74]

66. David Pitt-Watson, who led the Tomorrow's Investor programme for RSA, provided the example that if an employee paid a 2% annual management charge each year over 60 years (including time spent saving in work and in retirement), half their pension would disappear in fees. He drew a comparison with stakeholder pensions, where providers currently cannot charge more than 1.5% over the first 10 years, and thereafter cannot charge more than 1%.[75] As noted earlier in this chapter, DWP research suggested that typical charge levels were lower than those feared by the RSA.[76]

67. The Minister outlined several reasons why it might not be advisable to introduce a cap on charges at this stage in the implementation of auto-enrolment. Firstly, he explained that, since there are "dozens and dozens of different sorts of charges", introducing a cap on one type of charge might simply result in a provider increasing a different type of charge: "it could be a bit like a tyre: you squeeze this bit and think you have got it capped, and all the charges rush off over there."[77] Secondly, the Minister indicated that some investors might wish to pay a higher charge in return for an improved service from their pension scheme:

68. Thirdly, the Minister suggested that if the Government applied a cap, then the cap might become the standard level for charges, with providers increasing their fees to the level of the cap. He explained: "If you simply said, 'You cannot charge more than—to take a round number—1%' there would be a risk that everyone would say, 'Oh, well, that's the norm, so we will charge 1%.'"[79] Lawrence Churchill from NEST made a similar point, indicating that, when the cap was imposed on charges for stakeholder pensions, providers set their charges at the cap level, rather than below the cap.[80]

69. The current model for automatic enrolment will rely on scale and competition in the market to ensure that charges represent value for money. However, this model can only operate successfully if the pensions industry establishes transparency and clarity so that employers and individuals can compare schemes. It is also worth remembering that it will be employers who will be choosing pension schemes on behalf of their employees. The TUC expressed concern that there will not be sufficient incentives for employers to select a scheme that offers value for money and low charges for employees. They suggested that employers should be held accountable if they choose a pension provider that does not offer this.[81]

70. It should be borne in mind that the employer will choose the pension scheme but the consequences of that choice in terms of the level of charges and the potential lack of value for money will fall on the employee. Given the current complexity of pension scheme charges, it is important that the Government and the pensions industry create a model that helps protect employers against the risk that they will, inadvertently, select a scheme that offers poor value for money for their employees.

71. The Government must monitor the pension market to ensure that scale and competition between providers is effective in keeping charges at a low level. We recommend that the Government, or The Pensions Regulator, publish a report every two years on the value for money of pension scheme charges, including an assessment of the levels of fee applied under auto-enrolment.

72. Whilst we accept the Government's current rationale for not applying a cap on scheme charges, this approach will only work if all providers act with transparency and offer genuine value for money in relation to charges. During 2012, the pensions industry has an opportunity to demonstrate that it can operate fairly and effectively without a cap on charges. From 2013 onwards, if it transpires that some auto-enrolment providers are applying hidden charges, or charges that represent poor value for money, the Government should use its powers to intervene.

Short service refunds

73. In its December 2011 consultation paper Meeting future workplace pension challenges, the Government announced its intention to abolish the use of short service refunds for defined contribution (DC) occupational pension schemes. It expects the rule change to be introduced by 2014, subject to the parliamentary timetable.

74. Under the current short service refund rules, an individual can receive a refund of pension contributions if they leave an occupational pension scheme within two years. Employers' contributions can remain within the scheme to be used in accordance with scheme rules; for example to cover future employer contributions for other members or scheme administration costs. These employer contributions can therefore effectively be forfeited by the employee to subsidise other members. The Government felt that the short service refunds mechanism did not support the aim of increasing overall saving for retirement, with some individuals never accumulating pension pots.[82]

75. We welcome the Government's intention to ban short service refunds. This measure will help individuals experience the benefits of longer-term saving for retirement and reduce the risk that their employer contributions will be lost.

Active member discounts

76. Individuals can face higher charges for their pension schemes when they are no longer making contributions into that scheme, for example when they have moved to another employer. These higher charges are referred to as "active member discounts" or "deferred member penalties". Some witnesses voiced concerns about this type of charge; for example, The Pension Regulator (TPR) argued that it was "not fair or acceptable"[83]and the TUC called for active member discounts to be forbidden.[84] NEST confirmed that it will not have higher charges for inactive members than for contributing ones.[85]TPR told us that only 2% of trust-based schemes use active member discounts, but that these charges were more prevalent in contract-based schemes, which are expected to grow in number during the implementation of auto-enrolment.[86]

77. Jos Joures, Head of Workplace Pension Reform at DWP, explained that higher charges for inactive members sometimes reflected the fact that the cost of administering them was proportionately higher because the pots were often very small. If higher charges were not imposed for inactive members, it could sometimes mean that existing scheme members were in effect subsidising the administrative costs of deferred members.[87]

78. The Minister explained that the Government has brought active member discounts into the scope of its powers to cap pension scheme charges and said that the premiums applied to deferred members were "sometimes quite hard to justify". However, he suggested that the best way to resolve the issue would be to encourage individuals to consolidate their pension pots into a single scheme, as outlined in the Government's December 2011 consultation.[88] We are likely to return to this issue in our forthcoming inquiry into governance and best practice in workplace pension provision.

79. Active member discounts sometimes reflect the additional costs of administering inactive pensions but can also lead to disproportionately high charges for individuals who are no longer contributing to their scheme. We believe that pension providers should operate a fair balance between active and deferred members and that the Government should consider intervening if this issue is not resolved by greater consolidation of small pots into single schemes.

Annuities

80. Investors in defined contribution (DC) pension schemes use their pension pot to purchase an annuity from an insurer when they retire. This product will provide them with a regular income in retirement. Individuals will only make a single decision in choosing their annuity, and this major financial decision cannot be changed at a later date.

81. A joint report by the NAPF and the Pensions Institute at Cass Business School found that around half a million people retiring each year are receiving reduced incomes in retirement because there are obstacles preventing them from obtaining the best possible deal on their annuity. The report suggested that each annual cohort of pensions loses up to £1 billion in lifetime income as a result.[89] Age UK argued that the annuities market is not working adequately and recommended that savers should be automatically referred to either specialist advice or NEST when they reach retirement.[90] The Pensions Advisory Service suggested that fluctuations in annuity rates could lead to disaffection among individuals and potentially lower levels of participation in retirement saving.[91]

82. As NEST does not offer an annuity product, it is useful to consider its approach to helping its members to find an annuity. If a NEST member has a retirement pot worth more than £1,500, NEST will help them to look for a competitive rate through a panel of different retirement income providers. Their Retirement Tool will collect a range of quotations on how much retirement income different companies from its panel would give an individual in exchange for their pension pot. Members are also free to select another company if they prefer.[92]

83. In March 2012, the ABI launched a compulsory code of practice designed to encourage individuals to shop around for an annuity when they reach retirement. This represents a step in the right direction. Supporting individuals to achieve the best possible deal on their annuities is critical to the success of auto-enrolment and the DC pensions market more widely. We will return to this issue in more depth in our forthcoming inquiry into governance and best practice in workplace pension provision.

Trust-based and contract-based schemes

84. The regulation of workplace pension schemes is split between TPR and the Financial Services Authority (FSA):

TPR is the sole regulator of trust-based pension schemes. These schemes are overseen by a board of trustees who have a fiduciary duty to run the schemes in the best interests of members.
The FSA is the primary regulator of contract-based pension schemes. These schemes are not overseen by trustees and providers do not have the same fiduciary duty. Providers are subject to FSA rules and are also regulated by TPR.

85. FairPensions argued that the regulatory framework should be equally robust for all types of pension provision and that the Government should act to ensure that standards of governance and consumer protection are comparable across the market. They suggested that some employers may see contract-based provision as an "easy option" requiring employers to take on less responsibility. FairPensions recommended that the FSA rules regarding conflicts of interest and obligations towards savers should be strengthened given that contract-based pensions fulfil the same role as trust-based schemes.[93]

86. Some witnesses questioned the existence of two separate regulators for DC schemes. The Investment Management Association said that the respective roles of TPR and FSA were "not totally clear" and suggested that the Government consider options to "rationalise" regulation.[94] The Building and Civil Engineering Benefit Schemes also commented that DC pensions "would benefit from a simple common regulatory framework, regardless of whether it is a trust-based or contract-based scheme".[95] The NAPF told us that "there should be a single regulator for pensions and that should be the Pensions Regulator".[96]

87. TPR assured us that they would work closely with the FSA wherever the regulatory boundaries were drawn. Bill Galvin of TPR also explained that the current structure may make more sense in terms of keeping financial services under FSA regulation: "Looking at the current structure, you would come to the conclusion that it is more important for there to be a single regulator of financial services providers than it is to have a consistent view across all workplace pension provision."[97]

88. The Minister noted that a 2007 review had considered the respective regulatory roles of FSA and TPR, concluding that the bodies should continue with their separate roles. He believed that TPR has developed specialist expertise that may be lost if it was merged into a single "super-regulator".[98] His view was that it would not be advisable to undertake a significant restructuring of the regulatory bodies in the near future. We agree. However the advent of the new financial regulatory regime created by the Financial Services Bill, currently going through Parliament, offers the opportunity for the Financial Conduct Authority (a successor body to the FSA) to look at approaches such as that of introducing something akin to a fiduciary duty for those running contract-based schemes

Scheme governance

89. Witnesses shared some concerns about the effectiveness of governance arrangements for trust-based and contract-based schemes, with some calling for stronger quality criteria or certification to safeguard employees' interests.

90. A report published in 2011 by the Workplace Retirement Income Commission (WRIC) expressed concern about a "governance vacuum" within pension schemes that could lead to schemes not being operated in the best interests of participants.The WRIC noted that in trust-based schemes (overseen by a board of trustees) the trustees are able to oversee pension schemes in the interests of beneficiaries, but the extent to which they do so seems variable. For contract-based schemes (without trustees and associated fiduciary duties) it is usually only the employer who could ensure the scheme was operating in the employees' best interests, and the extent to which they do so is also variable.[99]

91. Evidence from Dean Wetton Advisory, an investment advisory firm, suggested introducing the certification of pension schemes that meet a high standard, as determined by The Pensions Regulator or another body. It pointed out that the NAPF already has a suitable certification scheme that could be used for this purpose: the Pensions Quality Mark.[100]

92. TPR has asked the pensions industry to take part in a dialogue on six principles for good design and governance of workplace DC pension provision. These principles were published in December 2011 and cover issues including fairness, accountability, transparency, effective governance and communication with members. TPR has stated that these principles will "form the basis of its regulatory approach going forward".[101] Its Chief Executive, Bill Galvin, told us that they would discuss the principles with the pensions industry before coming up with "hard proposals" about what they should look like for different parts of the pensions market.[102]However, it is not yet clear how TPR will act to ensure that these principles are adopted by pension providers or that TPR has the powers needed to enforce these principles. We will return to this issue in more detail in our forthcoming inquiry into workplace pension governance and best practice.

62 The Pensions Regulator (2012), Pension schemes: pension schemes under the new employer duties Back

63 ibid. Back

64 Financial Services Authority and The Pensions Regulator (2007), A guide on the regulation of work place contract-based pensions Back

65 New Zealand Inland Revenue, KiwiSaver for scheme providers, www.ird.govt.nz Back

66 KiwiSaver, Choosing your KiwiSaver scheme, www.KiwiSaver.govt.nz Back

67 Employees enrolled in NEST will pay a 1.8% contribution charge and a 0.3% annual management charge. Back

68 Ev 147 Back

69 Q 125 Back

70 Q 233 Back

71 Q 124 Back

72 National Association of Pension Funds (2011), Making Pension Charges Clearer Back

73 Ev 147 Back