Pension costs and transparency Contents

1Workplace pensions

Defined Contribution Pension Schemes

8.In a defined contribution (DC) pension scheme, an individual builds up an investment pot through contributions made by them and their employer. The value of the investment pot will change depending on returns, losses and charges. The individual carries the “funding risk” of these changes in value and their employer will not cover any losses in the event that the value of the investment pot falls. At retirement, individuals can turn the value of their investment pot into an income through options such as annuities (insurance products guaranteeing an income) and drawdown (withdrawing a proportion of the investment pot as cash).

9.Membership of DC schemes, already increasing, has increased significantly since automatic enrolment started in 2012 for the largest employers. Since February 2018, it has been compulsory for all employers automatically to enrol all eligible workers into a workplace pension scheme. In January 2019, the number of eligible jobholders enrolled into an automatic enrolment pension scheme rose above 10 million for the first time.4

10.Pension providers are able to charge individuals for holding their investment pots. No cap on charges was set at the outset of automatic enrolment, but the Pensions Act 2008 allowed the Department for Work and Pensions (DWP) to set a charge cap, should these charges reach inappropriately high levels. In its 2012 report on automatic enrolment, our predecessor Committee recommended that the Government should consider using its powers to intervene from 2013 onwards. It recommended that:

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.5

11.That Committee made a further recommendation on charges in its April 2013 report on improving governance and administration in workplace pension schemes, saying:

We further recommend that the Government carefully monitors the level of pension scheme charges more generally and reviews its position on capping charges in auto-enrolment schemes frequently, at least bi-annually, commencing in 2014. It should act without hesitation if it becomes apparent that some pension scheme members are at risk of detriment from high charges.6

12.The Government consulted on charge caps in October 2013 and announced in March 2014 that it would set an annual charge cap of 0.75% for DC schemes which are used for automatic enrolment from April 2015. The charge cap covers all member-borne charges and deductions, but excludes transaction costs.7 There are three permitted charging structures under the charge cap:

a)a single percentage charge–capped at 0.75 per cent of funds under management annually;

b)a combination of a percentage charge for new funds when they are contributed to the pot plus an annual percentage charge for funds under management;

c)a combination of an annual flat fee plus an annual percentage of funds under management charge.8

13.Guy Opperman, the Minister for Pensions and Financial Inclusion, announced in November 2017 that the charge cap was broadly working as intended and that it was not the time to change the level or scope of the cap.9 At the same time the Minister said that “In 2020 we intend to examine the level and scope of the charge cap, as well as permitted charging structures, to see whether a change is needed to protect members.”

14.Our predecessor Committee was warned in 2011 by the then Minister for Pensions that a cap might become the standard level for charges.10 Since the cap was introduced, however, providers do not seem to have increased their fees to the level of the cap. The DWP has found that charges in schemes qualifying for automatic enrolment are below the 0.75% charge cap, with members of trust-based schemes paying 0.38% on average and contract-based scheme members paying an average of 0.54%.11

15.Concerns have, however, been expressed about some charging structures permitted within the cap.12 The different maximum permitted charging structures can lead to different sized investment pots under otherwise identical conditions. Table 1 shows an example of how this might affect those who make continuous contributions at both the minimum and maximum automatic enrolment levels.

Table 1

16.There is a significantly different impact for dormant investment pots. As Table 2 shows, maximum charges under the different permitted charging structures give widely different results depending on the size of the pot. Smaller investment pots can be completely wiped out under the flat fee charging structure, even with a reliable annual return. With a reliable 5% annual return for 40 years, a dormant pot of £300 could be worth anything from £1,720 to £0 depending on the charging structure.

Table 2

17.PensionBee, an online pension manager, raised concerns with us about the flat fee charging structure used by the master trust NOW: Pensions, stating that:

NOW: Pensions have 1.6 million savers, with average pots of c.£300. NOW: Pensions have a unique charging structure, in that they charge a £1.50 admin fee, per month, per member, on top of 0.3% annual management charge.13

A £300 pot under NOW: Pensions’ charging structure would require an annual return of around 6.5% to maintain its nominal value.

18.NOW: Pensions told us:

We do not believe that it is appropriate for all members to pay a blanket percentage charge determined by how much they have invested in their pension fund for two reasons. Firstly, it is impossible to identify how much of the charge is used to pay for investment management, and how much for scheme administration and communication. Secondly, the larger the member’s fund, the higher the charge. This leads to the cost of running the scheme for members with small funds being significantly subsidised by those with larger funds, who are typically closer to retirement.14

19.The charge cap of 0.75% on defined contribution pension schemes used for automatic enrolment does not appear to have caused charges to rise to the level at which it was set, with average charges being between 0.38 and 0.54% depending on the scheme type. But not all charges are covered by the cap, and the full extent of charges outside the cap is not known. That makes it impossible to know how well the cap is working in practice.

20.We are concerned that permitting a combination of a flat fee plus a percentage of funds under management charge has the potential to completely erode small dormant investment pots. If this were to happen, many savers’ confidence in automatic enrolment could be fatally undermined.

21.We recommend that DWP review the level and scope of the charge cap, as well as permitted charging structures, in 2020. The review should consider preventing flat fee charging structures being applied to dormant pension pots and revisit measures to proactively consolidate smaller pots.

Defined Benefit pension schemes

22.In a defined benefit (DB) pension scheme, an individual receives a specified regular pension income at retirement. Both the employer and employee contribute to a collective fund from which the income is drawn. The income will depend on factors including length of service and contributions. The employer sponsoring the scheme is responsible for funding any shortfall if the collective fund is insufficient to meet the specified pension incomes. Defined benefit schemes have largely been in decline, with the number of active memberships falling by 49% between 2010 and 2018.15

23.Provided that a defined benefit scheme remains well funded, then the associated costs of the scheme’s investments do not have a direct impact on its members. Charlotte Clark, Strategy Director for Private Pensions at DWP, told us:

While I do not want to be dismissive of it, there is no member detriment if they (DB schemes) get it wrong. There is if they get the investment wrong, but not the charges because ultimately those are borne by the employer.16

24.Many DB schemes in the UK are not well funded, with 63% in deficit.17 A large number of these schemes have closed to new members and many members have seen changes to their benefits to make their schemes more affordable. If those schemes had been better funded, these decisions may have been avoided.

25.In most cases, members of defined benefit pension schemes are not directly impacted by the costs or investment decisions of their scheme. However, in an environment in which many defined benefit schemes are in deficit, being closed to new members or reducing member benefits, it is important that the same scrutiny to value for money is given by trustees as it is for defined contribution schemes. Better scrutiny of value for money in defined benefit schemes will either justify or avoid the need for the often difficult decisions being taken about the future of pension schemes.

The role of Trustees and Independent Governance Committees

26.Pension schemes can be either trust-based or contract-based. A trust-based scheme is governed by a trustee board with a fiduciary duty towards the scheme’s members. Contract-based schemes are governed by a provider who has contracts with individual scheme members.

27.Trust-based schemes are regulated by the Pensions Regulator (TPR) and include DB schemes and some DC schemes. DC trust-based schemes include DC trust schemes run by a single employer and master trust schemes run by a single provider open to multiple employers.

28.Contract-based schemes are regulated by the Financial Conduct Authority (FCA) and include: workplace personal pension schemes (workplace DC schemes run by a provider for a group of employees from a single employer) and individual personal pension schemes (DC schemes run by a provider for individuals).

Independent Governance Committees

29.Since April 2015, providers of FCA-regulated workplace personal pension schemes have been required to appoint an Independent Governance Committee (IGC).18 IGCs have a duty to scrutinise the value for money of the provider’s workplace schemes, raising concerns and making recommendations to the provider’s board as appropriate. IGCs must act solely in the interests of scheme members, and act independently of the provider. An IGC has a minimum of five members, the majority of whom must be independent of the employer, including an independent chair.

30.IGCs were introduced in the wake of a 2013 Office of Fair Trading (OFT) market study of workplace pension schemes in the context of automatic enrolment.19 The study revealed competition problems in the pension investment market, including those managing the schemes offering a “very weak buyer side” in negotiations, complex products, and the potential for conflicts of interest. As part of its findings, the OFT estimated that £30bn of customers’ money was exposed to risk of poor value.20

31.Pritheeva Rasaratnam, Head of Pensions and Funds Policy at the FCA, told us that the FCA and DWP assessed the effectiveness of IGCs in 2016. The 2016 assessment found that IGCs had “reduced charges on £20 billion of those assets to below 1%” and in December 2017 the FCA and DWP found that IGCs “had reduced charges below 1% on a further £4.9 billion of those assets”.21 The 2016 joint review by the FCA and DWP found that IGCs were “generally effective… by influencing, supporting and advancing the reduction in costs and charges that has been achieved so far.” It noted, however, “specific instances” where IGCs “could have played a more proactive and rigorous role in driving providers to agree robust actions more quickly.”22 In the light of this broadly positive initial verdict, the FCA announced that it would postpone its plan to conduct a full review of the effectiveness of IGCs.23

32.In February 2018, a study by the investment transparency campaign group ShareAction examined the quality of the work done by IGCs for 16 of the largest UK pension providers. ShareAction concluded that IGC assessments of value for money were often “vague and offer only unsubstantiated claims that savers’ interests are being protected [ … ] In a number of cases, IGC reports provide insufficient information to enable savers to understand the value for money they are getting.”24

33.Others were positive about the role IGCs have played. Royal London, a mutual life, pensions and investment company, told us that the measures are proving effective and that “IGCs have secured reductions and removal of charges from providers on workplace pension schemes including ourselves where we have capped some charges and removed others like some policy fees.”25

34.Independent Governance Committees are now established and fulfilling a necessary role. It is the right time for a comprehensive review to take place. We note that the FCA is now planning this review, having previously postponed doing so. In the light of the concerns which are being expressed about the work of some Independent Governance Committees, the FCA must not postpone this any further.

Information provided to Trustees and Independent Governance Committees

35.Although trustees may delegate their day-to-day investment decisions to an authorised fund manager, they remain responsible for the investment strategy which the scheme’s fund managers must follow. The Pensions Regulator states that trustees should set up appropriate procedures to review:

a)the fund manager’s performance in accordance with the targets or mandate trustees have set them; and

b)the fees and management charges they are levying.26

The FCA similarly requires that IGCs assess the levels of charges, both direct and indirect, borne by relevant policyholders, including transaction costs.

36.The evidence we received questioned how effective these requirements have been in practice. Dr Anna Tilba, an Associate Professor in Strategy and Governance in Durham University Business School, told us:

… persistent inefficiencies in pension fund governance and lack of trustee understanding of operating costs of pension funds are eroding future retirement incomes. This is coupled with asset managers’ unwillingness to disclose all the explicit and implicit costs attached to each investment.

Yet, it is near impossible for investors to figure out how much their investments are costing them because additional costs are hidden and too high.27

37.Colin Meech, National Officer at UNISON, gave a worrying account of the difficulties schemes experienced in identifying costs. In the Netherlands, a template is used across the industry to identify pension scheme costs. When Mr Meech asked for the cost template used in the Netherlands to be completed by investment managers in the UK:

Everyone was saying, “Why are you interested in costs because it is performance that matters”? … We had five managers. Three of them took 11 months to fill it out and two point-blank refused to fill it out.28

Mr Meech argued that there had to be a legal compulsion for fund managers to use an industry template because “otherwise people can avoid” providing the data.29

38.Mr Meech went on to note that many schemes are simply not aware of their costs. The West Midlands Local Authority scheme volunteered to run a template spreadsheet to collect data on costs. The scheme had a £12 billion fund and £10 million reported on asset management fees. Mr Meech told us that “After the exercise, they had to restate that, from £10 million to £92 million, and they got £10 million back” and said that “If you do not understand your real return, you cannot change strategy; you cannot work out whether you are getting the best value.”30

39.The Institutional Disclosure Working Group (IDWG) was established by the FCA as a group of industry and investor representatives to address costs transparency under the independent chairmanship of Dr Chris Sier.31 The IDWG was tasked with developing a set of standardised cost disclosure templates for asset management services to provide to institutional investors.

40.The IDWG began its work in September 2017 and made its final recommendations to the FCA in June 2018. Its recommendations included: the use of five templates at different levels of detail and covering all asset classes; that use of the templates should be voluntary but encouraged through other means; and that a new body or group should be created and convened by autumn 2018 to curate and update the framework.32

41.Witnesses had mixed views about whether the common template would be sufficient. Dr Chris Sier said that the proposed template would address transparency needs because it dealt with the root causes of the problem and created a set of data standards which would remove the risk of trustees not knowing what to ask for. In addition, he said that:

The recommended framework is also supported by the FCA and carries that gravitas, but the most important reason why I think it will work is that the committee that I chaired was made up of senior representatives of the asset management industry, all of whom signed up to agree, on behalf of the industry, to adhere to this data collection standard, and this is very important… It will be very hard for an asset manager, when asked for this data, to say no.33

42.However, Dr Sier added that “the next problem we have to face is how we get trustees to ask for the data”.34 Andy Agathangelou, founding Chair of the Transparency Task Force, said that in his view, “we are a long, long way from solving the problem, and it would be a huge mistake to underestimate how much more work needs to be done”35 and that it was “a high-risk strategy to not move towards a mandatory framework” for disclosure of costs.36 Colin Meech, National Officer at UNISON, noted that “in the Netherlands it is a compulsory process” and added “That is what we need.”37

43.The Investment Association (IA) told us that the investment management industry “fully supported” the work of the IDWG to develop a common template for cost disclosure to trustees and that, as a result of recent regulatory change, and the IDWG work, it was “confident that full transparency is being achieved and that pension fund trustees and IGCs will have the information they need to help inform their decision making in relation to investment”. The IA added that cost transparency “is a foundation of trust, particularly in the post-2008 environment”.38

44.In November 2018 the Cost Transparency Initiative (CTI) was launched with support from the Pensions and Lifetime Savings Association, IA and Local Government Pension Scheme Advisory Board. The CTI was given responsibility, by the FCA, for progressing the IDWG’s work on the templates. The CTI is chaired by Mel Duffield, Pensions Strategy Executive at the Universities Superannuation Scheme. The CTI set out to:

Provide a clear voice for the interests of asset owners as we improve cost transparency.

Run a pilot phase to test the new cost transparency templates and supporting technical and communications materials until early 2019.

Following the pilot, roll-out the templates to the asset management and pensions industries to encourage fully transparent and standardised cost and charge information for institutional investors.39

45.The CTI’s standards were launched on 21 May, after we had concluded our evidence gathering. The standards include templates and guidance to report pension scheme costs and charges in a standardised format.40 At the launch of the standards, Mel Duffield, Chair of the Cost Transparency Initiative, said:

We will now push for wide-spread adoption of the templates and guidance over the next 12 months and promote the benefits both savers and pension fund trustees’ can experience from their use. The Board will review the take-up of the templates and guidance after the end of the reporting period in April 2020 and will be working closely with Government, regulators, and industry to ensure high adoption levels in the interim.41

Guy Opperman, Minister for Pensions and Financial Inclusion, said:

I’d strongly encourage trustees and investment managers to embrace the Cost Transparency Initiative and adopt the new templates. The Government will legislate robustly to make this happen if the industry does not resolve this on a voluntary basis at speed.42

46.We have received worrying evidence that some trustees are making investment decisions without a clear understanding of how much those decisions cost. It does not appear that these are isolated cases. We welcome the proposals put forward by the Institutional Disclosure Working Group to address this through increased costs transparency. Now that the Institutional Disclosure Working Group’s successor, the Cost Transparency Initiative, has published the disclosure templates, the measure of success will be how quickly and comprehensively they are adopted.

47.We recognise that there is not a perfect one-size-fits-all model for reporting costs and that developing templates is an ongoing process. The Minister for Pensions and Financial Inclusion warned the industry that, if they fail to embrace the Cost Transparency Initiative, the Government would respond by legislating. We are not convinced that this will provide sufficient incentive to achieve a high take up through voluntary disclosure.

48.We recommend that the Government bring forward legislation to make the disclosure templates mandatory for both defined contribution and defined benefit schemes.

49.We recommend that, to avoid poor quality and untimely data, the disclosure templates are supported by an independent verification process. Compliance should be overseen by the relevant regulators, who should be given any additional powers they might need to tackle non-compliance.

50.We recommend that schemes should be supported to collect additional information if the template does not fully cover their individual scheme needs. This information should be available for scheme members as part of the wider information provided on value for money including information on exit charges and any other costs associated with transfer of their pot. The FCA should explore the creation of a public register of asset managers’ compliance records with reasonable data requests.

Value for money

51.We repeatedly heard in evidence that there is no clear definition of what good value for money means for pension schemes. Perceptions of value for money will vary depending on the perspective being considered and attitudes to risk, return, costs and other factors. Several submissions stressed that costs are only one part of the value for money equation. Partners Group, a private equity firm, told us:

The DC market in the UK has evolved in such a way that “cost” has been mistaken for “value for money”. Trustees and other stakeholders are incentivised to choose the lowest cost product rather than the best performing (possibly more expensive) product, due to the impression that if something goes wrong they are then less likely to be held accountable.43

52.The DWP said that “The Government has not sought to be prescriptive about what trustees should consider value for members to be, or to impose a single common definition of value for money.”44 In a joint letter the Minister for Pensions and Inclusion and the Economic Secretary to the Treasury told us:

There is a trade-off to be struck here. For a higher long-range return, members will need to take more risk. That will mean more volatility in the value of their pension pot on their pension journey–but memberships will have different attitudes to risk, and may be able to tolerate more or less volatility in the value of their pot.45

The Ministers also said that members may also value the quality of communication, online tools and the scheme’s investment strategy. Other factors raised to us included: customer service, communication with members and environmental, social and governance (ESG) factors.

53.In its Investment Consultants Market Investigation, the Competition and Markets Authority (CMA) raised concerns about the information given to trustees, finding that:

Investment performance is often reported on a gross of fees basis which does not reflect the real outcome for the pension scheme.
Information on fees provided by fiduciary managers to current customers lacks sufficient clarity with fees for the fiduciary management service often bundled with the underlying asset management fees.
It is difficult for prospective fiduciary management to compare across providers due to a variety of methods used to calculate investment performance.46

54.The CMA put forward proposals to address these problems, including:

Trustees will need to run competitive tenders with at least three fiduciary managers if they delegate more than 20% of their investment decisions. Those who have already appointed a fiduciary manager must put the service out to tender within five years.
Fiduciary management firms must provide potential clients with clear information on their fees using a standard approach to show performance.
Investment consultancy firms offering fiduciary management services will be required to separate their marketing of fiduciary management from their provision of investment consultancy advice.
Pension scheme trustees will be required to set strategic objectives for their investment consultant so that they are able to judge the quality of their service.47

Those recommendations came into effect in June 2019.48

55.The CMA further recommended that “the FCA should maintain oversight of the transparency of asset management fee reporting, in order that the progress made by the Institutional Disclosure Working Group is maintained”, TPR should produce guidance to help trustees using these services and that legislation should enable TPR to oversee the new requirements on trustees.49

56.ShareAction, a charity promoting transparency and responsible investment practices by pension funds, told us in written evidence that “Greater transparency and more targeted, engaging communications will put consumers and consumer interest groups in a better position to judge whether they are getting value for money from their scheme.”50

57.Trustees of trust-based DC schemes are required to produce an annual chair’s statement. Since April 2018, these statements are required to include additional information on charges and transaction costs and to make this information available free of charge on a publicly-accessible website. Failure to produce a compliant statement results in an automatic mandatory fine of between £500 and £2,000 from the Pensions Regulator.

58.The Pensions Regulator has set out its expectations on charges and transaction costs:

The charges and (where available) transaction costs borne by members in respect of each individual fund throughout the scheme year should be clearly set out, perhaps in a table so it is clear which relate to the default arrangement(s) and which relate to the non-default arrangement(s)

We expect the trustees to confirm in the statement that they have taken account of statutory guidance when preparing this section of the statement and, if applicable, explain why they have deviated from the approach set out in that guidance.51

59.Trustees are also required to give an assessment of the value they have provided the scheme’s members. The Pensions Regulator expects this to show either that:

the trustees have concluded that the scheme is offering value for members and have explained how they reached this conclusion, or

the trustees have concluded that the scheme is not offering value for members, have set out why and what action they are taking to address this, eg improving value for members within the current scheme or exploring transition to an alternative arrangement.52

By November 2019, all relevant schemes will have to have met the new requirements for chair’s statements.

60.There is no agreed definition of what is meant by value for money in the pensions industry. Although individual schemes will need to vary their value for money goals, without agreed definitions it is not possible to make effective comparisons.

61.We fully recognise that value for money is not solely about costs, but costs inevitably form an important part of the equation. Complexity and layers of intermediaries mean that many trustees do not have access to suitable information to make judgements about the costs of managing their schemes. Schemes should clearly communicate their interpretation of value for money, and how it will be achieved, to their members.

62.The Competition and Markets Authority’s Investment Consultants Market Investigation final report, published during the course of this inquiry, contains welcome proposals to address conflicts of interest and cosy relationships between schemes and asset managers, and to ensure that trustees are actively seeking value for money.

63.We note that the Government legislated in February 2018 to require occupational defined contribution schemes to publish their assessment of value for members and that all schemes will have published their assessment by November 2019.

64.We recommend that the Government reviews the initial impact of requiring occupational defined contribution schemes to publish their assessment of value for members in 2020. The review should assess whether or not this requirement leads to better scheme focus on achieving value for money and better communication to scheme members about value for money.

4 The Pensions Regulator, Automatic enrolment, declaration of compliance report, July 2012 - end April 2019, May 2019, p2

5 Work and Pensions Committee, Eight Report of Session 2010–12, Automatic enrolment in workplace pensions and the National Employment Savings Trust, HC 1494, March 2012, para 72

6 Work and Pensions Committee, Sixth Report of Session 2012–13, Improving governance and best practice in workplace pensions, HC 768-I, April 2013, para 45

7 DWP, Better workplace pensions: further measures for savers, Cm 8840, March 2014, p40

8 DWP, The charge cap: guidance for trustees and managers of occupational schemesv, March 2015, updated October 2016, pp 5–6

9 DWP, Pensions: Written Statement - HCWS249, 16 November 2017

10 Work and Pensions Committee, Eighth Report of Session 2010–12, Automatic enrolment in workplace pensions and the National Employment Savings Trust, HC 1494, March 2012, para 68

11 DWP, Pension Charges Survey 2016, October 2017

12 Written evidence from PensionBee (PCT0012)

13 Written evidence from PensionBee (PCT0012)

14 Written evidence from Now: Pensions (PCT0029)

15 The Pensions Regulator, DB Pensions landscape, 2018, p3

16 Q236

17 Pension Protection Fund, The Purple Book, December 2018, p24

18 Financial Conduct Authority, Independent Governance Committee, first published 23 February 2016, updated 20 May 2019

19 Office of Fair Trading, Defined contribution workplace market study, September 2013

20 Ibid., para 1.19

21 Q170

22 DWP and Financial Conduct Authority, Remedying Poor Value Legacy Workplace Pension Schemes: Findings from the Joint Review of Industry Progress against the Independent Project Board Recommendations, December 2016, para 5.2

23 Financial Conduct Authority, Annual Report and Accounts 2016/17, 5 July 2017, p29

24 ShareAction, Who Watches the Watchers? Transparency and Accountability in Workplace Personal Pensions, February 2018

25 Royal London (PCT0046)

26 The Pensions Regulator, Trustee Guidance, issued December 2007

27 Dr Anna Tilba (PCT0027)

28 Q74

29 Q75

30 Q75

31 Financial Conduct Authority, Institutional disclosure working group, first published 8 September 2017, updated 9 November 2018

32 Institutional Disclosure Working Group (IDWG), Report to FCA, June 2018, p4

33 Q4

34 Q7