DC Debate Q1 (part 2): How can the industry create value for savers?

Does the charge cap need revisiting?

John Reeve: I would suggest that any industry that tries to regulate itself by controlling prices is doomed to failure. This is a strategy that will inevitably lead to a race to the bottom in terms of quality, service and value for money. If we were to limit the price of burgers, you can be sure they would soon contain even less beef.

Expectations are already leading to norms of 0.5 per cent or even 0.35 per cent. This will stifle innovation. What we need is more focus on a broader range of measures such as net returns, diversifying portfolios, and value for money.

It would be better to revisit the charge cap in 12 months’ time, by which point we should have more visibility on the reviews into asset management, auto-enrolment, transaction cost disclosure and the pension schemes bill

Helen Ball, Sackers

Helen Ball: We need to wait for the dust to settle, as the cap has only been in place for two years so far. If we change it there will inevitably be some kind of consequence – a greater number of investment strategies switching to passive funds, or the volume of member communications being reduced, or simplified administration services becoming standard fare, with employers having to pay for add-ons.

There is too much going on with the current reviews into asset management, auto-enrolment, transaction cost disclosure and the pension schemes bill to know what the implications could be. It would be better to revisit the charge cap in 12 months’ time, by which point we should have more visibility on these issues.

Simon Chinnery: While there is a review being undertaken this year of the charge cap that applies to auto-enrolment scheme default funds, evidence to date shows that many investment products and blended defaults are coming in well below the 0.75 per cent cap. It would therefore seem that market competition is doing its job in keeping a strong focus on fees.

The challenge to deliver well-diversified default solutions in auto-enrolment has already been met, but if DC default design should be able to access the wider assets available, such as illiquid alternatives, then continuing price compression may result in less completion and asset-restricted funds.

Laurie Edmans: What matters most to members is the outcome at retirement relative to their needs and expectations. The importance of gaining a small percentage of extra investment performance or marginally reducing charges fades into insignificance compared with the importance of (affordable) contributions that can deliver an outcome at retirement in line with expectations.

A cut to the charge cap that reduces the ability of providers and others to engage people would be counterproductive. It is a fat lot of good being surprised by a totally inadequate pension pot, to be told, ‘But the charges were low’. An increase to enable more complex investment offerings would be difficult for me to rationalise, though. A better understanding is needed of what charges are spent on, not just how much is taken.

Alistair Byrne: The charge cap provides an important backstop in ensuring value for money in smaller and older schemes, but market competition means most savers in workplace schemes are already paying less than the cap.

The variable nature of transaction costs depending on market conditions means they are better dealt with by disclosure – as is being planned – than inclusion in the cap. The DC market will also benefit from a period of regulatory consistency and stability.

Laura Myers: The flat charge cap approach we have at the moment needs to be reviewed as it leads to disparities in what DC schemes can achieve.

In particular, it hampers what they can invest in, especially for bundled schemes. These schemes are forced into certain assets and funds, and consequently will not be able to use many investment innovations. Unfortunately, I think this will reduce member outcomes for those schemes.

We also need stronger regulation on disclosure of all costs – so it is clear what members are paying. Even with the charge cap we do not have anywhere near enough clarity on costs.

Andy Dickson: Given that millions of new employees are being enrolled into pension schemes for the first time and also that the employee is not usually involved in the buying process of the DC scheme, it is important that some protection is in place. It is therefore quite logical that the charge cap should indeed be revisited over time to ensure it is meeting the original objectives.

That said, a period of fee stability would be helpful to allow for innovation. The DC landscape has changed remarkably with the advent of freedom and choice. The macro-economic and political backdrop is also continually changing.

It is important there remains sufficient fee ‘headroom’ to allow DC savers to access a wide range of investment opportunities that will support their retirement needs so they are not left solely to the mercy of market beta.

Neil McPherson: The cap enforces a valuable discipline: that fees and transparency matter. The cap was brought into being to protect members from high, opaque charges eroding returns by stealth.

There is talk that it has had the unintended consequence of eroding returns by restricting members’ access to the latest investment techniques. They are only restricted because providers will not lower their pricing. At the margin there may be some higher incremental cost, but the overwhelming cost is manager compensation.

So it is about profit, which brings you back to why the cap was introduced in the first place. Moreover, it applies to the default fund. Investment innovations can be offered without the cap alongside the default fund, with a focus on communicating to members why it is worth paying more.

Has the DC world come any closer to defining what constitutes value for money?

Reeve: It has got further away from what the public considers represents value for money. The industry is still fixated with returns. However, those investing in DC arrangements are increasingly millennials, who view the world very differently from the way we did at their age. Increasingly, members of DC schemes want to see their savings being used to do good rather than focusing entirely on return.

While the industry has been questioning what allowance they can take of service and cost transparency in assessing value for money, the conversation has moved on. In my discussion with millennials, they have indicated that they would happily pay a little more in charges to be sure that their money was being invested where it can do some good as well as earn them a reasonable (not necessarily maximum) return.

Ball: DC trustees and independent governance committees are getting more confident at assessing value for money. However, we need to collectively encourage greater flexibility and less of a tick-box approach.

Genuine and careful assessment of the member needs for each scheme requires further development, as trustees are often faced with fairly standardised consultancy services in this area.

There is also a lack of comparable information on costs and charges, and some timidity or passivity in challenging and developing the ‘next steps’ suggestions that trustees can sometimes receive as a means to improving value. Greater experience will lead to better assessment over time, as this is not something that will be achieved overnight.

Chinnery: The work undertaken by various independent governance committees has definitely helped to expand this definition beyond merely equating the level of fees as to what constitutes good value for clients.

Edmans: Not yet, but – thanks largely to the work of IGCs, many of which have realised that improving member outcomes is not just about cutting costs – a sound, member-based view of what constitutes value for money, using techniques developed in markets outside financial services, could become clearer.

Whether the market and policymakers are ready for the conclusions will be interesting. The DC world is still in its infancy. The obvious UK problem is inadequacy, and considering only ‘hard measures’ – investment vehicles, charges – will not change that.

Turner saw using inertia as the only answer to disengagement. Is that a good enough answer 10 years on? Most perceptions of value for money implicitly assume as much. People retiring with unfulfilled expectations will not look kindly on an industry and policies which took a two-dimensional view.

Byrne: It remains a challenge to define precisely. From an investment perspective returns net of fees, charges and transaction costs are the key metric, though this should be adjusted for risk as many members and fiduciaries will value a smoother journey. Members will also benefit from clear communication and good customer services when they engage with their scheme.

Myers: With the introduction of the new guide by the Pensions Regulator in the latest Code of Practice 13, the industry is now more comfortable around what constitutes good value for members.

While this area is still subjective – and it is at the discretion of each trustee body to decide – in practice what is required is just an analysis on what benefits the scheme provides members versus the costs the members pay. The power of this analysis is in getting data to compare what you currently provide to other similar schemes. You will then be able to act on any areas identified for improvement.

Dickson: We sponsored independent research on this topic last year, undertaken by the Pensions Policy Institute, to help support the industry with this question. The conclusion of the research was that no single individual factor determined value for money in DC workplace pensions.

McPherson: There is a great deal of thought and effort being put into value for money, which is admirable, and the decision not to impose a definition by the regulator was a good one, but I do not feel we have made a massive leap forward. Aside from well accepted tenets such as, ‘It’s not just fees’ and the need to include administration, communication and consider quality as being worth paying for, we are yet to see the eureka moment.

The debate will continue to evolve and the forthcoming chair and IGC statements will provide a good indication of how thinking has developed. Best practice will result from experience and more regulatory guidance.

How will the dashboard change pension saving?

Reeve: I hope that the existence of the dashboard will enable the industry to better engage with people and to raise the level of the conversation. There is a danger that the dashboard gives a false sense of security. The general public massively underestimates the amount they need in retirement. Innovation by providers, regulators and educators will be needed to move away from the idea that information is knowledge and that this automatically leads to good decisions.

Instead we need to build on this extra information to create a holistic view of a person’s circumstances to help them make informed decisions. Pensions are just one part, and we need to stop being so arrogant as to think that pensions are different from savings. The dashboard is a vital but small part of the change that is needed.

We need to stop being so arrogant as to think that pensions are different from savings

John Reeve, Cosan Consulting

Ball: Technology will change pension saving. Automation, efficiency and higher expectations of immediate access to information will feed members’ interest in their pension savings, particularly when higher automatic enrolment contribution rates come in, pot sizes increase and members feel more personally invested.

This will happen when fewer employees will have a traditional DB benefit as their back-up pension arrangement.

The success of the dashboard will depend on its scope, ease of use, simplicity of approach and degree of support from employers and financial institutions.

If the drive to scale in DC pensions continues, with mastertrusts and larger DC schemes operating the lion’s share of DC provision, the dashboard could work out really well.

But this will only work if everyone buys into the concept, and is willing to invest time and resources in making it a success.

Edmans: Radically, I would hope, once it has worked its way into the public consciousness. The key thing which makes a difference to people in a DC world is if they know where they stand; most people do not. The pensions dashboard can change that.

Of course, ideally it would be a retirement dashboard, not just a pensions dashboard. But it will be a huge leap forward and a platform, in this digital age, for future developments.

Allied to other engagement and communications activity, it could make pensions turn the corner.

Byrne: Retirement savers often struggle to understand what they have and whether they are on track for the retirement income they desire. The dashboard should help them understand where they have got to on the journey.

That said, inertia and lack of engagement will still be an issue in promoting saving. Better information, such as the dashboard, will still have to be used alongside nudges like auto-enrolment and auto-escalation.

Myers: The dashboard will be a great help to members, particularly around helping them to make sensible decisions on key choices such as the amount to save into their pension and what to do with their pot at retirement.

At the moment, members do not often have complete knowledge of all their pension savings and that is understandable when the average person in the UK is expected to accumulate 11 workplace pensions in their lifetime.

If the dashboard is successful, it will really help members to trace their savings and have full knowledge of all their retirement savings, which will ultimately lead to better decisions.

Dickson: This is a great initiative and has the potential to transform millions of people’s understanding of how much pension savings they have and as a result, how much they need to save for their future.

For most people, trying to understand how much pension savings they have can be really difficult unless they transfer to their latest employer. We also know that most people do not do this.

Currently there is not really any mechanism or way for people to see all their pension savings collated into one place. The dashboard aims to provide this.

McPherson: I doubt it will change pension saving and have serious doubts that it will ever get off the ground in a meaningful form. That is not to say it is not a noble idea. The trouble is, it should have been thought of and implemented decades ago.

The dashboard is being developed under the auspices of the Association of British Insurers and will be effectively funded by the insurers, who will, unsurprisingly, want some return from their investment.

Their previous foray into consolidation with corporate platforms received a lukewarm response from the target audience. The providers will be wary of this new initiative unless there are clear long-term benefits.

Moreover with cross-industry IT projects, there is a real danger that the original aims drown in a sea of self-interest and IT complexity. The project must be driven by, and retain focus on, customer outcomes rather than how the plumbing might be put together.