DC consolidation and small pots limit can reduce value for money

In a report published on Wednesday, the research body analysed how pension schemes and members fare under non-capped and capped charging structures.

One of the conclusions of the study, sponsored by B&CE, the provider of The People’s Pension, is that the new regulations dictating that pots worth less than £100 cannot incur flat fees from April 2022 may result in these being subsidised through increased charges on larger pots. This is likely to result in higher charges for members with the latter, the report warned.

“For providers targeting the automatic enrolment market, most new members (who have not transferred existing funds in) will pass through the stage during which flat fees cannot be charged, increasing the strain on their existing book,” it said.

This research shows how significantly charges can impact retirement incomes. With charges generally lower in workplace pensions than in retail, for many people thinking about transferring out of lower-cost workplace pensions it would be better to stay put

Phil Brown, B&CE

This balance is further strained when pots that provide the cross-subsidisation are transferred out of the scheme to other providers through consolidation, it added.

The report stated that the master trust industry is unlikely to achieve breakeven on costs until around 2025 without the application of a combination charge.

In 2019, the cost to administer a deferred pot was £13 and for an active pot this rate stood at £19.60. To cover these costs, at an industry average charge of 0.48 per cent of funds under management, these require pot sizes of £2,700 and £4,100 respectively.

“Where there is greater need for providers to support the costs of small pots, this will divert the charges taken from members who remain saving with automatic enrolment providers,” the report stated.

“This will, effectively, reduce the value for money that they derive from their charges as a greater amount may be used to support other members.”

Variation on charges persists

Although the difference in charges between auto-enrolment schemes and those outside the scope of the cap has reduced in recent years, there is still significant variation in the fees levied by schemes outside of the cap.

Tim Pike, head of modelling at the PPI and author of the report, noted that the government responses following the charge cap consultation launched in January 2021 “resulted in several proposals about future policy on charges in qualifying schemes”.

He said: “While the government has not taken any policy decisions regarding the proposal to introduce a single permissible charging structure, they are considering their next steps.” 

Proposals for a single charging structure for auto-enrolment should introduce greater simplicity and easier comparisons across the market. However, it could widen the gap between these schemes and those operating outside of the charge cap, the report stated.

“This will alter the balance of how different schemes provide value for money for their members,” Pike added. 

Employer decisions not driven by charges

One of the key findings of the report is that scheme selection and fund choice by employers is not primarily driven by charges.

Member charges for auto-enrolment schemes depend on the commercial considerations of providers, with a number tailoring their charges as a response to employer needs.

The report found that many employers — most notably small and micro-companies — engaged with advisers when implementing auto-enrolment and choosing a scheme. 

For these advisers, the factors that influenced their selection of a provider related to ease of set-up and use, simplicity, and the perceived reliability of the scheme.

These primary considerations were favoured and prioritised above the influence of member charges structured advantageously for their employees.

This resulted in the majority of employers selecting Nest, with many recognising the links it has to the government as a positive. As at March 31 2021, 881,000 employers had selected the master trust as its scheme provider.

Members not engaged with charges

The report also found that members are not generally engaged with charges and transfers are generally not motivated by fees.

While there are a number of reasons why a member would want to transfer their pension — consolidation, controlling fees, improved access flexibility and investment opportunities — individuals are primarily concerned about potential investment performance over other factors, the report stated.

Charges are considered as they will affect the overall returns and growth of a pension pot. 

“However, consumers will attempt to keep decisions simple rather than engage in the trade-off between benefits and charges, and if they do not realise these benefits they will only be worse off with higher charges,” the report said.

The Financial Conduct Authority has previously stated that “low engagement, complex charges and a lack of awareness of charges prevent consumers from finding more competitive products”, which in turn can lead to a marketplace that is less competitive on charges.

Value-for-money regulations for all

Following the research, B&CE has backed plans for new value-for-money regulations to be applied to the retail market, as well as workplace pensions.

The FCA and the Pensions Regulator are currently inviting comments on a joint discussion paper on driving value for money within defined contribution schemes.

B&CE argued that savers should have a clear idea about how different pension schemes and products compare and, while charges are very important, this should be broader than charges.

Phil Brown, director of policy and external affairs at B&CE, said: “This research shows how significantly charges can impact retirement incomes. With charges generally lower in workplace pensions than in retail, for many people thinking about transferring out of lower-cost workplace pensions it would be better to stay put.”

However, he noted that “value for money is about more than just charges”.

He added: “The FCA and TPR are right to propose a value-for-money framework that covers all DC pensions, as savers should be able to examine the value for money offered by both workplace and retail pensions.

“It will be tough to fine-tune, but it will provide real transparency to both professionals and savers.”