What a 1% cap could mean for AE value

A possible 1 per cent cap was reported by the Financial Times earlier this month. While the change could encourage schemes to use their scale to negotiate-down charges, some scheme managers and consultants have expressed concern over the effect a cap would have on investment innovation.

It shouldn’t be about price but you can quantify it, so inevitably that’s the bit that everyone focuses on

“We’re in danger of pushing ourselves towards the very cheapest arrangement that we can have without any consideration of value or the type of service we can get or indeed the type of investment arrangements we can make available to people, and that worries me,” said Lesley Williams, group pensions director at Whitbread, speaking at Pensions Week’s UK Leadership of Pensions Summit earlier this month.

The hotelier’s UK scheme uses a diversified growth arrangement, which the scheme built itself. While this is not the cheapest fund on the market, it offers good value for money because there is some diversification of risk, Williams told delegates.

Whether a product provides value for money is more important than price when judging the rewards a scheme can offer members, according to many in the pensions industry.

“It shouldn’t be about price but you can quantify it, so inevitably that’s the bit that everyone focuses on. It should be about value, but value’s a very uncertain thing because it’s going to be about 20 years before these pots come to fruition,” Neil Latham, principal in Punter Southall’s defined contribution consultancy team, told delegates.

Much of the focus on cost is because of historic contract-based pension scheme charges, such as high annual membership fees and active member discounts, Martin Thompson, a director at Premier Benefit Solutions, told the summit.

He believes there is a danger of looking at investment costs as a type of annual charge, when the investment element of an annual membership charge can be quite small.

“What we should be doing is driving out the other cost elements that make up an annual management charge, like historic commissions and things like that that are still being paid, because I see that’s where the biggest risk is for some employees,” Thompson said. “[This is] because they’re just locked into an old scheme; their employer thinks they’ve got a scheme in place and [so] they’ve enrolled them into that.”

Cap impact

During the early 1990s a 1 per cent management charge cap was proposed for stakeholder pension providers. As a result, commercial pension providers had to adjust their offerings so they could continue to operate in the marketplace.

“Since that was 15 or more years ago and [providers] have moved technology forward quite a lot to improve efficiency, a 1 per cent charge cap shouldn’t be too onerous and shouldn’t have too much impact on the market,” says Richard Butcher, managing director at independent trustee company PTL.

Yet Butcher says there are still smaller suppliers that charge more than 1 per cent for their products. “These could struggle, not necessarily because they haven’t got the technology to offer sub-1 per cent, but their offering may be unorthodox in another way, for example they may offer a very particular range of investment funds where the charges would be higher,” he adds.

There is still the danger that a fee cap could drive out diversification. A good-quality scheme can generally buy a passive fund within around 0.25-0.4 per cent, Butcher says, but the charges for schemes investing in diversified growth funds can be in excess of 1 per cent.

There is arguably more of a case for keeping charges applied to default funds at a low level, he says, adding: “It is not unreasonable to argue we should be keeping those in a low-charge environment, because they’re not actively participating and therefore not able to make a judgment about the absolute level of charge.”

However, a cap could also in effect end up outlawing more esoteric forms of investment, for example sharia funds, Butcher says. This is because there are very few sharia funds in the market and they tend to be quite expensive because of the governance requirements that are attached to them.

Driving quality

From April 1 this year the National Association of Pension Funds’ Pension Quality Mark lowered its cap on charges from 1 per cent to 0.75 per cent. This means that in order to achieve the PQM, schemes have to prove that all charges paid by members in the default fund do not exceed 0.75 per cent a year.

This covers all fees, including annual management charges, as well as administration, contribution and consultancy fees.

The PQM cap will hit a large proportion of investment offerings and therefore effectively outlaw them, according to Butcher. He says this will press the profits of providers, reducing their motivation to innovate and invest in their business.

“In a strange cyclical way, if the insurers make a profit it’s a good thing for the shareholders, and we shouldn’t forget that pension funds are often the shareholders in the insurers,” he adds.

However, Richard Wilson, senior policy adviser to the NAPF, says setting a charge cap at 0.75 per cent would ensure schemes are good value for money.

“We see that the majority of employers can get innovative investment strategies for less than 0.75 per cent,” Wilson says.

“We always listen to what people say and are happy to talk to people who have concerns and look at evidence from investment managers,” he adds.

The NAPF has given PQM holders a two-year grandfathering period to reduce their fees to less than 0.75 per cent. Wilson says the organisation is constantly reviewing the time period in which schemes have to do this.

“If people are having genuine problems renegotiating with their fund managers and pension scheme providers, we will listen to them,” he says.