The focus on costs in recent years has led to a number of trends that may not be in the long-term best interests of members, writes Redington's Jon Parker.
Well, not quite. We need to consider more carefully whether the charge cap hinders the quality of the pension services being provided – do members get sub-optimal outcomes, and therefore poorer value, because pension providers are restricted in the amount they can charge?
The UK is the only major pension market where a charge cap is applied, and this does not feed through favourably to international pension rankings.
If we are to design DC plans that offer both value for money and the chance of good retirement outcomes, then low costs cannot be the only answer
The UK is now ranked 15th (a C+) on the Mercer Melbourne Index of leading international pension systems. Of course, this is just one aspect that feeds into the overall ranking, but it does provide some comparable perspective.
The focus on costs in recent years has led to a number of trends, which may not be in the long-term best interests of members.
Passive could come unstuck
The first is a harmonisation of investment approach, with low-cost passive becoming the dominant way of delivering returns.
When markets keep going up, this feels like a great solution. When they do not, there is little scope to lessen the effect of negative returns or the ability to choose between winners and losers.
When you have gone as low as you can on investment spend, it is very difficult to then go back up. New investment opportunities and asset classes that would be of real benefit to long-term investors are out of reach to a large part of the DC market.
Other leading DC markets like Australia and Canada use the large, stable capital flows that come from pension schemes and put it to work in asset classes such as infrastructure.
In fact, many attractive infrastructure projects in the UK, such as the Leeds Bradford and Manchester airports, are owned not by UK pension savers, but by those in Australia.
Low cost can mean low impact
Government and regulators are rightly encouraging pension schemes and other institutional investors to consider environmental, social and governance factors when making investment decisions.
And members themselves are taking more of an interest in where their hard-earned money is invested.
However, what they may hear in many circumstances, is that even though schemes may like to do something more impactful with members money, this cannot be done under current cost restrictions.
Considerable value is being lost both in investment returns and the opportunity to really get people more engaged in saving for their future.
Cap is changing the shape of the industry
A second trend that has been driven in part by this focus on costs is a reduction in the number of pension providers active in the workplace market. In the last two years alone, two prominent providers – Zurich and BlackRock – have exited the market.*
Although mastertrusts have taken up some of the slack, there are important questions to be asked about the long-term viability of workplace pensions as a market where companies are prepared to invest, innovate and deliver better outcomes.
Finally, the provision of certain services that could potentially enhance value for money are out of reach for UK DC savers because of the way in which charges are structured.
For example, a US service provider like Financial Engines, which offers pension portfolio advice and management, would not entertain coming to the UK. Financial Engines’ clients who have used its retirement ‘Help’ service have, on average, increased median returns by 3.32 per cent a year net of fees.
Auto-enrolment has been tremendously successful in improving coverage of pensions in the UK. But, if we are to design DC plans that offer both value for money and the chance of good retirement outcomes, then low costs cannot be the only answer.
Jon Parker is director of DC and financial wellbeing consulting at Redington
*This article has been corrected to amend an assertion that Standard Life has left the workplace pensions market. The transfer of its book to Phoenix has not yet been completed, and Standard Life will remain open to new pensions business under the partnership.
