DWP’s move to DC universal charge structure could do ‘serious damage’

The DWP’s consultation, which closed on Friday, put forward measures designed to prevent the erosion of small pots by removing flat-fee charging on pots under £100, while also suggesting a move to a single universal AMC structure for default funds of DC schemes used for auto-enrolment.

The DWP said in its consultation, launched in May, that such a structure would “enable better member comprehension of the charges they pay, and of their pension’s other features, and in doing so improve member engagement”.

There are currently three permitted charging structures: a single percentage charge of the pot value, taken at the end of each year and capped at 0.75 per cent of funds under management; a combination of a percentage charged on each new contribution made, plus an annual percentage of funds under management charge; and a combination of a monthly or annual flat fee plus an annual percentage of funds under management charge. 

We believe the proposal to move universally to a percentage AMC charge could do serious damage to the pensions market, which is currently vibrant and competitive offering a range of propositions and employer choice with bespoke charging

Kate Smith, Aegon

The consultation proposed whittling this down to a single, universal charging structure allowing for a single percentage AMC “based on the value of the member’s pot within the default fund”.

Universal structure could do ‘serious damage’

Aspects of the proposal were praised at the time, not least the move to outlaw combination charges, which some industry commentators said confused members, made comparing charges difficult, and in some cases could erase savings entirely.

However, relatively few pension schemes use combination charges. Those that do tend to be master trusts, whose business models and profitability could be damaged by the change.

Hence experts have further warned of the repercussions of making such change.

Kate Smith, head of pensions at Aegon, said: “We believe the proposal to move universally to a percentage AMC charge could do serious damage to the pensions market, which is currently vibrant and competitive offering a range of propositions and employer choice with bespoke charging.

“Universal pension charging could encourage a race to the bottom in terms of charges and ‘vanilla’ pension propositions, with competition stifled, forcing some schemes to exit the market. All of this would be detrimental to member retirement outcomes,” she continued.

Darren Philp, director of policy at Smart Pension, questioned the timing of the proposals. “While there are clearly merits in having a standardised approach to charging, we would question the timing,” he said.

“The auto-enrolment market is still relatively immature and the risk of unintended consequences of moving to a single charging structure could be huge.”

He argued that it would be better for the government to focus its energy on “developing a better framework for assessing value for money, introducing the pensions dashboards, solving the small pots issue, and focusing on investments to better serve society and the planet, rather than trying to fix something that isn’t broken”.

The consultation also sought views on whether employers would continue to pay auto-enrolment contributions to a pension chosen by an employee, as an alternative to the employer’s workplace pension.    

Smith said: “Employers are at the heart of auto-enrolment, and much of its success has been down to them. Any break with the link to the employer by forcing them to pay into a pension chosen by an employee introduces more costs and complexity and risks undermining the future success of auto-enrolment and workplace saving.” 

She added that many employers contribute more than the auto-enrolment minimum and may be less likely to do this if they are forced to pay into a scheme that is not their workplace scheme, “especially if it costs them more to do so”.  

‘Symbolic gesture’ won’t solve small pots problem

The government also proposed to tackle the small pots problem by banning flat fee charges on pots of under £100.

Citing research from the Pensions Policy Institute, the DWP stated that without intervention, “the number of deferred pension pots in master trust schemes could increase from 8m to as much as 27m by 2035”. 

“The proliferation of small pots is a cause for significant concern within the automatic enrolment workplace pensions market, as it presents a number of risks for scheme members, pension providers and the reputation of automatic enrolment,” it said.

Additionally, the charging of flat fees on small pots erodes their value to members. 

The DWP’s consultation stated that the issue “is around the disproportionality between the cost of administering the increasing number of small pots in comparison to the revenue generated. The charging out of very small pots may risk undermining the progress made in normalising pension saving under the hugely successful automatic enrolment policy”.

It argued that setting a de minimis pot size — £100 — below which flat fees cannot be charged would strike the right balance between protecting members and maintaining the financial sustainability of scheme providers.

Industry experts were not optimistic, however. 

Smith said that while she was “empathetic” to the government’s wish to stop small pots being wiped out by flat fees, “a pot of £100 will make no difference to income in retirement, making this more of a symbolic gesture rather than a genuine way to improve members’ retirement outcomes”. 

She continued: “A far better way of improving member outcomes would be to join this up with the joint industry/government initiative looking at small pots solutions, rather than advancing this as a standalone policy. 

“Removing the flat fee for pots of £100 or less creates a barrier to small pot consolidation, as the new scheme’s charges are likely to be higher once the flat fee has been cancelled.”

Sue Pemberton, head of DC consulting and technology at Premier Pensions, was likewise sympathetic to the intent, but argued that the government had not given scheme providers time to implement the charging threshold.

“The issue is that it will be difficult for providers to apply this charge threshold in the current timescale. At the moment, the DWP intends for the threshold to come into force in April 2022 and many providers are unlikely to be able to join the dots in time,” she warned.

“The problem is that some providers will be running their schemes across different platforms. An individual member could have small pots scattered across multiple platforms and it is the total pot size that needs to be measured to establish if charges should be levied.

“Arguably, it’s the providers who will lose out if they cannot establish if the total pot size is above the charge threshold. Getting this right will be a major, time-consuming task. There is a need for speed and delaying too long could be costly, but the DWP should offer providers a transition period.”

The DWP has been approached for comment.