The UK’s introduction of auto-enrolment in 2012 has meant that 28 million people in this country are saving into a workplace pension today, compared with a mere 2 million 11 years ago. While this has clearly been a successful initiative, policy-makers acknowledge that the system still lacks engagement, which is problematic.
Even the Pensions Regulator believes that it is “built and driven by inertia” because so few participants bother assessing their savings and so few employers review the schemes they sponsor. Such apathy creates a moribund ecosystem that’s a breeding ground for inadequacy.
That’s why the consultation paper Value for Money: a framework on metrics, standards and disclosures, which closed to responses in March, makes a mark in the proverbial sand as the sector and its regulators seek to improve this situation. A source close to the consultation – the result of work by the government, the Pensions Regulator and the Financial Conduct Authority (FCA) shaped by discussions with the industry – has suggested that an update could be published within weeks.
Cost versus value in pensions
Cost is clearly an important factor in pensions investment. Virtually everyone linked to the industry agrees that the management charges a saver pays for their investments will affect the size of their retirement pot. But cost and value are different things – and the consultation has shifted the emphasis to the latter.
Henry Tapper is the founder and executive chairman of AgeWage, which helps people and organisations to gauge the value for money provided by their pension schemes. He observes that “employers typically see pensions in terms of something identified by their procurement teams. They focus on cost, because that’s the one factor they can easily understand and measure, but they don’t consider factors such as the members’ experience. I am worried about a race to the bottom.”
Tapper cites a case involving a £1bn pension mandate that was seeking a new pension provider. The lowest quote it received was 0.09% a year.
“That’s too low,” he says. “It’s almost impossible to see how a firm could make good-quality investments and offer good service at that price. This creates a scary situation where price is dominating, as employers seeking pension schemes have no concept of value.”
The Pensions Regulator has stated that the three key elements of the Value for Money framework are costs and charges, investment performance and service quality. Costs have already been dealt with to a degree, because a charge cap of 0.75% (for the pension provider’s default portfolio) has been in place since 2015.
Some players have suggested that the overly aggressive capping of fees by the watchdog could have a negative impact on investment performance and customer service. They do have a case for arguing that high quality in these two elements is impossible to deliver on the cheap.
Pooling pension resources
It’s a delicate equation to balance, then, but a solution has been proposed: consolidation. As nearly all industries do, the pension and investment management sector offers clear examples of economies of scale.
Indeed, the idea of so-called super-funds has been generating significant column inches. One particularly forthright proponent – the Lord Mayor of London, Nicholas Lyons – has suggested that smaller defined contribution schemes should contribute to a £50bn fund that would back some of the UK’s high-growth firms. Former prime minister Sir Tony Blair has also espoused the potential of super-funds.
Some of the world’s largest and most successful pension schemes invest anywhere between 20% and 35% of their funds in unlisted securities across infrastructure, real estate and private equity, including venture capital. The equivalent figure in the UK is 7%, but it’s something that super-fund advocates believe could increase, benefiting investment performance in the process.
Edmund Truell, founder of the Pension SuperFund, argues that the simplest way to reduce the cost burden of pension schemes, particularly smaller ones, is to pool their resources. He explains: “The cost of running a small fund can be 5% of assets, which can be damaging. The best remedy is consolidation – and we can see that from examples in countries such as Canada, where pension fund costs are 0.4% a year.”
Truell, who chaired the London Pensions Fund Authority (LPFA) when Boris Johnson was the city’s mayor, oversaw the merger of the Lancashire County Pension Fund and the LPFA in 2014, encouraging mergers between other schemes since then.
Truell’s belief in the benefits of consolidation is so strong that he suggests that the regulator should adopt a “comply or explain” policy on this matter. By this he means that funds should actively seek to pool resources with others or be obliged to explain why they’re not doing so.
Improving pensions engagement
While the Pension SuperFund is aimed at defined benefit schemes, which provide a guaranteed income for retirees based on their salary and length of service, the master trust structure has emerged in recent years as a way for defined contribution schemes to benefit from pooling.
Moving on from the cost/quality equation, the general apathy among British consumers towards retirement saving may be an even tougher problem to solve, particularly in the case of workplace pensions.
Scheme members need to be made more aware of their pension choices, including knowing how much they and their employer are contributing and what their investment options are. Employers also need to be more fully engaged in the schemes they’re providing, but very few have pension expertise. As a result, they often find it hard to review the quality of their offerings.
Tapper established the Pension Playpen service in 2013, while auto-enrolment was still in its early stages. This helped 7,000 organisations to choose a workplace pension in the so-called staging period that lasted until 2018, by which time all employers had to have established their schemes.
“When we launched the Pension Playpen, we were probably the biggest value-for-money people out there,” he says. “But it could still be difficult to engage people – you can lead them to water, but you can’t make them drink.”
Key barriers to engagement cited by financial advisers include limited access to information, coupled with a lack of transparency from pension providers. Some in the sector hope that the regulators will review the gap between pensions advice (specific product recommendations) and guidance (more general suggestions), potentially loosening restrictions on the latter to enhance the availability of information.
With the government right behind them, the Pensions Regulator and the FCA will no doubt be hoping that they can construct a Value for Money framework that will lower these barriers and make clear information about pension providers’ fees, performance and service accessible to employers and employees. The availability of easily comparable data should improve customer engagement, shake the world of workplace pension provision out of its torpor and add some much-needed dynamism to the market.