3 Ensuring pension schemes offer value
for money |
50. Employers will be responsible for choosing an
auto-enrolment pension scheme on behalf of their employees. They
can choose from a wide range of private providers or they can
opt for a NEST scheme. Employers will therefore have an important
role in comparing pension schemes and selecting a scheme in the
best interests of their staff. This chapter considers the extent
to which employers and employees can be assured that pension providers
will operate with transparency and offer products that represent
good value for money.
Criteria for auto-enrolment providers
51. Providers must meet certain criteria established
by the Government and regulated by The Pensions Regulator (TPR)
in order to offer an auto-enrolment pension scheme. For example,
UK pension providers must be tax registered and must offer occupational
or personal pension schemes. Non-UK pension schemes must meet
additional qualifying criteria relating to regulation in their
country. In addition, there are minimum requirements according
to the type of pension scheme (for example, defined benefit (DB),
defined contribution (DC) or hybrid schemes which combine elements
of DB and DC schemes). For example, the requirements for DC occupational
pension schemes require employers to make minimum contributions
at a set rate.
52. Although providers are required to meet these
criteria, they will not be assessed against them by TPR as part
of a registration process. Instead, it will be for the employer
to satisfy themselves that the pension scheme they plan to use
to fulfil their auto-enrolment duties meets the criteria.
 TPR and the
Financial Services Authority take a risk-based approach to regulation,
whereby resources are concentrated on organisations where they
identify the greatest risk to the security of members' benefits.
53. It is useful to compare the UK criteria with
the requirements on pension providers offering the KiwiSaver scheme
in New Zealand. Organisations wanting to provide KiwiSaver schemes
need to be certified by the NZ Inland Revenue and meet requirements
set out by the Financial Markets Authority before they can register
a scheme. These include meeting certain IT requirements, implementing
a business continuity plan, providing data to the Government and
taking part in annual review meetings with the Inland Revenue.
All providers are required to sign a scheme provider agreement
before they can provide a KiwiSaver scheme.
All KiwiSaver schemes are regulated by the Financial Markets Authority
and schemes are required to have charges that are "not unreasonable".
Although the New Zealand Government has not defined a cap for
charges, providers can only offer a KiwiSaver scheme if their
charging structure has been assessed and considered to be reasonable.
54. The regulatory arrangements for providers under
the KiwiSaver are significantly stronger than the requirements
faced by providers wishing to offer auto-enrolment schemes in
the UK. It is arguable that the New Zealand system offers a higher
level of protection for savers that could increase their chances
of receiving good value for money on their investment.
55. Employers will be responsible for ensuring
that their pension provider meets the Government's criteria for
auto-enrolment. Providers are not currently required to register
with The Pensions Regulator to ensure that they are eligible.
This may represent a regulatory gap, and we are concerned that
some employers may unknowingly enrol their staff in schemes that
do not meet the criteria. Equally, the criteria for providers
appear relatively light compared with the New Zealand model. The
Government must monitor this situation closely. It should act
to strengthen the minimum criteria for providers, or require providers
to register with The Pensions Regulator, if it becomes clear that
some providers are not safeguarding the interests of pension scheme
Transparency of pension scheme
56. Comparing pension charges can be very complex
due to the different types of fee that can be applied. These can
- Contribution charges: investors
are charged a percentage of each contribution they pay into their
- Annual management charges:
every year investors are charged a percentage of the total pension
pot amount they have invested.
- Fixed administration charges:
investors pay a fixed monthly or annual fee, for example £2
a month or £20 a year, regardless of the size of their pot.
- Trading charges: taxes and
commissions incurred each time an asset is traded.
- Active member discounts: increased
charges once the employee ceases to contribute.
57. DWP research examining a sample of schemes found
a current mean charge level, expressed as a percentage of funds
under management, for defined contribution (DC) occupational schemes
of 1.23% (with a median charge level of 1%), and charge levels
for most contract-based workplace schemes at 1% or lower. The
Department therefore expected that NEST's charges (broadly equivalent
to a 0.5% annual management charge)
would act as a benchmark across the pensions industry which, combined
with a competitive pensions market, should keep charges for auto-enrolment
schemes low. Otto
Thoresen from ABI echoed the expectation that NEST's low charges
would force other providers to keep their charges competitive:
"the existence of NEST [...] is setting standards that will
force the market to normalise at a level that I think we should
be able to demonstrate is good value for money for the services
58. Lawrence Churchill, the Chair of NEST, highlighted
the complexity of setting a single transparent measure for pension
scheme charges, indicating that there could be variation in annual
management charges (AMCs) within a single pension provider:
People using AMCs have multiple AMCs, and you
are never sure which one you are getting at any point in time,
and when you stop paying contributions, the costs suddenly go
up. Even in the beguiling simplicity of one currency, there are
Joanne Segars from the NAPF highlighted the need
for the industry to develop a common language around pension charges:
We have been looking at the way in which different
providers and different pension schemes describe what they are
doing. Some of them talk about bid-offer spreads, some talk about
reductions in yields, some give percentage AMC and some talk about
59. Due to the current complexity and lack of transparency
around pension scheme charges, there is the potential for pension
providers to misrepresent the fees applied by their competitors,
even if they do so inadvertently. This may become an issue as
providers compete increasingly against each other for auto-enrolment
contracts. The Advertising Standards Council and the Financial
Services Authority have powers to regulate product-related claims,
and the increased transparency of charges would help reduce the
risk of any miscommunication around competitors' fees, demystifying
the industry, and therefore encouraging pension saving.
60. At its annual conference in October 2011, the
NAPF announced that it planned to hold an industry summit on fee
transparency. Its aim was to develop a code of practice for pension
providers that would help customers understand and compare pension
scheme charges. A working group has been established to explore
the issues in depth and the NAPF proposed launching the code in
spring 2012, ahead of the launch of auto-enrolment. A NAPF discussion
paper put forward several ideas for fee transparency, including:
ensuring fees are disclosed in a standard format to employers;
providing annual information to employees about the cash amount
they have paid in charges; ensuring transaction costs are disclosed;
creating a comparison website for charges; and adopting a standardised
method of comparing charges.
61. If auto-enrolment is to be successful in convincing
people to increase their retirement saving, it is essential that
providers offer value for money for employees who are automatically
enrolled and that they demonstrate that this is the case. A competitive
market of providers should help promote this but it will only
work if charges are clear, understandable and comparable. In the
insurance industry, comparison websites are available to enable
people to compare providers, and we believe that the pensions
industry should aim to establish a similar model.
62. Current industry practice and regulation does
not offer sufficient transparency for employers or savers. We
welcome the work that the NAPF and the pensions industry are undertaking
to develop transparency around pension scheme charges and look
forward to the NAPF's code of practice.
63. We expect to see the industry make progress
on improving transparency and will continue to monitor their actions
in this regard. It is imperative that the pensions industry establishes
a clear, accessible and universally-adopted model to allow the
comparison of charges and that this is in place by the end of
2012. This would ensure that the model is available to all employers
choosing schemes from 2013 onwards.
Regulation of fees and charges
64. The criteria for auto-enrolment pensions, as
determined by the Government and published by The Pensions Regulator,
currently do not restrict the level of charge that can be applied
by a pension provider. DWP has stated that it will monitor charge
levels across the market and emphasised that it has reserve powers
in the Pensions Act 2008, which would allow a charge cap to be
set should auto-enrolment charges reach inappropriately high levels.
65. The Royal Society of Arts' (RSA) Tomorrow's Investor
programme argued that the current consumer protection legislation
that regulates workplace pensions is being "abandoned"
alongside the introduction of auto-enrolment, increasing the risk
of high charges: "There will be no restrictions on how much
[providers] can charge, and we can expect that many will be sold
pensions where 50% or more of their potential pension disappears
in charges. Some of these fees will be hidden from customers."
66. David Pitt-Watson, who led the Tomorrow's Investor
programme for RSA, provided the example that if an employee paid
a 2% annual management charge each year over 60 years (including
time spent saving in work and in retirement), half their pension
would disappear in fees. He drew a comparison with stakeholder
pensions, where providers currently cannot charge more than 1.5%
over the first 10 years, and thereafter cannot charge more than
1%. As noted earlier
in this chapter, DWP research suggested that typical charge levels
were lower than those feared by the RSA. 
67. The Minister outlined several reasons why it
might not be advisable to introduce a cap on charges at this stage
in the implementation of auto-enrolment. Firstly, he explained
that, since there are "dozens and dozens of different sorts
of charges", introducing a cap on one type of charge might
simply result in a provider increasing a different type of charge:
"it could be a bit like a tyre: you squeeze this bit and
think you have got it capped, and all the charges rush off over
the Minister indicated that some investors might wish to pay a
higher charge in return for an improved service from their pension
Plain vanilla default funds are fine, but if
somebody wants tutti frutti or knickerbocker glory or whatever,
they should be able to choose that, if they know what they are
doing and it is an informed choice. Perhaps the charges are higher,
but they feel that they are getting something for that. 
68. Thirdly, the Minister suggested that if the Government
applied a cap, then the cap might become the standard level for
charges, with providers increasing their fees to the level of
the cap. He explained: "If you simply said, 'You cannot charge
more thanto take a round number1%' there would be
a risk that everyone would say, 'Oh, well, that's the norm, so
we will charge 1%.'"
Lawrence Churchill from NEST made a similar point, indicating
that, when the cap was imposed on charges for stakeholder pensions,
providers set their charges at the cap level, rather than below
69. The current model for automatic enrolment will
rely on scale and competition in the market to ensure that charges
represent value for money. However, this model can only operate
successfully if the pensions industry establishes transparency
and clarity so that employers and individuals can compare schemes.
It is also worth remembering that it will be employers who will
be choosing pension schemes on behalf of their employees. The
TUC expressed concern that there will not be sufficient incentives
for employers to select a scheme that offers value for money and
low charges for employees. They suggested that employers should
be held accountable if they choose a pension provider that does
not offer this.
70. It should be borne in mind that the employer
will choose the pension scheme but the consequences of that choice
in terms of the level of charges and the potential lack of value
for money will fall on the employee. Given the current complexity
of pension scheme charges, it is important that the Government
and the pensions industry create a model that helps protect employers
against the risk that they will, inadvertently, select a scheme
that offers poor value for money for their employees.
71. The Government must monitor the pension market
to ensure that scale and competition between providers is effective
in keeping charges at a low level. We recommend that the Government,
or The Pensions Regulator, publish a report every two years on
the value for money of pension scheme charges, including an assessment
of the levels of fee applied under auto-enrolment.
72. Whilst we accept the Government's current
rationale for not applying a cap on scheme charges, this approach
will only work if all providers act with transparency and offer
genuine value for money in relation to charges. During 2012, the
pensions industry has an opportunity to demonstrate that it can
operate fairly and effectively without a cap on charges. From
2013 onwards, if it transpires that some auto-enrolment providers
are applying hidden charges, or charges that represent poor value
for money, the Government should use its powers to intervene.
Short service refunds
73. In its December 2011 consultation paper Meeting
future workplace pension challenges, the Government announced
its intention to abolish the use of short service refunds for
defined contribution (DC) occupational pension schemes. It expects
the rule change to be introduced by 2014, subject to the parliamentary
74. Under the current short service refund rules,
an individual can receive a refund of pension contributions if
they leave an occupational pension scheme within two years. Employers'
contributions can remain within the scheme to be used in accordance
with scheme rules; for example to cover future employer contributions
for other members or scheme administration costs. These employer
contributions can therefore effectively be forfeited by the employee
to subsidise other members. The Government felt that the short
service refunds mechanism did not support the aim of increasing
overall saving for retirement, with some individuals never accumulating
75. We welcome the Government's intention to ban
short service refunds. This measure will help individuals experience
the benefits of longer-term saving for retirement and reduce the
risk that their employer contributions will be lost.
Active member discounts
76. Individuals can face higher charges for their
pension schemes when they are no longer making contributions into
that scheme, for example when they have moved to another employer.
These higher charges are referred to as "active member discounts"
or "deferred member penalties". Some witnesses voiced
concerns about this type of charge; for example, The Pension Regulator
(TPR) argued that it was "not fair or acceptable"
and the TUC called for active member discounts to be forbidden.
NEST confirmed that it will not have higher charges for inactive
members than for contributing ones.
TPR told us that only 2% of trust-based schemes use active
member discounts, but that these charges were more prevalent in
contract-based schemes, which are expected to grow in number during
the implementation of auto-enrolment.
77. Jos Joures, Head of Workplace Pension Reform
at DWP, explained that higher charges for inactive members sometimes
reflected the fact that the cost of administering them was proportionately
higher because the pots were often very small. If higher charges
were not imposed for inactive members, it could sometimes mean
that existing scheme members were in effect subsidising the administrative
costs of deferred members. 
78. The Minister explained that the Government has
brought active member discounts into the scope of its powers to
cap pension scheme charges and said that the premiums applied
to deferred members were "sometimes quite hard to justify".
However, he suggested that the best way to resolve the issue would
be to encourage individuals to consolidate their pension pots
into a single scheme, as outlined in the Government's December
We are likely to return to this issue in our forthcoming inquiry
into governance and best practice in workplace pension provision.
79. Active member discounts sometimes reflect
the additional costs of administering inactive pensions but can
also lead to disproportionately high charges for individuals who
are no longer contributing to their scheme. We believe that pension
providers should operate a fair balance between active and deferred
members and that the Government should consider intervening if
this issue is not resolved by greater consolidation of small pots
into single schemes.
80. Investors in defined contribution (DC) pension
schemes use their pension pot to purchase an annuity from an insurer
when they retire. This product will provide them with a regular
income in retirement. Individuals will only make a single decision
in choosing their annuity, and this major financial decision cannot
be changed at a later date.
81. A joint report by the NAPF and the Pensions Institute
at Cass Business School found that around half a million people
retiring each year are receiving reduced incomes in retirement
because there are obstacles preventing them from obtaining the
best possible deal on their annuity. The report suggested that
each annual cohort of pensions loses up to £1 billion in
lifetime income as a result.
Age UK argued that the annuities market is not working adequately
and recommended that savers should be automatically referred to
either specialist advice or NEST when they reach retirement.
The Pensions Advisory Service suggested that fluctuations in annuity
rates could lead to disaffection among individuals and potentially
lower levels of participation in retirement saving.
82. As NEST does not offer an annuity product, it
is useful to consider its approach to helping its members to find
an annuity. If a NEST member has a retirement pot worth more than
£1,500, NEST will help them to look for a competitive rate
through a panel of different retirement income providers. Their
Retirement Tool will collect a range of quotations on how much
retirement income different companies from its panel would give
an individual in exchange for their pension pot. Members are also
free to select another company if they prefer.
83. In March 2012, the ABI launched a compulsory
code of practice designed to encourage individuals to shop around
for an annuity when they reach retirement. This represents a step
in the right direction. Supporting individuals to achieve the
best possible deal on their annuities is critical to the success
of auto-enrolment and the DC pensions market more widely. We will
return to this issue in more depth in our forthcoming inquiry
into governance and best practice in workplace pension provision.
Trust-based and contract-based
84. The regulation of workplace pension schemes is
split between TPR and the Financial Services Authority (FSA):
- TPR is the sole regulator of trust-based pension
schemes. These schemes are overseen by a board of trustees who
have a fiduciary duty to run the schemes in the best interests
- The FSA is the primary regulator of contract-based
pension schemes. These schemes are not overseen by trustees and
providers do not have the same fiduciary duty. Providers are subject
to FSA rules and are also regulated by TPR.
85. FairPensions argued that the regulatory framework
should be equally robust for all types of pension provision and
that the Government should act to ensure that standards of governance
and consumer protection are comparable across the market. They
suggested that some employers may see contract-based provision
as an "easy option" requiring employers to take on less
responsibility. FairPensions recommended that the FSA rules regarding
conflicts of interest and obligations towards savers should be
strengthened given that contract-based pensions fulfil the same
role as trust-based schemes.
86. Some witnesses questioned the existence of two
separate regulators for DC schemes. The Investment Management
Association said that the respective roles of TPR and FSA were
"not totally clear" and suggested that the Government
consider options to "rationalise" regulation.
The Building and Civil Engineering Benefit Schemes also commented
that DC pensions "would benefit from a simple common regulatory
framework, regardless of whether it is a trust-based or contract-based
NAPF told us that "there should be a single regulator for
pensions and that should be the Pensions Regulator".
87. TPR assured us that they would work closely with
the FSA wherever the regulatory boundaries were drawn. Bill Galvin
of TPR also explained that the current structure may make more
sense in terms of keeping financial services under FSA regulation:
"Looking at the current structure, you would come to the
conclusion that it is more important for there to be a single
regulator of financial services providers than it is to have a
consistent view across all workplace pension provision."
88. The Minister noted that a 2007 review had considered
the respective regulatory roles of FSA and TPR, concluding that
the bodies should continue with their separate roles. He believed
that TPR has developed specialist expertise that may be lost if
it was merged into a single "super-regulator".
His view was that it would not be advisable to undertake a significant
restructuring of the regulatory bodies in the near future. We
agree. However the advent of the new financial regulatory regime
created by the Financial Services Bill, currently going through
Parliament, offers the opportunity for the Financial Conduct Authority
(a successor body to the FSA) to look at approaches such as that
of introducing something akin to a fiduciary duty for those running
89. Witnesses shared some concerns about the effectiveness
of governance arrangements for trust-based and contract-based
schemes, with some calling for stronger quality criteria or certification
to safeguard employees' interests.
90. A report published in 2011 by the Workplace Retirement
Income Commission (WRIC) expressed concern about a "governance
vacuum" within pension schemes that could lead to schemes
not being operated in the best interests of participants.
The WRIC noted that in trust-based schemes (overseen by
a board of trustees) the trustees are able to oversee pension
schemes in the interests of beneficiaries, but the extent to which
they do so seems variable. For contract-based schemes (without
trustees and associated fiduciary duties) it is usually only the
employer who could ensure the scheme was operating in the employees'
best interests, and the extent to which they do so is also variable.
91. Evidence from Dean Wetton Advisory, an investment
advisory firm, suggested introducing the certification of pension
schemes that meet a high standard, as determined by The Pensions
Regulator or another body. It pointed out that the NAPF already
has a suitable certification scheme that could be used for this
purpose: the Pensions Quality Mark.
92. TPR has asked the pensions industry to take part
in a dialogue on six principles for good design and governance
of workplace DC pension provision. These principles were published
in December 2011 and cover issues including fairness, accountability,
transparency, effective governance and communication with members.
TPR has stated that these principles will "form the basis
of its regulatory approach going forward".
Its Chief Executive, Bill Galvin, told us that they would discuss
the principles with the pensions industry before coming up with
"hard proposals" about what they should look like for
different parts of the pensions market.
However, it is not yet clear how TPR will act to ensure
that these principles are adopted by pension providers or that
TPR has the powers needed to enforce these principles. We will
return to this issue in more detail in our forthcoming inquiry
into workplace pension governance and best practice.
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