The Defined contribution workplace pension market study, published by the Office of Fair Trading (OFT) in September 2013, was very critical of contract-based pensions at a time when auto-enrolment is requiring employers to arrange new pension schemes for most of their staff.
What is a contract-based defined contribution (DC) pension scheme?
A contract-based DC scheme is based on contributions from both employers and staff. It can be a group personal pension (GPP), a stakeholder scheme or a group self-invested personal pension (Sipp).
What are the origins of contract-based DC pensions?
GPPs were introduced in 1988, followed by stakeholder pensions in April 2001, specifically aimed at employees on low incomes. These plans succeeded in driving down charges, but have since fallen out of fashion.
Where can employers get more information and advice?
The Pensions Regulator on 0845 600 1011 or www.thepensionsregulator.gov.uk
The Society of Pension Consultants on 020 7353 1688 or www.thesocietyofpensionconsultants.co.uk
The Pensions Advisory Service on 0845 601 2923 or www.pensionsadvisoryservice.org.uk
What are the costs involved?
An annual management charge, typically between 0.4% and 0.7%, is applied to members’ funds, with a lower charge for passive funds. In March 2014, the government announced it will set a charges cap of 0.75% for workplace pensions. Under auto-enrolment, contribution levels will rise incrementally and the full employer contributions of 3% of banded earnings will not have to be paid until October 2018.
What are the legal implications?
Employers are obliged to put an auto-enrolment scheme in place by their staging date, although they can request a delay.
What are the tax issues?
Tax breaks are available to both employers and employees. If employees pay above the basic rate of tax, they have to claim additional tax relief via their tax return.
What is the annual spend on contract-based DC schemes?
According to the Association of British Insurers, single premium pensions business was worth £32.1 billion in 2012, an increase of 3% from £31.1 billion in 2011, while regular premium pensions business was £4.3 billion, down 1.4% from £4.4 billion in 2011.
Which providers have the biggest market share?
Providers are having no difficulty in attracting business: the supply/demand dynamics are actually the other way. Aegon, Aviva, Fidelity, Friends Life, HSBC, Legal and General, MetLife, Prudential, Scottish Life, Scottish Widows, Standard Life and Zurich Life are all big players. Then there is the National Employment Savings Trust (Nest), where the limit on annual contributions and the restrictions on transfers into and out have damaged take-up, although that is partly offset by its hub, which appeals to smaller employers by semi-automating many auto-enrolment processes.
Which providers have increased their market share?
Legal and General is said to be gaining employer clients fast, while in February Standard Life said that auto-enrolment had helped it to secure more than 340,000 new customers during the year.
The OFT’s investigation identified about £30 billion of savings in pre-2001 pension schemes that may not be achieving value for money compared with more recent plans, that tend to have lower charges.
The investigation is critical because, by 2018, up to nine million workers will be automatically enrolled into a defined contribution (DC) workplace pension scheme . The Association of British Insurers (ABI) and its members have agreed to undertake an audit of these schemes and report into an Independent Project Board.
The OFT stopped short of recommending a cap on scheme charges, but pensions minister Steve Webb is keen to impose some sort of ceiling. In March 2014, the government announced a cap of 0.75% for default investment funds in auto-enrolment schemes to apply from April 2015.
According to government figures, an employee who saves £100 a month over a typical working lifetime of 46 years could lose almost £170,000 from their pension pot with a 1% charge and more than £230,000 with a 1.5% charge.
There is also speculation that pension fund managers will be forced to disclose all their charges, following a campaign by former Tory Chancellor Lord Lawson, who believes compulsory disclosure will go a long way towards removing excessive charging in this competitive marketplace.
Criticism of charges
Politicians and groups such as the National Association of Pension Funds (NAPF), which have been highly critical of traditional pension charges, have highlighted the benefits of master trusts, which are cheaper and offer economies of scale, and there has been some traction in these arrangements.
One concern about auto-enrolment is that pension plans are individually priced depending on employee numbers, contributions and staff turnover, so some small employers will be denied access to schemes other than the National Employment Savings Trust (Nest), which is mandated to offer terms to any employer that applies.
Providers fought to win business from the big employers, with staging dates at the beginning of the auto-enrolment process, because large-scale schemes are more profitable and also to build a critical mass in the market, but providers are less keen to take on employers with itinerant workforces or those with poor record-keeping.
Employers with existing pension schemes are even finding that their provider may not want to open up the scheme to all staff or want to set up a new scheme specifically for auto-enrolment.
About 44,500 medium-sized employers will be required to have schemes in place this year, which itself will need a lot of capacity, but the numbers are set to rise sharply: about 450,000 organisations will be required to comply in 2016, and 850,000 the year after. At least 12 months of planning is required ahead of staging dates to beat the rush.
Those employers with a choice will want to select a provider that has a clear commitment to this market, experienced staff who can support a complex implementation and future projects, and efficient administrative capability.
Pension providers have worked hard to make themselves attractive to larger, more profitable, employers with improved communication around the funds on offer, in particular tailoring default funds to the scheme membership.
However, a high level of bespoke tinkering is open to criticism that it is a device to keep consultants and advisers in business, because most employees fit neatly into just a few risk profiles that are well served by basic diversified investment strategies.
Some advisers have been devising a multitude of fund blends and suggesting different blends and strategies for similar clients. It is certainly more of struggle for consultants to make money on the DC side than it was with defined benefit (DB) schemes.
Providers are also developing stronger governance around their schemes, partly as a response to increasing scrutiny by The Pensions Regulator.
Focus on retirement choice
Today, there is much greater awareness about the importance of choices such as annuity or drawdown at the point of retirement, and some providers offer an annuity support service and access to secure modelling websites to help members think about their retirement income.
Under measures announced by Chancellor George Osborne in the Budget 2014 in March, from April 2015, pension scheme members will no longer have to convert their pension pot into an annuity at retirement. Instead, they will have the choice of taking their pension wealth as a lump sum, drawdown or as an annuity.
Other measures impacting DC pensions annoucned in the 2014 Budget include the proposal that from April 2015, people will still be able to take a tax-free lump sum of up to 25% of the value of the pensions pot (as per current rules), however any cash taken over the 25% tax-free amount will be taxed at the person’s marginal tax rate and no longer at 55%.
Also, from 27 March 2014, the amount the member can drawdown each year will be increased from 120% to 150% of an equivalent annuity (that is, the amount an annuity would have paid out in that year). In order to be allowed to ’drawdown’ from a pension, DC members must earn at least £12,000 a year. This is down from the current £20,000 a year income limit.
Providers that are currently doing particularly well in contract-based selection exercises are Legal and General, Fidelity and Zurich, which are seen as having strong propositions and an ability to implement schemes during a period when other providers are distracted by auto-enrolment .
Legal and General and The People’s Pension seem to be picking up a lot of the ‘low-quality’ end of the market: schemes with many employees but low earnings and high turnover. Hargreaves Lansdown is also doing quite well with its corporate wrap, attracting £511 million worth of assets under management by the end of December 2013, up from £222 million a year before.
- More large (62%) and medium-sized (52%) employers felt the auto-enrolment process would take four months or longer than those who said so in autumn 2012 (49% and 43%, respectively).
- 41% of small employers said they would leave it as late as possible before thinking about how to comply with auto-enrolment.
- 52% of medium-sized employers, 65% of smaller employers and 59% of micro employers indicated an intention to obtain external advice, such as from a benefits consultancy, accountant or independent financial advisery firm.
(Employers’ awareness, understanding and activity relating to workplace pension reforms, The Pensions Regulator, spring 2013)
- Of the 40% of respondents that were auto-enrolled into a pension scheme, only 15% have opted out.
- Nine out of 10 25- to 34-year-olds stayed in their scheme.
- 64% of respondents that had not been auto-enrolled and had decided on their course of action said they would stay in the scheme.
(Workplace pensions survey, National Association of Pension Funds, spring 2013)