Consultancy charging: the next pensions charges scandal?
With auto-enrolment into workplace pension schemes just around the corner (the largest employers will start enrolling staff in October), the features of the schemes into which workers will be automatically enrolled continues to receive scrutiny.
One of the difficulties, however, is that we are far from certain about what all of the schemes used by employers for auto-enrolment will look like, especially in terms of charging structures. The introduction of automatic enrolment is coinciding with the implementation of the Retail Distribution Review (RDR), that is, new Financial Services Authority (FSA) rules which will ban commission-based fees for advice. The implications of this for newly enrolled pensions savers are as yet unknown, but could be hugely detrimental to attempts to increase saving rates among low-to-median earners.
This is because so-called ‘consultancy charging’ is set to take the place of commission, at least for some workplace pension schemes.
Currently, when an employer enrols an employee into a workplace pension, any advice associated with the establishment of the scheme is paid for not by the employer, but by the provider whose product the employer chooses, through the payment of commission to the financial adviser. Clearly this represents a conflict of interest for advisers, and the RDR is therefore correct to outlaw payment by commission, and insist upon up-front payments for financial advice.
From the saver’s perspective, however, it is not clear that the RDR will change a great deal – and if consultancy charging becomes common, it may lead to pensions charges becoming even more opaque. At the moment, of course, the cost of paying commission is passed on to savers eventually: typically, an additional 0.4 per cent of any pensions saving pot is taken out by providers through a higher annual management charge, compared to similar schemes established without financial advice.
The problem arises when, now that employers themselves are required to pay up-front for financial advice, employers elect to pass on the cost of advice to their automatically enrolled staff through consultancy charging. Although larger firms appear to be absorbing the costs of outside help, it is possible that many smaller firms already dealing with the new burden of minimum employer contributions into workplace pension schemes, and to some extent with administering these schemes, will agree with a financial adviser that the fees for advice will be taken directly from scheme members’ pension pots.
This would be barely any different to the current arrangements, except for the fact that advisers will need to be paid more or less straight away by the advisee, not by providers. If an adviser is looking to recoup a typical cost of £250-£500 per member, they could apply a consultancy charge in the first few months of the scheme, or the first year, that could take a huge chunk out of members’ pots in the immediate wake of automatic enrolment. Indeed, the FSA has said it would be comfortable with up to 35 per cent of members’ pots being used to pay consultancy charges in the first year.
Clearly that would be a public relations disaster for automatic enrolment – notwithstanding the fact that there is actually no limit at all on consultancy charging. This situation essentially arises out of the new conflict of interest that employers will encounter in taking advice on establishing a workplace pension scheme. Although the UK occupational pensions system rightly expects employers to act as custodians of workplace pensions saving, the possibility to charge the cost of advice directly to employees’ pension pots means that employers will have no direct interest in ensuring that advice fees are not excessive.
The government must therefore consider banning consultancy charging. The advice in question will primarily benefit, or even exclusively benefit, the employer receiving the advice, not the employees paying for it. The government has the power to cap charges which are deemed not in the interest of the members of workplace pension schemes – if consultancy charging is applied as expected, there will be a strong rationale for government intervention.
The problem is compounded by the fact that pensions consultants will not be required to be fully-qualified financial advisers regulated by the FSA, because advice to employers is an unregulated activity – in contrast to advice to consumers. (The Pensions Regulator has raised concerns about this situation.) There will therefore be no constraints on the kind of advisers that will be funded through consultancy charging, even though the people paying the fees will be the consumers (the pension scheme members) rather than their employers.
And it could be compounded further if the government pursues its preferred option for dealing with the small pension pot dilemma, that is, a ‘pot follows member’ approach whereby individual savers take their pension pot with them to a new workplace scheme, should they change employer, through an automatic transfer. It appears to be possible that consultancy charges will be levied on all new entrants of a scheme, even if the employee in question has paid consultancy charges in a previous scheme.
The government cannot afford to be complacent on this issue. The potential gains from automatic enrolment, which are vast, mean that consultancy charging – essentially an unintended consequence of the largely separate RDR process – must not be allowed to derail the significant progress made to date.