Governing pension schemes in the interests of members
There are basically two models of workplace pension.
- The traditional model is run by trustees, who have a legal duty to act solely in the interests of their members. In pensions jargon, these are known as occupational pensions, though I prefer to call them trust-based pensions.
- The more recent approach is the contract or group personal pension. These will have been set up by the employer, but is essentially a bulk-bought personal pension for employees. The legal relationships are between each individual worker and the pensions company who invests their individual pension pot. They are commercial products run for a profit.
Last year the Office of Fair Trading (OFT) produced a damning report into the market for DC pensions. But a combination of government and industry responses persuaded them not to take the issue further. Whether these will go anywhere near far enough is now a live issue.
But let’s first go back to the OFT report. This is an extract from the full report:
- The buyer side of the DC workplace pensions market is one of the weakest that the OFT has analysed in recent years.
- Part of the reason for this is that most employees do not engage with or understand their pensions. Pensions are complicated products, the benefits of which occur, for many people, a long time in the future. Considerable survey evidence testifies to the low levels of understanding and engagement that many employees have in relation to their pensions.
- Furthermore, while the person who takes the risks and rewards of a DC workplace pension is the scheme member, they are not responsible for choosing key elements of the product. Instead, the choice of a DC workplace pension rests
largely with the employer.
The report was serious enough to trigger a full scale inquiry by the Competition Commission which could have resulted in big changes forced on the industry.
But a combination of planned action in response by government, the industry and regulators was enough to head off this nuclear option.
First the industry is expected to own up to and deal with old pension schemes with high charges. This has started with an audit which certainly reveals some people have savings in some pretty poor schemes. This is part of what it found:
- Between £23.2bn and £25.8bn of AUM is potentially exposed to charges of above 1%. Around half of this is potentially exposed to charges above 1.5%; between £5.6bn and £8.0bn is potentially exposed to charges above 2%; and around £0.9bn is potentially exposed to charges above 3%.
- Schemes where savers are potentially exposed to the very highest charges are more likely to have complex charge structures. Nearly all AUM potentially exposed to charges of over 3% are in schemes with monthly fees or deductions from contributions.
- The majority of the AUM exposed to charges over 3% (£0.7bn out of £0.9bn) is held by savers with pots of less than £10k. Of this, over 90% is held by savers that are paid-up and have stopped contributing. For such savers the impact of monthly fees can result in a very high impact of charges.
- We estimate that there are 407,000 savers that have joined schemes in the last 3 years who could be exposed to a charge of over 1% in the future. Of these, 178,000 could be exposed to charges over 2% and 22,000 to charges over 3%.
To put these numbers in context the government is capping fees for auto-enrolment pensions at 0.75 per cent. And this chart shows the difference that a 1 per cent increase in charges can make.
To ensure follow up on this audit and to act in consumer interests the government is legislating to set up Independent Governance Committees (IGCs) to monitor commercial pension providers.
This is probably better than nothing, but there are real doubts about whether it goes far enough.
First there are real problems with IGCs. They are appointed by the pensions companies so are not independent. Nor do they really have all the powers of governance that well-managed trust based pensions have – they can hardly sack their fund managers. I suppose though that they can claim to be committees.
Nor is there any requirement to have an employee/ consumer voice involved in governance, though single workplace occupational schemes are required to have member nominated trustees.
Secondly they don’t fix the basic problem with this market. It will still be employers buying a pension for their staff with no incentive to provide the best deal possible that best suits their staff. Of course some employers will make a careful choice and the auto-enrolment revolution means that there are good options around, but many employers will ask what is the easiest way to meet our regulatory requirements, not what is best for our staff.
This is why Trust based governance makes more sense. Instead of choosing a scheme for their staff, the employer chooses an organisation much better placed than they are to run a pension in the interests of their staff, not anyone’s shareholders. It is likely to have both the scale and good governance that are needed to keep charges down and deliver good outcomes for savers. In addition trust based bodies are much better placed to deliver pension income in retirement and share and pool risk – hard enough when it is between different members of schemes, close to impossible when shareholders want a share too.
This is not to say that all trusts are great. Some are too small, and some so-called mastertrusts that cover more than one employer have been set up by for-profit companies to provide a thin trust-based governance layer on commercial products, originally to exploit short-service refunds that benefit employers not staff . These look more like (not very) IGCs than proper trusts. Nor are all contract-based products poor value, of course. A handful in the largest employers are effectively monitored by good governance committees, and others have been set up by employers who do take care about buying low charge and smartly invested defaults.
Moving to a wholly trust based system will not be popular with insurance companies, but if they are to stick with IGCs then they need to make them work, not leave them looking like a week-old sticking plaster.
That is why it is alarming- if not that surprising – to read on Henry Tapper’s blog that
The question is who is going to do the challenging? In last week’s policy statement, the FCA held with their original idea of allowing corporate trustees to participate on IGCs. The duties of Corporate Trustees are the responsibility of a firm of Professional Trustees but not the responsibility of a named individual. Expect corporate trustees to be singularly lacking in personal conviction and long on formulaic box-ticking.
If you add to the corporate trustee, the two insurer nominated trustees, you have a block vote of 3 out of 5 trustees that potentially could block any contentious stuff getting either to the insurer or (heaven forbid) to the policyholders.
It’s time for those who value independence to stand up and be counted and to raise their hands.
If a hard core of sympathetic corporate trustees , insurance executives and stooges drawn from the bibulous world of NAPF conferences are allowed to pack these committees, IGCs and GAAs will have the teeth of a new born baby.
This is exactly the kind of outcome that those of us who have always wanted trust based governance to renew our lobbying of governments and regulators as it will confirm our fears. On the other hand IGCs with teeth and genuine independence will inevitably blunt our calls, and cause us to lobby elsewhere.
Photo from Rubén on Flickr