April is not just about pension freedom and choice – it also hails the introduction of the charge cap and the end of AMDs. John Lappin finds employers who thought they had sorted AE facing some hefty bills
Is the 0.75 per cent charge cap that comes into force this month the dog that didn’t bark? Or is it simply not receiving the attention it deserves because freedom and choice has been hogging the headlines?
Some experts suggest it is the balance sheets of the insurers that have borne the brunt of the policy, taking on board any AMC cut where they had to and, for the most part, levelling down deferred member charges, with active members on the whole not suffering as a result. But some employers have also ended up with five-figure bills where they have had to change their scheme but found no commission to pay for it.
Deloitte partner Andrew Power says: “Most providers have accepted it is going to be the way of the world. There may be technical details in terms of ‘This fund is very popular but it has a higher AMC’, but generally, providers dealing with large or medium companies are within the price cap.
“It may be more of a problem with SMEs, particularly the S part – so fewer than five- or 10-employee SMEs. The AMC is difficult to argue with. There is some incremental cost but, in most cases, I am seeing people roll over and say ‘OK, that is the way we are going to have to go’.”
Independent pension consultant Rachel Vahey says: “I don’t think the charge cap is the biggest issue for the industry at the moment, certainly as far as new schemes are concerned. Many of the schemes and providers were already operating at a low charge for their default fund in automatic enrolment schemes. So practically, few of them have had to make any really substantial change.
“The pension freedom changes have swamped resources on every front – money, time, IT, people, expertise. Maybe, in comparison, the charge cap seems fairly straightforward and schemes have just got on and done it.”
Institute of Directors senior adviser on financial services policy Malcolm Small says: “If you look at the cap closely, it’s more of a loose-fitting collar, with both front-end and ongoing charges permitted to accommodate Nest easily.
“In reality, most providers are sticking to 0.75 per cent AMC as the benchmark, because to go beyond that will look toppy. The challenge for providers will be to make money within this cap – and that is another story. There’s a fairly widespread view that price caps will drive consolidation and that’s a view I’d support.”
JLT employee benefits director Mark Pemberthy says: “From a charge cap perspective, broadly at employer or scheme level, it has not been too big an issue. The providers have taken all the pain in the contract-based world. We have seen hundreds of millions of pounds of balance-sheet write-downs and that has effectively been the buffer that has enabled the charge cap to be absorbed within the current scheme framework.”
First Actuarial director Henry Tapper concurs. He says: “The impact is a gradual turning of the screw; the turning-off of trail in 2016 will hurt more. It won’t be until the charge cap incorporates transaction costs that it will really hurt, although insurers have had to take some technical impairments in 2014 to meet it.
“The threat of a 0.5 per cent cap is still there and would be very much alive if Labour were returned. It may not have bitten but it is gnawing away and it isn’t going away.”
The removal of active member discounts is mostly being resolved with costs being absorbed by the provider. Jelf Employee Benefits head of benefits strategy Steve Herbert says: “With most insurers, even before the cap was on the table, they said ‘When it comes in, we will level down’. There have been some cases where it has levelled up but mostly for the consumer this has been a good deal.”
But many workplace advisers are circumspect about the impact of the cap, saying it may reduce frequency or quality of communications.
Parklands IFS principal Paul Yallop says: “We run a number of corporate schemes within the 0.75 per cent charge cap. Previously, we ran them at under 1 per cent and gave more regular company visits. The payment we receive from the provider allows us to have individual time every year with all staff members and, in turn, we have a 100 per cent staff take-up on all the schemes we run.
“The average member contribution is 8 per cent and, because they have been educated rather than forced, the members take pensions seriously.”
He continues: “Once our commission has been removed and if the business will not pay our fee, we would be pushed to tell the member we will bill them for a 10- to 30-minute meeting each year.
“In the past, it was built into the annual charge – which I doubt will reduce once we are out of the equation. I fail to see where the members will be the winners. We also deal with the members’ retirement options and, in nearly all cases, we get them a better rate on the open market.”
Indeed, that issue, which is now also bound up with communicating freedom and choice, is highlighted by many advisers.
Pemberthy says: “We have concerns that some employers are looking at what they are spending money on. There has been a slight rebalancing in terms of fewer assets and less time spent on member communications and education, and more spent on governance, scheme design and strategy.
“Commission used to support a lot of member education, interaction and guidance. That is being eroded across IFAs and corporate advisers.
“It is inevitable that employee support will drift away. With freedom and choice, now is not a great time for that.”
Pemberthy suggests other compromises may be needed. He says: “There have been some compromises around investment design, where schemes were starting to use diversified growth funds and volatility-managed investment solutions. Some of those have had to be diluted to make sure the overall scheme fits with the charge cap.”
Buck Consultants at Xerox head of DC and wealth Sue Pemberton says: “Less money out in charges is more money into the pension. The hit may be on the level of specialisation available, in terms of where an employer has a limited budget to cope with pension freedoms, put good governance in, review the default fund and increase contributions. The calls on employers are getting greater and greater.
“The areas where we can add value include putting in a blended fund, focusing the communications and making them more individual. Employers will have to think about where these sit in the priorities.”
Yet advisers suggest that, on the whole, there has been limited disruption to their own client base.
Pemberton says: “Most schemes are of a size where it wasn’t an issue. Where it was an issue is mainly where we inherited a commission case. It could be where we have put in a blended fund as well, although sometimes the providers have taken the hit. It has created additional work in trying to make sure members get the most attractive charges. That work will continue where commission has not been removed completely.”
Herbert envisages a compliance risk for one group of employers. He says: “There are two layers. With our client bank, most of the insurers have said ‘We have to reduce our books’, so for most employers, whether they are aware of it or not, the job has been done.
“Yet there will be some schemes where that can’t happen. Do those employers know they have a problem? I think most don’t know.
“There will probably be companies that went their own way on AE: they ticked the box, didn’t take advice and their scheme wasn’t attractive enough to take them below the line on cost. There may be some that think they are compliant but don’t know for sure, and there may be problems down the line.
“It is the employer’s issue if you are auto-enrolling people into a non-compliant scheme. The scheme provider is contracted to provide what they are contracted to provide. If they don’t want to cut charges to the level of the cap, it is up to them.”
Pemberthy says: “As we get to smaller employers where the commercial models are not so clear-cut for providers, we have seen the introduction of employer fees to supplement the AMC and we will see some resistance from employers as we go through the SME market. There is still a way to run to find out how the cap will impact.”
Finance & Technology Research Centre director Ian McKenna believes the cap is encouraging major changes in the market, particularly around the alignment of distribution and manufacturing.
He says: “What the cap is causing people to do at the larger end of the market – and the move by Aon to create its own contract-based DC programme is one example – is to say that, in the absence of commission, the revenue mechanism that they used has gone so they need to re-engineer the value chain.
“Creating value is done by bringing different components together and fulfilling a very different role.
“If you look at what Aon has done with Bigblue Touch, it has outsourced the investment and admin to BlackRock; it has a very impressive technology layer in it as well. It will have a product that will compare very well in the manufacturing space.
“Partly this is Aon leveraging size. It is a direction of travel and it is not the only organisation that will be doing this. It will be organisations of Aon’s size but also those another tier down.”
However, with an election pending, as Tapper points out, there is still the possibility of a further screwing-down of the cap. This has consultants worried, particularly about what could be delivered in terms of investment and communications.
Pemberthy agrees. He says: “There are concerns that the cap could be reviewed again, or indeed, if transaction charges are included, that there would be an issue for the investment strategies that could be delivered within the default. That might be counterproductive for some schemes.”
Pemberton adds: “That would make schemes very vanilla. With 0.75 per cent, you can still often make schemes bespoke; it is difficult at 0.5 per cent.
“Across the industry, there is little difference in scheme structure and IT, but with default funds, they are being reviewed extensively. We are trying to future-proof them and there is a lot of work going into that. There is an issue about whether that could be maintained.”
IN FOCUS: Employers taking the pain
Lighthouse Group Employee Benefits
Lighthouse Group Employee Benefits managing director Roger Sanders says the big shake-up is not in new business, where the cap is taken as read, but in legacy business, including that recently adapted for auto-enrolment.
He says these employers perhaps decided to use an existing GPP for auto-enrolment and tweak it a bit, but this is not always sustainable with a 75bps cap.
The ending of adviser remuneration and commission, in theory by 2016 but in practice sooner, will also change the market, he predicts, with many companies turning off the tap now.
For some of these schemes – especially if they already had tight costs, partly achieved through the AMD – the 75bps cap may be very difficult to deliver without extra costs for the employer.
Sanders says: “We have employers coming to us saying ‘Can you help us?’ It hinges on the 75bps and that is the trigger where it means the employer must pay something on top. Previously, it was painless for employers.
“In a recent case, an employer had 400 to 500 employees in a GPP and had to stage all staff – so around 850. It had low opt-outs and was paying the minimum. This was all done through a national IFA.
“But that adviser has written to say ‘Commission is stopping on this scheme in April 2015, which is a year early. So we can no longer service your scheme, with all that entails – including the middleware – without a fee. And the fee is £60,000 a year plus VAT.’
“We know the firm as we also pitched for it originally. We have said ‘Come back to us’, but the FD is between a rock and a hard place. We have said we will do it more cheaply but the firm will still be looking at a fee of around £30,000.”
Sanders adds: “Employers like that feel very hard done by, with an industry that has allowed them to use existing products and a Government that said ‘We are going to make better member outcomes by reducing the cost’.
“The employer has now got a major cost – equivalent to as much as two full-time members of staff. I have a lot of sympathy. If we had started fresh in 2012, we could have managed expectations, but collectively as an industry we have not managed expectations.
“We are managing them now, that’s for sure. For smaller employers, the costs are more manageable. But larger employers are feeling slightly misled and I don’t know if they are pointing the finger at the DWP, the providers or the intermediaries.”