Just two years into auto-enrolment a tidal wave of change and missed expectations means a secondary switching market is beginning to emerge. John Lappin investigates
As auto-enrolment progresses through the ranks of small businesses, a secondary market is already establishing itself among the early stagers and even some more recent ones.
Corporate advice firm Johnson Fleming took the message out to its clients earlier this summer with a guide for employers who want to switch scheme provider – driven in part by the huge shifts in the nature of the market. The firm cited the active member discount and commission ban, the coming charge cap, and the approaching three year re-auto-enrolment window as reason enough to consider changing scheme, but it also says some providers and advisers have not proved to be up to the mark.
It has now been followed by provider Standard Life which has also just launched its own guide to changing schemes though in its case aimed at advisers.
Johnson Fleming consultancy director Iain Chadwick says the raft of regulatory and legislative changes mean that businesses may have no choice but to reappraise their schemes, but in addition many are feeling let down by the support they have received from their existing auto-enrolment provider.
The case for a review and possible switch is also boosted by the three year re-enrolment anniversary.
In his view, the amount of change means not all the pain is over for some providers. He has also seen pension firms that were offering great service 12 months ago, decline in standards so, if anything, due diligence is even more important.
Chadwick says that while it is well documented that a number of providers have struggled with AE, many advisers have not had as strong a service proposition as they might have had or thought they had.
“Where in the past the employer has relied on their adviser for service, the adviser may have relied on the product provider. There could be an adviser service gap. Sometimes providers have been left to pick up more work than expected, because advisers have delivered less to their clients than they might have.”
“If you add up all of that forced change, to the fact some employers aren’t happy with the terms they have, it is bound to push people to look for change.”
Given changes to the way employers must pay for advice and support, says Chadwick, employers are also more focused on the service they receive.
“Is the adviser adding value? With the ending of commission, and with employers paying directly for the support for the first time, they may be thinking am I getting value right now? It is on a value rather than a cost measure.”
He says that a commission-free market is now emerging and it has some attractive characteristics.
“I think there is a wider range of pricing from providers, but that means you may be able to get a better deal. Providers are aware of where they do and don’t make money. You can attract some great terms if you have a scheme that is the right shape,” he says.
“The market will settle over the next 18 to 24 months. At that stage opportunities will exist to get a better real for many schemes. At that point there may well be significant change to schemes but beyond that if legislation is stable we expect a stable market for the long term beyond that”.
Independent pensions consultant Rachel Vahey says: “Providers will always argue that advisers should be switching schemes – a ‘they would say that wouldn’t they’ moment. “However, advisers together with their employer clients are probably constantly reviewing schemes, and therefore considering switching. There are many elements which are constantly changing, for example technology and employer needs. And of course administration promises may not stack up in reality, and employers and advisers may not be receiving value for money. A switch could mean a big improvement on a day to day basis. “Of course there is also an array of changing financial dynamics at play at the moment, which may mean providers are forcing these reviews, through turning off trail commission on schemes.”
Hargreaves Lansdown head of pension research Tom McPhail says in his firm’s experience switching is being driven by the fact that an employer’s pension provider hasn’t worked out as they hoped, or they haven’t had the level of support they thought they were going to get.
Standard Life head of workplace strategy Jamie Jenkins sees several drivers including the approaching triennial reviews but also the retirement income reforms.
He says: Triennial reviews will start in earnest next October so big schemes will want at least six months to make changes. For some big schemes, the triennial review will be a big deal and will be a natural prompt or catalyst.
“But we are also seeing activity from mid-sized schemes that a year ago or six months ago went with their incumbent scheme and auto-enrolled with them but are now thinking about moving. It is a sign of healthy market, but we have a proposition to help that transition.”
But he also sees the budget reforms as arguably a bigger driver.
“The question for providers of group schemes is what they will offer at retirement. Some providers are starting to show their hand. Some employers are thinking, if you can’t provide my employees with a post retirement service, do I partner with a second provider or do we seek to move now? Trustees are asking those same questions.”
JLT Employee Benefits director Mark Pemberthy warns against moving just for the sake of it.
He says: “I don’t think schemes should move just because of a bit more auto-enrolment functionality unless things are absolutely dysfunctional. But when you are looking at all the features that make up a good DC scheme, if the current scheme isn’t giving good value to members or isn’t providing the outcomes the sponsor is looking for, then reviewing provider or design is appropriate.”
Agreeing with Jenkins, he says a lot of schemes have gone through AE without changing provider, but that could all now change.
“Many of these schemes will have been in place for a long time. But wow there is a huge amount of change – they will have been impacted by charge cap by active member discounts, by commission, they might have the provider might differentiate functionality in terms of next year’s budget reforms. Good governance dictates every two, three or five years, you should review. The justification has to be that the scheme isn’t doing what the members or the sponsors require it to do. But changing for change sake is disruptive.”
Spence & Partners DC Pension consultant Mike Spink at says there is a considerable contrast between large employers and SMEs. “The shape of the adviser and client relationship will often differ across the large employer, SME and micro employer sectors,” he says.
“At the large company end, the adviser firm will often sit amongst the top ten actuarial consulting firms, which now have well developed corporate DC advice divisions. Here, the services purchased will usually cover not just the qualifying scheme selection and establishment work, but some form of ongoing monitoring of the scheme. This regular monitoring would usually be supplemented by a full market review every three years, testing the incumbent’s DC proposition against their peers.
“But within the SME and micro sectors, the picture is very varied. While some employers might seek such services, many will just be seeking an adviser to help the company achieve AE compliance with no plans – at least at outset – to implement any form of scheme review.”
He says there is also a different situation where the client is a trustee entity.
He says: “Code of Practice 13 will require the trustees to evidence how the qualifying scheme is monitored and tested against other schemes on value for money grounds. Advisers can help trustees audit the scheme against the 31 quality features and help complete TPR’s governance statement”. He notes that this is required for scheme years ending after January 1st next year.
He also believes the process of review could be accelerated.” While the earliest bundled qualifying schemes wouldn’t usually be scheduled for market review until late 2015, two particular issues might accelerate this process. Firstly, providers are hurting: it would seem strange if as big a player as Scottish Widows were the only firm struggling to cope with the last few years’ pensions upheaval.
“So there will be a heightened focus on service standards and how providers plan to resource their administration teams to maintain or improve high quality client servicing. Secondly, employers and trustees will be speaking to their advisers and providers about the draft Taxation of Pensions Bill and which retirement options should in future be made available to members. As a minimum, the default strategy will require review.”
However, for these schemes at least he believes the charge cap may not be too significant an issue.
“Even though the larger qualifying schemes will have been negotiated well before the default fund charge cap was decided, we would expect the majority of these schemes will have secured default fund total expense ratios well within the new cap.”
McPhail says the tie in with commission and scheme switches is interesting. “Most life offices have turned the taps off, and that has presumably led some intermediaries looking to take a step back from schemes. They have said to employers we will give you this level of support expecting to get an income stream off it. Now it has dried up and if they are uncomfortable going back to an employer asking them to pay a fee or the employer won’t pay a fee, something is going to have to give. It might just be that an intermediary walks away from the scheme, and then the employer may say without support from an intermediary they will go to Nest”.
Pemberthy adds: “Even where commission was a factor, schemes were still changing to lower charges and different levels of functionality. It was not just about commission, it was about improving the outcome. One of the big changes if you take commission away is there is no subsidy or revenue paying for the work that goes into reviewing, administering and communicating a change of scheme. That has now got to be paid for by the sponsor. From a sponsor’s point of view, they have to see real value in doing that.”
A professional trustee’s perspective on adviser master trusts
With so much change in the air, PTL managing director Richard Butcher has deep concerns about the sustainability of the proliferation of new adviser-sponsored master trusts.
Butcher says: “The critical thing that is often overlooked is the sustainability of the provider. I am genuinely concerned. There are traditional providers, the insurers and investment managers but there are lot of unorthodox providers rushing into the market. Third party administrators, firms of advisers and others, people whose core skills are not traditionally creating a packaged DC arrangement.”
He says that as a master trust specialist he has had to put off three firms that have approached him to set up a master trust, cautioning that the process is considerably more complex than he thinks they believe it to be.
Butcher says some firms are eyeing the small employer end of the AE market in the belief big providers won’t play there. But he says a business plan based on winning 10 per cent of small employers can easily miss its targets for premium income, especially with around 30 players vying for that business.
He questions what patience the backers of such an operation might have if it looks as if they may not just fail to get a return on capital but to perhaps to lose their initial investment as well.
“What are the consequences for employers if they auto-enrol with one of these schemes. What do they do if it hasn’t worked? What if it is a disorderly failure and trustees have to dip into members’ funds. What if an employee says to an employer if they have accumulated £1,000, I just lost £300 of that because you have to go looking for another master trust?”
“Employers need to look for sustainability. They need to ensure the trustees, their adviser or they themselves have tested the business mode. If it is L&G or some other big provider, they may not have to dig too deep, but if it is ‘ABC’ IFA master trust, you need to dig deep. As it gets to the lower end of the market these grandiose business plans start to go off track. I would expect a disorderly failure at the end of next year or into 2016.”