Pension scheme members have a new champion. Should they fall victim to inappropriate costs within their defined contribution plan, a newly appointed independent governance committee (IGC) will step in and challenge their provider to make the necessary changes.
IGCs are the brainchild of the Financial Conduct Authority, but are they a long-overdue innovation and guardian angel for pension savers or is it now a case of too many cooks spoiling the broth?
The regulator announced plans to introduce the committees last August after an Office of Fair Trading investigation found that the buyer side of the market was “one of the weakest that the OFT has analysed in recent years”, identifying a potential conflict of interest between employers and the schemes they offer.
The FCA ruled that employers make most of the key decisions but may lack the capability and/or incentive to ensure that members of their schemes receive value for money in the long term. To this end, IGCs have been billed as a key part of the improvements in the governance of workplace pensions.
In short, the IGCs’ job is to enforce the 0.75 per cent annual charge cap on default funds introduced last month.
FCA director of strategy and competition Christopher Woolard said in February that employees and ex-employees were often unlikely to know whether their workplace scheme delivered value for money for them.
“It is important that schemes are operating in the interests of members and IGCs are a significant step in a package of measures aimed at improving the value of workplace pensions,” he said.
A KPMG paper entitled The Cap of DC Scheme Charges concluded that the combined raft of changes proved it was “safe to say that Steve Webb has his eye firmly on protecting members”.
It continued: “For the majority in the industry, the lack of full transparency in charges has been a concern for some time. However, without industry-wide support it has been difficult to resolve. The new requirements are set to change that.
“This is a positive step for the industry and is likely to complete the picture on charges and the transparency of these to trustees and IGCs – and then on to members as well.”
Towers Watson also welcomes the changes, particularly the downward pressure on pension costs.
Senior consultant Roy Edie says: “In the current market, most DC schemes appear to have just a simple fund-based charge, rather than a more complex mix of fund-based, allocation-rate and fixed-fee deductions. However, there is still room for improvement”.
Edie says the monitoring of costs will probably continue to evolve but, for now, IGCs will need to be aware of the charges that apply to the policies they monitor and satisfy themselves that they are fair and proportionate.
Added value
Capita Employee Benefits head of marketing and research Robin Hames says: “We will be looking to see which providers have constituted their IGC as something that is really looking to deliver added value and which have simply looked to meet their new obligations in the easiest way.
“While there are core things they must look at, they will all have different terms of engagement with their sponsoring provider so we could see different approaches being taken.”
But not everyone is in agreement that IGCs will have a wholly positive effect on schemes. While the aims are admirable, the ongoing focus on cost above all else raises concerns that there could be a negative impact on the running of pension funds.
When the charge cap was announ-ced, many in the fund management industry said it would mean the end of actively run funds within pension schemes because only passive vehicles would be able to come in on budget. Similarly, they said alternative assets such as infrastructure and volatility-reducing instruments would have to go because of their cost implications, leading to lower returns for scheme members in the accumulation stage.
JP Morgan Asset Management head of UK defined contribution Simon Chinnery warns: “If price is driven too low, the ability to access active strategies that have proven benefits in the world of defined benefit and wealth management will be limited or curtailed completely.
“We have undertaken research in the US into prioritising one risk in glide path design and have included funds that are concentrated, fee-sensitive passively managed strategies, run in the belief that this is a more efficient way to invest longer-term.
“However, this means that the portfolio is often more constrained in asset class choices, since certain types of investment are difficult or costly to access passively. We found that these less diversified glide paths can increase market and event risk, longevity risk and inflation risk. Some predict that savvier scheme members will opt out of the default in order to access high-return assets no longer available under the charge cap.”
Active management
But Aon Hewitt senior DC investment consultant Ryan Taylor says IGCs may in fact help to champion the use of active management and other higher-cost investments where the rewards justify the charge.
“Many platform providers already operate investment committees that oversee the default investment options offered by that provider as well as the ones recommended by the client’s advisers. As a result, value for money is already a key consideration for new investment strategies, which has resulted in a greater focus on passive solutions,” he says.
“However, where it can be demonstrated that an active approach to investment management can add value – such as in the multi-asset space where the focus is on reducing the level of volatility, or in the at/through retirement space where there is a
need to meet a member’s income requirements – there is no reason why actively managed funds cannot continue to be used.”
Issues beyond cost
IGCs will be expected to consider all charges, whether direct or indirect, relating to the funds in which the policyholders are investing, but the National Association of Pension Funds thinks the committees should focus on issues beyond cost.
It says: “The FCA should make it explicitly clear that IGCs can consider all issues that make a difference to members, including member communications, administration and support for members approaching retirement.”
Taylor says cost clarification is enough to be getting on with for now.
“Many provider default solutions are marketed to members as being zero per cent cost and therefore, on the face of it, it is difficult to determine if these are value for money.
“The IGCs will need to understand what services are being provided and how the overall cost the member is being charged is attributed to each of these services. This is before we even start to ask questions of fund managers in respect of transaction costs and the like.”
IGCs are required to report annually on the value for money their firm’s scheme members are receiving. This report must be publicly available and provided on request. The committee, made up of at least five members, will have to communicate its findings with scheme members.
Confusion reigns
Transparency is high on the agenda for IGCs, which must ensure that members are fully aware of the costs they are paying. However, Taylor recognises that too much disclosure can be confusing.
“One of the lessons that needs to be learned from the disclosure of additional expenses is that when members see a TER they assume that is what they are paying, without realising that part of that cost has already been accounted for in the performance of their fund,” he warns.
“Therefore they double-count it. This has the potential to be compounded if we also disclose other charges, and the evidence of value for money will only become harder as a result.”
The effectiveness of IGCs themselves will also be monitored, in particular whether their presence at a firm makes a difference to scheme members. The NAPF questioned how effective they would be in the event that they concluded that members were not receiving value for money.
“While we support the focus on governance, we have some scepticism about the extent to which IGCs will be able to influence the behaviour of pension providers. IGCs will play mostly an advisory role, rather than having direct powers like trustees, and pension providers have responsibilities to their shareholders,” said the NAPF in a response to the FCA.
Even if ICGs are found to be effective at keeping pension costs down, Chinnery questions whether this is the right approach.
“The DC default investment model is quickly evolving beyond mechanistic life-cycle structures. There is a move towards more sophisticated target date fund solutions, which can still offer returns in a lower-yield and lower-fee world,” he says.
“I suspect we will see a further push for a charge cap to be more widely applied across the industry.
“Making sure end investors are not being ripped off is critical but, if income replacement levels fall, I still have a niggle: cheap investments for members but at what cost?”
