In a report published today, VFM: Assessing value for money in defined contribution default funds, the Pensions Institute argues that charges are a key determinant in outcomes for default fund members. While its research, which modeled the returns of a range of old and new default funds, found a notable trade-off between risk and return along the investible frontier, only funds with low charges lie along it. Default funds with low charges were consistently among the better performers while those with high charges were consistently amongst the worst performers. Modelling showed the default fund with the highest average replacement rate was 23.8 per cent over 40 years, compared to 15.3 per cent for the worst.
The report also found potential for massive improvement in outcomes were legacy schemes with high charges and poor investment structures to be transferred en masse into better quality modern schemes with lower charges. The Pensions Institute called on the Government to facilitate changes to contract law to allow such transfers to be made without the individual consent of scheme members where it is clearly in their best interests.
The report predicts that fierce competition will very quickly consolidate the market to just five or six major trust-based multi-employer schemes by 2020, in a DC market that will grow from £296bn today to £1.7trn by 2030. It says rapid consolidation among providers could lead to market instability and the sale of pension books to uncompetitive consolidators.
The report says the only meaningful measure of outcome is the member’s income replacement ratio (RR), which it describes as ratio of the pension in the first year of retirement to the final salary before retirement. It says the focus on fund size as a target is misguided because it does not take into account annuity-conversion costs, interest rate risk and longevity risk.
The Pensions Institute says it has seen emerging evidence that cherry-picking, where providers take on only the profitable section of a workforce, is undermining SME trust.
Dr Debbie Harrison, visiting professor at the Pensions Institute at Cass Business School said: “Fierce competition is likely to result in the domination of five or six trust-based multi-employer schemes by 2020. Rapid consolidation among providers could lead to market instability and the sale of pension books to uncompetitive consolidators. There is an uncertain future in market for many EBCs and in particular formerly commission-based corporate advisers.”
Hymans Robertson partner and head of DC consulting Lee Hollingworth said: “We need to remember that there is more to this debate than charges and that contribution rates are also a significant determinant of outcomes.”
