While the Pensions Bill continues its passage through the House of Commons, PADA’s consultation on how it proposes to charge for personal accounts is coming to a close.
The argument has moved from how low the charges should be to the shape of charges, and PADA has set itself three criteria for deciding how to take the issue forward – retirement outcomes for members, judged in terms of fairness within generations and across generations, participation, based on how members will perceive the charging structures and sustainability, in terms of providing a viable funding solution that minimises scheme costs and business risks.
The structure that PADA eventually adopts will have a significant bearing on the private sector pensions industry, both in terms of how the state-sponsored version compares in reduction in yield and how the new body will pay for itself. It is also likely to inform the debate over how charges are structured in private sector pensions.
PADA is now grappling with many of the same issues that have vexed pension providers for years – how to charge for a product that is expensive to set up when assets under management are small. It is looking at five different charging structures, none of which, says the Pensions Policy Institute, satisfy all of the criteria. A report of from the PPI last month said: “Overall, there is no single charging structure that performs well against all of the criteria. The proposed criteria are interdependent, and hard to rank.”
The options on the table are a straightforward annual management charge, a joining charge plus an AMC, an annual flat fee, a contribution charge and a contribution charge plus an AMC.
“There is a strong argument to say that the shape of the charging structure should take account of the environment which commercial operations are obliged to operate in,” says Alasdair Buchanan, group head of communications at Scottish Life.
However, the sheer costs involved in running a business in this way, something that life offices will need no explaining, are likely to push this option to the back burner, despite the fact that this is the solution that is fairest to all participants and is best understood by end consumers.
Such is the level of up front borrowing to fund the new personal accounts administration on a flat AMC model that the body that supersedes PADA could be faced with a bill of up to £12bn for interest alone, according to the PPI’s findings.
With the pensions industry adamant that taxpayer subsidies for personal accounts will amount to unfair competition, such a potential expense would seem to put this option onto the back burner.
“This is the commercial reality of setting up pensions businesses. The opportunity to use existing infrastructure has been overlooked by the government,” says Steve Folkard, head of pensions and savings policy at Axa.
PADA’s research has found that consumers do not feel that the charging structure would be an important consideration for them in determining whether o opt out from personal accounts after being auto-enrolled. But those questioned in the research did express a preference for a single type of charge rather than a combination of charges, and the idea of a joining charge had the most negative response, suggesting it could lead to lower participation rates.
The PPI has estimated the payback times for borrowing as ranging between zero and 28 years, dependent on the shape of the charge. A joining charge plus AMC requires no borrowing at all from 2012 while an AMC alone will take between 15 and 28 years to pay back. Contribution charges and annual flat fees both have payback periods of two to three years.
Meanwhile, PADA will also have to address the issue of how charges affect different scheme members. Annual flat fees will impact low earners more and those that contribute for a short period of time. Indeed if no protection were introduced alongside a flat fee, this could mean that some people lose the whole of their saving to charges, says the PPI.
“One of the problems of a flat AMC approach is that as fund sizes begin to grow, it may be a relatively unattractive option to stick with personal accounts, as private pensions may be able to offer a cheaper deal,” says Buchanan.
Whatever option is adopted, providers and advisers will be keeping an eye on developments to make sure that the cost of capital to the body that eventually administers personal accounts is based on market realities. Setting up a competitor to a healthy private industry with state subsidies could risk damaging not only businesses, but also levels of saving across the wider population. The Department for Work and Pensions says it does not want that to happen. The industry will be looking to keep it to its word.