A second round of IGC reports show most charges have been brought down, but transaction costs remain hard to pin down. Michael Klimes looks at the key findings
Two years has passed since the independent governance committees (IGC) were introduced to improve value for money in contract-based pensions to generate better outcomes for customers.
The second annual reports are now starting to come through, with the first published by the IGCs for Legal and General (L&G), Scottish Widows, Standard Life and Prudential.
All report that providers have abolished or capped exit fees, and made progress in delivering value for money to policyholders.
The main contrast between Prudential and Scottish Widows versus Standard Life and L&G is that the first two have abolished exit fees, going beyond the FCA's 1% regulatory cap on early exit fees introduced on 1 April.
According to Prudential's IGC, the provider has axed all exit fees and removed charges taken for adviser commission payments.
Meanwhile, Scottish Widows capped scheme charges for legacy products at 1% and removed all exit penalties from April.
L&G's IGC says while it hoped all exit charges would be abolished, they will instead be capped at 1% as at 31 March 2017. However, the IGC won some concessions as the cap will be extended to any member that meets the definition of ill-health before age 55 and will be waived in the cases of serious ill health.
For older policies, a 1% annual charge cap has been applied to all active and former members of workplace pension schemes.
Standard Life has reduced the number of members who pay more than 1% annually from 266,684 as at 31 December 2015 to 45,557 as at 31 December 2016. It also complied with the FCA's exit fee cap as at 15 February ahead of the April deadline.
Having reviewed around 178 different default strategies, which are invested in by over one million policyholders, the IGC concluded the vast majority provide value for money.
Clearly these developments are positive - albeit some driven by regulatory changes such as the exit fee cap.
However, there is no room for complacency, with all the IGCs admitting there is more work to be done on transaction costs. Despite some progress in getting a better handle on these costs, many are using best guess estimates to come up with the figures.
This is made difficult by a lack of agreement on how these costs should be disclosed. The Financial Conduct Authority (FCA) is expected to publish disclosure regulations for asset managers at some point in the second quarter.
The Scottish Widows IGC asked the provider to analyse transaction costs for 29 of the largest equity funds used in the Pension Investment Approaches (PIAs). These are the small group of investment options used as default funds in auto-enrolment workplace pension schemes, and include a mixture of active and passive strategies.
Standard Life examined yearly transaction costs during 2015 for the core default funds and found the costs fell within the range of 0.1% to 0.2%.
The transaction costs for L&G's default funds ranged between 0.04% and 0.08%, while the equivalent for Prudential is 0.07% for the 12 months to 30 June 2016 based on average allocations for customers.
These are considerably lower than the FCA's 0.5% average transaction cost estimate for actively managed equity investment, as set out in its interim asset management review last year.
One obvious reason for the discrepancy is that the level of transaction costs is dependent on what type of fund is being measured, with passive investment generally incurring fewer costs than active. The higher the number of transactions within a fund's strategy - or the portfolio turnover rate - the higher the transaction cost level.
Scottish Widows IGC chairman Babloo Ramamurthy says: "The FCA's figure of 0.5% covers actively managed equity funds, which are more concentrated, specialist and much smaller - 'boutique' might be the best term for them.
"The transaction costs for a large passively managed equity fund might be 0.05%. For a small specialist concentrated boutique active equity fund, transaction costs might be 1%."
Of the 29 funds that the Scottish Widows IGC looked at, 14 are passively managed equity funds, and 15 are actively managed equity funds.
"The large actively managed equity funds are diversified and don't tend to change from the benchmark very much. The active ones we looked at are all very large and tend to be invested in a range of equities, which makes this type of fund very low risk.
This would explain why the transaction costs are very low in these funds.
"Typical workplace pension products are at the lower end of the transaction cost spectrum while retail and unit-based tend to be at the higher end."
While Prudential IGC chairman Lawrence Churchill agrees different fund types could explain the difference between the FCA and IGC figures, he believes there are two other explanations. One is the methodology used to calculate transaction costs, and the second is that pension providers have economies of scale, which in theory could make them more efficient and lower costs for members.
The FCA says in a written statement: "We cannot comment on individual IGC reports, but reasons why the costs differ could depend on a number of factors such as: The methodology used (for both implicit and explicit costs), the strategy used (active vs passive), the level of transactions within the strategy or the portfolio turnover rate, the asset classes covered (our estimate was for equities only)."
The IGCs are waiting for the FCA's disclosure regulations, which are expected be finalised this summer.
"When the FCA produces the regulations we can then drill down and make accurate comparisons. Over time it might drive out inefficiencies across the industry," says Churchill.
He believes IGCs have to be careful about how much information they publish about transaction costs.
"IGC reports might not be the best vehicle to share all details on asset management costs. There might be more specialist publications which could do that. The IGC report has to keep itself at a more general level. The question about how much you select which might be of interest to the reader is a delicate one."
First Actuarial business development director Henry Tapper hopes the regulations can be incorporated into the IGC reports from April 2018.
"People need to know what they are paying for," he says. "I would like to see the creation of an independent fund utility which collects data, ensures it is consistent, and is used by all asset managers and providers."
Until the FCA finalises its cost disclosure rules, IGCs will be in the dark to some degree about how to tackle transaction costs.
Cleary IGCs have made progress in delivering value for money for members during the past two years.
But if they really want to get on top of costs comprehensively, the issue of transaction costs has to be tackled.
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