Jonathan Stapleton says we need to increase DC scheme fees if we hope to improve investment quality and the sustainability of providers.
We all like a bargain - and, if you asked 100 people if they wanted to pay less for a particular good or service, it is unlikely many would say 'no'. People often assume that paying less leads to better value for money.
I think the same applies to pensions.
The campaign to improve fee transparency and to reduce the costs and charges on defined contribution (DC) schemes has undoubtedly had some major successes. There has been a reduction in the number of providers charging exorbitant amounts for average products and the cap on early exit pension charges has also helped.
But I believe you can go too far with this agenda. The charge cap applied to auto-enrolment DC defaults, for instance, is a great way to reduce investment costs, but it does little to improve the quality of DC investments, either in terms of performance or structure (are lifestyle funds really the best vehicles for our DC cash?).
I wonder if it is time to consider moving against the orthodoxy of 'less is more' when it comes to DC default funds and to consider paying more to get more.
There are a number of key reasons a rise in fees - or a different way of charging fees - must be considered.
First, hardly any pension provider is currently making any money out of DC at the moment.
Look at NEST (which won't break even until 2026, at which point its debt to the Department for Work and Pensions will have hit £1.2bn). Other providers are in the same boat - with firms making very little if any money on their DC offerings and hoping to recoup this over the longer term when assets under management have reached a much higher level. Some providers have already given up, selling themselves to rivals, and I expect more will follow over the coming weeks and months.
Part of this is down to the way in which providers rely on annual management fees (AMCs) to provide all their income.
Such fees mean those with bigger pots pay far more than those with smaller pots; those with larger funds subsidise those with smaller funds; and the provider has to wait a long time to get payback on their investment into scheme setup, development and marketing.
While we have become used to them, AMCs are also unfair as they do not distinguish between the fixed and variable costs of running, administrating and investing a DC pot - and my hat goes off to providers such as Now Pensions, who have tried to experiment with different charging structure in order to reflect these fixed and variable costs more accurately (in Now Pensions' case, by charging a monthly admin fee of £1.50 in addition to an AMC of 0.3%).
The pressure to reduce costs has not only meant payback periods for providers have been extended but also that the amount of money available for the investment content in the default offerings of these schemes has been squeezed ever further.
Members opting for a default offering in any major scheme are unlikely to receive anything more sophisticated than a passive lifestyle default. And, given that over 95% of people choose the default, this matters, especially at a time when the next financial crisis could be just around the corner.
Perhaps the time has come for us to adopt a different tack. To start choosing value for money over cost alone and, dare I say, paying more for our DC schemes.
Yes, members want low cost, and they don't want to be ripped off by providers; but they also want a quality investment offering that will be robust in all market conditions.
Jonathan Stapleton is editor of Professional Pensions
Email him at: [email protected]
Follow Jonathan on Twitter at: https://twitter.com/jonstapleton
