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Ian Naismith: The case for lower charges is not clear cut

The debate about pension charges ignores the effect of persistancy and that those with small pots are subsidised in early years of scheme membership.

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I have an unbelievably good offer for you.

Your employer will implement automatic enrolment on 1 January 2014. If your pension is with my company, we will set up your plan and provide you with information about it.  We will collect contributions, keep records and send you a yearly update.

When you move employer, which on average will be after four years, we will automatically transfer your pension to your new company’s scheme without any charge. And we will do all that for a total charge of less than £10 over the four years.

You may be thinking I should apply for a job with an Icelandic bank, but this ‘unbelievably good offer’ will be made to hundreds of thousands of consumers in the coming months. It is what is available under automatic enrolment to someone earning £15,000 a year where pension contributions are at the legislative minimum, with a 0.5 per cent annual management charge.

This contrasts with the figures for the effect of charges in the DWP’s consultation on pension charging, which range from £5,400 to £236,000.

It illustrates how heavily geared pension charges are: short-term, low value business makes no commercial sense to providers and is only justified by the charges collected from those who stay for the long term. Provider profitability depends not on increasing the level of charges over time, as the consultation paper suggests, but on maintaining charges at the initial level.

And that presents a potential problem. If a scheme member with low contributions leaves in the early years under ‘pot follows member’, the provider will be sitting on a loss for that member. That will be balanced partly by having new members transferring funds built up in other schemes and partly by some members remaining in the scheme long enough to make up for those who leave early. 

However, it is likely that some providers who enter the market at the start will fail to achieve sufficient scale to compete for business in the long term. They may then not have a stream of members transferring in and will have paid the up-front cost of playing in the market without competing for long enough to recover their outlay.

Looking further ahead, in 10 years time people who have been automatically enrolled will be building up worthwhile funds. New players are then likely to enter the market with aggressive pricing to attract business away from those who have taken the initial pain of automatic enrolment. Competition will drive down prices, as it should, and politicians may reduce the cap on charges, including for existing schemes. Providers who were relying on keeping the original terms indefinitely may then have to book substantial losses.

This does not mean that providers should avoid this market or that it will be unprofitable for everyone. It does show, though, that the workplace pensions market carries significant risks for the unwary, and is certainly not the cash cow some seem to imagine.

Wise providers will tread with caution, playing in sectors where they can provide superior value at acceptable risk. They will leave Nest and its cohorts to service the lower end of the market. Wise advisers will make judgements on which providers are likely to be in for the long haul, and which may end up exiting quite quickly.

Ian Naismith is head of pensions market development at Scottish Widows

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  1. Even the regulator understands that the lowest charges hardly ever equate to the best value. Yet the government remains fixated on price over value and refuses to countenance all and any representations to the contrary..

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