The DWP has accepted that small employers will face a limited choice of providers under its proposals to set a charge cap on automatic enrolment workplace pensions.
It admits that it expects a charge cap of 1 per cent or 0.75 per cent to mean that some providers will withdraw their offerings for smaller employers, leading to less choice and competition in this area of the market. The recent OFT review of workplace pensions rejected price capping.
The Government’s price capping proposals would drive more small employers into Nest which has caused much controversy in the pensions industry by deducting upfront charges of 1.8 per cent from employee contributions, in addition to the usual annual management charge.
This charging structure represents particularly poor value for employees who leave their employer after less than 5 years in the scheme, who will take with them a pension pot diminished by equivalent annual charges of between 3.8 per cent (if they leave after 1 year) and 1 per cent (if they leave after 5 years).
It would take five years in a Nest scheme before it became better value than a flat rate 1 per cent scheme and 15 years to beat a 0.5 per cent AMC scheme.
The taxpayer funded Nest scheme leaves employers with much of the work involved in setting up auto enrolment. Many of the private sector alternatives that a price cap could squeeze out offer employers more support to maximise the take up of auto enrolment amongst their employees, which is supposed to be the objective of the exercise.
Experience of price capping in other markets suggests that some pension providers will seek to recover their costs by making charges that fall outside of the price cap. The introduction of price capping is likely to drive private sector providers to adopt Nest’s approach of deducting some charges from pension contributions.
Other approaches will also emerge. For instance Legal & General already charge small employers £1000 for accessing their workplace pension product, this charge being in addition to L&G’s own annual charge taken from the pension fund.
So price capping is likely to displace further costs onto the UK’s hard pressed small employers and encourage the proliferation of more complex charging structures.
Analysis carried out for Royal London by management consultancy Deloitte suggests that competition offers a better solution for reducing pension charges levied on all defined contribution pension schemes.
The growth in the size of pension funds resulting from auto enrolment will produce significant scale economies enabling charges to fall by close to 40 per cent from the average level of around 51 basis points today.
Price competition between providers is vital to ensure that these gains go to pension scheme members in lower charges, rather than increasing dividends for insurance company shareholders. Price capping places these gains at risk if it establishes an effective price floor by reducing competition in the short term which is key to driving down charges in the medium term.
The Government’s thinking on price capping seems confused. In the household energy market where prices are set to soar the Government rejects price capping in favour of increasing the levels of competitive rivalry.
In the workplace pensions market where charges are set to fall the DWP proposes to introduce price controls that it accepts will undermine the very competition that will ensure charges are driven down. Is anyone in Government joining up the dots here?
If the DWP wishes to maximise the downwards pressure on pension charges it should introduce into the Pensions Act a requirement for all employers to review their schemes once every 5 years, and , unless there are good reasons to the contrary ,to switch to lower cost schemes where they find them. This, along with other recommendations made by the recent OFT review, will maximise competition in the market.
Phil Loney is chief executive at Royal London