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The right combination

Criticism of the proposed charging structure for Nest is missing the point, says Steven Cameron, head of business regulation at Aegon, who argues that a combination charge secures a satisfactory outcome for most savers

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The recent Department for Work and Pensions’ announcement on the charging structure for the national employers savings trust has prompted some strong support but, equally, some strong criticism.

The DWP has indicated that Nest will charge a very low 0.3 per cent of fund value each year, in line with Lord Turner’s aspirations. In addition, to cover the significant scheme start-up and initial member joining costs, 2 per cent of each contribution will be deducted for a period estimated as between 10 and 20 years.

Taken together, this combination is significantly lower than the stakeholder price cap.

There is no denying that a mono fund charge looks simpler than any form of combination but an analysis of projected returns shows a combination charge gives as good or better an outcome for most savers.

Crucially, it is also more financially secure, significantly reducing the risk that the Government may need to step in if things go wrong.

Nest charges have been criticised as being high compared with the biggest occupational schemes, some of which can present low charges to members because the employer is paying for running costs separately.

But in any case, this is missing the point. Nest is designed for those people who do not work for a big employer and have no access to good provision. Many of them are low or moderate-earners and could not come close to the Nest charge levels on an individual basis.

Other commentators are calling the 2 per cent contribution charge “huge”. Perhaps the use of percentages is obscuring the actual size of deductions.

In the first year of phased auto-enrolment, a median earner would pay around £150 to the scheme. Tax relief and employer contributions raise this to around £380. For this person, the combination of 2 per cent of contribution and 0.3 per cent of fund amounts to less than £1 a month in the first year and an average of less than £2 a month for the first five years.

Surely “huge” is an exaggeration – and we must avoid inadvertently scaring off many people who would benefit from joining.

Much of the commentary so far has been distinctly short-term, with a focus on the small group that will retire within five years time.

As with any structure, there are winners and losers and it is correct that this group would have been better off with a mono charge. In fact, current means-tested benefits would leave some better off from not joining at all. But the DWP has correctly looked at the needs of people in a wide range of circumstances and, on this basis, as the Personal Accounts Delivery Authority shows in its briefing note (Why Does the Proposed Combination Charge for Nest Meet its Low-charge Objective?), a combination structure is better for every one of the other six groups analysed.

The key aim of any pension scheme should be getting people to save regularly for the long term. Looking at charges from this perspective, a fund-based charge of 0.5 per cent a year (which Pada’s recent briefing shows is broadly financially neutral to the announced combination) would take out 10 per cent more in charges in year 15, compared with the combination proposal and 30 per cent more in year 25.

Returning to the subject of opting out, some have suggested a combination charge will put people off joining, citing Pada research. Aegon carried out its own research, which demonstrated that a combination charging structure is no more likely to encourage opt-out than a mono structure.

Pada’s 2007 research explained a variety of charging structures to 76 individuals. The researchers then commented on opinions and attitudes expressed. From this, certain shapes appeared preferable to others.

This research was informative at the time but it never aimed to reflect the way potential members will be presented with the Nest charges. To address this, Aegon carried out its own research in 2008, specifically seeking to replicate the situation that customers will find themselves in when being auto-enrolled into Nest.

A total of 634 individuals were split into two groups and shown a one-page card explaining the basics of Nest. Half were shown a document with a single fund charge of 0.5 per cent, the others a combination structure of 5 per cent of contributions and 0.3 per cent of fund. The documents were otherwise identical.

Individuals were not asked to make comparisons between structures because, in practice, this is not what will happen on joining Nest.

Our key conclusion was the charging shape made no difference whatsoever to whether an individual would remain auto-enrolled in Nest. In fact, the charging structure was far down the list of deciding factors – something those of us who live and breathe pensions should bear in mind.

It has been suggested that the Government should simply pay for all the initial costs rather than levying 2 per cent on contributions.

The Government has already covered some quite considerable costs relating to Pada activities. Looking ahead, Government funding is really taxpayer funding.

The Pensions Policy Institute’s 2007 analysis showed that a flat fund charge of 0.5 per cent might have required Nest to borrow £2.4bn that would have taken an estimated 18 years to repay.

It simply does not stack up, particularly in the current climate, to expect the Government to give such a huge amount to a start-up venture like Nest. It goes completely against the emphasis on boosting short-term Government cashflow and repaying Government debt.

Of course, the 2 per cent contribution charge in the first year will not cover all year-one costs. A smaller but still very substantial amount of borrowing will be required and the Government is intending to provide this on favourable terms (below commercially available) – effectively extending a further subsidy to Nest.

The DWP decision does not just have an impact on Nest – it is relevant to pensions much more generally.

The announcement highlights that solely fund-based charge structures, which stakeholder pensions forced the market to move to, are not necessarily best. Providers and advisers know this only too well, having seen the availability of pension advice shrink dramatically, with a knock-on reduction in take-up and savings rates.

A move away from mono-charge will also be consistent with meeting adviser needs after the retail distribution review. The replacement of commission with advisercharging, agreed between adviser and customer, will lead to separate charges for manufacturing and advice.

Advisers are likely to want paid-for initial advice through an initial monetary amount or a percentage of premiums in the early years. The FSA’s proposed ban on provider factoring means payments to advisers will be timed to match deductions from policies – and no longer recouped over time through an ongoing fund charge. So, in the broader pension environment, where there is advice to employees and/or employer, combination charging structures will become the norm.

To deliver Lord Turner’s aim of more people saving more for retirement, we need two things. First, Nest has to be a success – representing good value to those who join and, importantly, financially stable. Second, we absolutely need a thriving private pensions sector. It is for these reasons that Aegon has lobbied for, and fully supports, the DWP’s combination charge decision.

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