Yvonne Braun, Director, Long Term Savings PolicyIf the Government really wants all savers in legacy schemes to receive value for money, it must play its part
The publication in December of the final report of the Independent Project Board (IPB) has put legacy pension products firmly in the spotlight. While the debate to date has centred on what providers will do to improve value for money, the Government also has a role to play.
The Minister for Pensions has been vocal in calling for big, bold actions from providers. Providers are ready to act, but Government must itself show boldness to allow them to do so. Specifically, the DWP should give providers the power to move members to a new scheme or fund without their consent where it has been verified by the Independent Governance Committee (IGC) that such a move is in the best interests of scheme members.
Without this change, reform will not be complete until individual consent has been obtained from every scheme member. This is because the individual contracts held between the provider and the scheme member limit the power of providers to make unilateral changes, even if it is deemed to be in the best interests of scheme members.
Based on providers’ experience we know that a solution that relies on customer consent will never wholly address the issue because most people don’t engage with their workplace pensions. Indeed, this logic is central to the Government’s flagship policy of automatic enrolment.
It is difficult to free savers from the chains they ignore
In essence, improving a scheme’s value for money is a matter of reducing or waiving charges. Where charges are within the provider’s control, doing this sustainably will often require moving members onto a modern operating platform that can be operated at a much lower cost than a legacy platform, with the savings passed on to the member.
Lowering or waiving a provider’s administrative charges won’t always be enough to ensure savers get value for money though. This can happen when the provider doesn’t set all the charges, such as when the investment fund is run by a third party. In these cases the answer lies in moving savers into a new lower-charged investment fund.
For automatic enrolment schemes, such changes are already happening en masse. Some large providers estimate that as a result up to 50% of the assets identified as "at risk" by the IPB have already been dealt with.
Critically, this is happening because the introduction of the charge cap is a legislative imperative for providers to act to lower charges for active scheme members. In contrast, no such legislative imperative exists for paid-up members of active schemes or members of closed schemes. This significantly limits the powers of providers to act in the interests of those members.
Where the solution is to move customers to a new platform, it isn’t possible to do so without their consent if it might result in reduced benefits for some members. Modern platforms are cheaper to operate precisely because they are simple and don’t allow for complex charging or benefit structures. As shown by the IPB, the impact of complex structures on individuals varies wildly, depending on their personal choices and circumstances; a scheme that is poor value for 99% of members may be perfect for the other 1%. These complex structures make it impossible to modernise and lower costs while perfectly protecting benefits for all scheme members.
The difficulty doesn’t stop there. In a contract-based pension, the investment fund is the choice of the individual; providers have no ability to unilaterally move a member’s pot from one investment fund to another. This means that where the solution to high charges lies in moving the individual to a new fund, providers can’t do so unless the customer agrees to the switch.
Salvation lies within… DWP
Giving pension providers a legislative mandate to act in the collective best interests of savers will put all contract-based scheme members on an equal footing with members of trust-based schemes; trustees currently have much more discretion to take actions that they believe are in the best interests of scheme members.
This could be achieved by allowing without consent transfers on the basis that three broad conditions have been met:
- The provider’s IGC establishes that the scheme does not offer value for money for members and changes are required;
- The provider demonstrates to the satisfaction of the IGC that there is no practicable alternative to a transfer; and,
- It is independently established that the benefits and fund characteristics in the new scheme are broadly equal to those in existing scheme.
In addition to protecting savers from actions that may not be in their interests, this approach would protect savers from the very real costs of stasis and inaction that the current system has a bias towards. It would do so by ensuring that IGCs more closely mimic the trustee boards they have been set up to mirror.
Of course, this proposal is not without challenges. As the IPB set out, changes that benefit one saver may disadvantage another. This means IGCs may need to make tough decisions about what is in the best interests of the majority of scheme members collectively, rather than individually.
A second challenge is that, under current contract law, if a provider unilaterally moves a saver to a new fund that is retrospectively shown to perform worse than the original fund, the saver could be entitled to compensation. In contrast, members of trust-based schemes have no such recourse. So that providers and IGCs felt able to make use of their powers, any legislative change would also need to give providers protection from such claims if they can prove that due process was followed and the decision was independently judged to be in the collective interests of savers at the time it was taken.
While significant, such legislative changes would not be without precedent. Part VII transfers allowed under the Financial Services and Markets Act 2000 allow firms to transfer business while merging, provided that the impact on members is independently assessed and a court approves the transfer. Similarly, the pot follows member legislation allows for the automatic consolidation of pension pots without member consent, on the basis that in general numerous small pots will be inefficient.
Time to act
We know that any such changes would need to be carefully considered and consulted upon. However, without legislative changes such as those set out above providers can’t take the bold actions they want to take to tackle legacy issues once and for all.