Pension funds and trustees need to know exactly what different DC pension providers are charging so they can compare them against each other. Gail Moss reports
As low investment returns, market volatility and the ever-present longevity problem put pressure on pension funds, trustees are continually looking for ways of cutting costs and boosting returns.
Because of this, fees paid to outside providers for administration, insurance and, most prominently, asset management, have come under the microscope as never before.
But cutting these costs is only a realistic goal if different providers can be properly compared with each other. That requires transparency. And methods of calculating - and hiding - charges can vary so wildly that full disclosure is often lacking.
High charges, however, can cause huge drains on pension fund performance. In the UK, for example, research for the department for work and pensions (DWP) found that 33% of occupational schemes and 45% of group personal pension plans had annual management charges (AMC) of over 1%. And 7% of the occupational schemes had AMCs of 3% or more.
The National Association of Pension Funds (NAPF) is therefore campaigning for a code of conduct for providers, which would provide information about charges to pension scheme members in a form they can understand, as well as creating a basis on which charges can be compared across the industry.
An industry summit took place last November, followed by a consultative document. Since then, a working group has been preparing a draft code, which was expected to be published as IPE went to press.
The issue has become urgent for the UK because of the introduction of auto-enrolment in October 2012, after which between five and eight million people will be brought into pension saving, according to the DWP. Up to one million employers who have never provided a pension scheme for employees will have to choose between offerings from different providers, charging different levels of fees.
“There are very few rules about the disclosure of charges at the point where the employer actually buys the scheme,” says Catherine Cunningham, policy adviser with the NAPF. “And providers may choose to show annual management charges but not total expense ratios, for example, or vice versa. The aim is to establish a standardised way of showing charges at this point and enable employers to compare schemes against each other.”
The first task, she says, will be to develop the code of conduct for disclosure of pension charges to employers, then add disclosure to individuals.
“It is envisaged that the code will take the form of a template which providers have to fill out and show to employers who approach them about buying their scheme,” says Cunningham. “The code may include rules for how they define charges and how calculations are made.”
The aim is to have the code in place over the summer, along with an implementation period.
However, in DC schemes particularly, most charges will be paid by the members. And trustees have a duty to give members as much information on these charges as possible.
Rather than merely disclose the charges, it is important for trustees to illustrate the impact of those charges in their explanatory literature, says Lee Hollingworth, head of DC, Hymans Robertson.
A 50bps charge doesn’t sound much, he says, but adds that members and trustees will clearly see the effect if illustrations include calculations showing how much a fund is worth over time with employer and employee contributions minus charges. The important thing is to show what happens in money terms, Hollingworth says.
But different employees have different levels of understanding; with auto-enrolment starting in the UK, this diversity is likely to increase.
Hollingworth suggests that employers should segment their workforce and design different communications for different groupings - for example, blue-collar workers, who might have little knowledge of pensions, and office workers, who may be more aware. One way of tailoring information to each segment is to use focus groups to assess levels of understanding.
“This also extends to delivery,” says Hollingworth. “Younger members may only take notice if they are given information via social media and apps, while other groups may prefer the traditional paper booklets and letters. And I would advise using everyday language, rather than jargon, although they could include a glossary of terms at the back.”
In the Netherlands, fund management charges range from 20bps to over 1.2% per year, according to Arjan van der Linden, investment consultant, Aon Hewitt.
However, he says the entry of premium pension institutions (PPI) into the market is helping drive down costs.
“PPIs allow individual scheme members to see the true costs and net contributions to their pension funds, via easily accessible web portals,” he says. “This is putting pressure on traditional DC providers to do the same.”
When advising pension schemes on selecting providers, Aon Hewitt’s request for proposal is tailored to the criteria - such as risk profile - of individual clients, and requires providers’ fees to be stated in a standardised format for easy comparison.
But what can pension funds do for themselves in terms of giving members information that is as complete as possible?
“They should take a proper look at what they really want to offer their members, including the pension offer, and the degree of freedom for choosing underlying investments,” says van der Linden. “They should then use web-based applications to show members what their pension will be, to avoid nasty surprises. For DC schemes, members’ monthly contributions can be broken down into x charges and y net investment into their fund. The application can then forecast the level of pension the member can expect, depending on the type of scheme they are in and, for PPI schemes, on the level of interest rates.”
When advising clients on pension fund providers, Towers Watson compares the outcomes of DC schemes using the same return components for all providers, adjusted according to each provider’s charging structure.
By law, members of DC schemes must be sent annual statements showing the “indicative pension” to be paid on retirement.
“But there is no mention of risk, nor of how charges are taken into account,” says Gaston Siegelaer, service line leader for DC investments at Towers Watson in the Netherlands. “We advise pension funds to give their members a level of insight over and above this, showing how individual choices impact on the level of costs, and how this affects the outcome of their pension.”
But he warns: “Too much information can obscure the message. Pension funds that aim at effective member communication therefore seek feedback from members as to whether they really obtain insight from the information they are getting.”
Furthermore, Siegelaer says: “One extra cost is the fee paid to insurance companies to buy an annuity, if this is not provided by the scheme itself. It can really make a difference to the level of pension, but it’s an issue that’s being ignored at present.”
In Spain, transparency is not such an issue, according to Aitor Corral, senior associate, investment department, Aon Hewitt.
“Both management and custody fees are charged according to the net asset value per share,” says Corral. “So ultimately, each member of the scheme pays a fee proportional to the amount of money they have invested in the fund.”
Additional expenses charged by auditors, actuaries and investment consultants are also generally calculated in the same way.
For pension scheme trustees, there is no particular problem either, says Corral.
“As management and custody fees are represented by a single percentage figure, it is very easy for control committees of pension funds to compare providers to decide which is the most competitive,” says Corral.
There may, however, be problems identifying underlying charges where asset managers invest in external funds.
“In some cases, there are fee-discounting agreements between pension fund managers and the managers of investable mutual funds,” he says.