Occupational Pension Schemes (Charges and Governance) Regulations 2015
Lord Bourne of Aberystwyth
That the Grand Committee do consider the Occupational Pension Schemes (Charges and Governance) Regulations 2015.
Relevant document: 22nd Report from the Joint Committee on Statutory Instruments
Lord Bourne of Aberystwyth (Con)
My Lords, I am satisfied that this instrument is compatible with the European Convention on Human Rights. The instrument was passed by the House of Commons on 3 March 2015 and, subject to your Lordships’ approval, will come into force on 6 April 2015.
As noble Lords will be aware, automatic enrolment has got off to an excellent start. We now have more than 5 million people enrolled in a workplace pension scheme. As we move towards our goal of automatically enrolling 10 million workers, we must be sure that their pension savings are invested in well governed schemes with fair and reasonable charges. The regulations will protect members in occupational schemes from high and unfair charges and will introduce new governance standards. The Financial Conduct Authority will introduce similar provisions for workplace personal pension schemes, which will come into effect on the same date.
First, the regulations introduce measures to control the level and types of charges in pension schemes used by employers to meet their automatic enrolment duties. There will be a cap on charges in the default arrangement within these schemes, protecting savers who have had little or no engagement with their pension savings.
Broadly speaking, a default arrangement is the arrangement into which a member contributes if they have not made an active choice about where their savings should be invested. Historically, not all schemes have had that sort of default arrangement. The regulations therefore set out two further tests to identify arrangements which are used in a similar way to the “true” defaults. In order to ensure member protection, they, too, will be subject to the cap.
The charge cap will be set at 0.75% annually of funds under management, or an equivalent combination charge. The regulations also restrict the charging structures that schemes may use in their default arrangement. Schemes must use either a single funds-under-management charge or a funds-under-management charge in combination with either a contribution charge or a flat fee. The cap covers all costs and charges relating to general scheme and investment administration. Transaction costs, along with a small number of other costs—including those associated with providing death benefits—are not included. The regulations provide two methods by which trustees can measure whether charges in their default arrangements have complied with the cap. They may decide which of these methodologies to use, depending on how they levy charges on members.
The regulations also ban active member discounts from April 2016. By these, we mean charges imposed on a member’s pot which are increased when they stop contributing to the scheme—for example, because they leave their job.
All of these measures on charges apply to occupational schemes offering money purchase benefits which are used by employers to meet their duties under automatic enrolment. They do not cover those schemes which include a promise to the member about the benefits that they will receive.
Secondly, these regulations set out minimum governance standards for relevant occupational pension schemes. These require trustees or scheme managers to ensure that default arrangements are designed in members’ interests and kept under review. They also require that core financial transactions are processed promptly and accurately, that trustees report on the level of charges and costs borne by scheme members, and that they assess the value of such costs and charges.
Baroness Drake (Lab)
My Lords, there is much to welcome in these regulations, including the banning of active member discounts—what I prefer to call “inactive member premiums”—where charges increase when a member stops contributing; the capping of charges at 0.75% in the default arrangements; that the cap will apply at the level of the individual member; and a set of minimum standards for governance, including the oversight of master trust multiple employer schemes where employers are not all part of the same corporate group. As I said, there is much to welcome.
When the staging of automatic enrolment is completed in 2018 and some 8 million to 9 million people will be newly saving, or saving more, most of them will not have made an active choice about their scheme or their investments. Many employers will be making most of the key decisions about their workplace schemes but they lack the capability and/or the incentive to ensure that workers receive value for money. Therefore, neither employers nor employees can be expected to drive competition—a proposition stated by numerous bodies in recent months.
As we know, auto-enrolment is built on inertia. At the same time, several reports reveal conflicts of interest in the industry. Therefore, it would be a failure of public policy if millions of citizens were auto-enrolled into workplace pensions but Parliament had not ensured that sound governance was in place and value for money delivered.
I am most grateful for the helpful replies to all my queries from the person at the DWP identified as the contact point in the Explanatory Memorandum. However, I have further questions. Regulation 3 specifies that, once an arrangement satisfies the definition of a “default arrangement”, it will always be a default arrangement and will be subject to the charge cap. If a scheme has a default arrangement covered by the charge cap but contributions then cease because the employer chooses to close that scheme, or a company becomes insolvent so that there is no employer, will the scheme’s default arrangement in those circumstances always remain subject to the charge cap? Are there any circumstances in which a default arrangement ceases to be covered by the cap?
Similarly, an employer’s scheme has a default arrangement but when an employee leaves, the employer is not bound to keep the ex-employee in their scheme. An increasing number of employers are choosing not to do that. If an ex-employee does not arrange their own transfer, the employer defaults their savings into a pension product that is not covered by the workplace pensions charges and governance protections. I can see no provision in these regulations that imposes restrictions on the pension products into which employers can default their ex-employees’ accumulated savings. I would be very happy to be told that I am wrong on this point.
Furthermore, if an employer is able to close their scheme and default arrangement, and bulk transfer the deferred members’ savings into an alternative pension product, which some can under the rules of their scheme, there appears to be no restriction on the products into which such bulk transfers can be made. Can the Minister say whether there are any restrictions on such bulk transfers, where they would breach the principle that a default arrangement is always covered by the charge cap?
Coming on to value for money, any charge not covered by the cap will be covered by the value-for-money assessment which trustees have to undertake on charges and transaction costs—a very welcome requirement—but some imponderables remain. TPR and the FCA want trustees and the independent governance committees to adopt a common approach. Although the Pensions Regulator publishes guidelines, good value is not defined in the regulations so it is not clear what is intended by a common approach. Trustees are required under the regulations to calculate,
“in so far as they are able … the transaction costs”,
which anticipates the complexities in the different types of costs—brokerage fees, bid-offer spreads, transaction taxes et cetera—and of getting hold of all the data. Trustees will need the co-operation of investment managers but if those managers are subject to confidentiality agreements with their own service providers, they will not provide all the information. So the Government need to consider such confidentiality agreements if transparency on transaction costs and other costs is to be achieved.
A matter of interest is how the charge cap will apply to the new pensions flexibilities. I welcome the provision that a saver who wants to access the new flexibilities and transfer out of their default arrangement into another scheme or draw-down arrangement will be protected by the cap for charges incurred by transferring out. But that leaves outside the cap the costs of transferring into the draw-down arrangement and the ongoing charges in the draw-down product. On the final rules for charges, the FCA reports that the Government have decided that, for the time being, draw-down should not constitute a core service and that in view of this temporary position, the FCA does not intend to amend its proposed rules. Can the Minister confirm that excluding from the charge cap the charges in income draw-down arrangements is indeed a temporary position and that they will be included later?
The regulations ban active member discounts but employers will be able to pay some or all of the charges on behalf of their current employee. So when Regulation 11(1) refers to prohibiting trustees and managers imposing higher charges “on a non-contributing member”, that means the overall level of charges to which the member’s pot is subject and not the charges borne by the member themselves—a subtle but important distinction.
The regulation allows employers to choose to subsidise active members, but active members cannot be subsidised by deferred members. I support the Government in wanting to allow generous employer practices towards employees who are active members. It will be important to ensure there is no masking of differential charging. The requirement that the amount the employer pays must be equal to the subsidy the employees receive will act as a control up to a point. But these practices will need to be properly documented by employers and providers if differential charging is not to be masked. The ban on applying higher charges applies to workers who cease contributing after 6 April 2016—not before, I understand. Similarly, the charge cap will not apply to those who ceased contributing before its introduction. That still leaves a lot of pension savings vulnerable to poor value for money.
The minimum standards of governance are welcome. The requirement on the chair to sign an annual statement will focus the minds of trustees, although many trustee boards are already very focused. Failure to prepare such a statement will result in a fine but it is unclear what the penalties are for non-compliance with other governance duties. Raising the governance standards in master trusts for multiemployer schemes is very welcome, but the requirement to have at least three trustees is a rather low threshold, especially as only two of them need to be independent of the provider.
I welcome the regulations because they represent an important start, not the end of the journey to achieve better value for the saver. However, there are still important matters to be addressed. A cap of 0.75% on a default arrangement needs to come down further. It is not the role of the saver or public policy to fund inefficient business models or conflicts of interest. Full transparency on all costs levied on the saver is needed. Extending the cap to include transaction costs is also a need, as is achieving value for money in draw-down products and annuities. We await the regulations to ban commission and consultancy charges in occupational schemes.
I repeat that there is much in these regulations that are welcome, but ensuring sound governance through the effective control of conflicts of interest I am sure remains unfinished business.
Baroness Donaghy (Lab)
My Lords, I feel to some extent that this is where I came in. I spent the 1970s persuading a number of university colleges to join a decent occupational pension scheme and to leave their insurance-based, extremely poor-value local college schemes. Incidentally, the charges for those poor-value schemes were between 4% and 5%. I was able to persuade people that that was such appalling value that they would be much better off in a different scheme. That is where I think there is a bit of repetition of history. That is not counting, of course, what the investment people took from the scheme; that was just the administration charge. Therefore, I cannot help thinking that in the pensions political world we take one step forward and then sometimes two steps back.
Inertia selling is something that I strongly agree with when it comes to an issue as important as pensions, and we certainly had that in the 1970s. People were joined up to their schemes and they had to take a step to opt out. That was made unlawful by a Conservative Government and it changed the pensions world substantially.
I am sorry if I have a good memory on these things but that is very important when we start off on something that might turn out to be a very good thing, as only history will show whether it is. My fear is that the smaller schemes will have a worse record on governance and compliance. The surveys that are pointed out in the Explanatory Memorandum prove that 24% of small schemes are likely not to conform, compared with 10% of big schemes. So here we go again on this roundabout. I understand that the Government do not want to force schemes together, but there is a logic in pointing out that you get better value for money in the larger schemes.
Baroness Sherlock (Lab)
My Lords, I thank the Minister for his explanation of these regulations, my noble friend Lady Drake for a characteristically thorough interrogation of them, and my noble friend Lady Donaghy for highlighting some very important lessons from the past that should inform our discussions today. I remind the Committee of my registered interest as the senior independent director of the Financial Ombudsman Service.
We on these Benches welcome the fact that action is now being taken to address the problems with governance and excessive charges. Like my noble friend Lady Drake, I welcome action on the active member discounts, although her terminology may indeed be a fairer description of what happens there.
As the Minister indicated, 5 million people are already saving in schemes under auto-enrolment, and that figure will end up closer to 9 million or 10 million in due course. The point made by my noble friend Lady Donaghy is crucial here. If we are to cap the charges levied on pension savers in such schemes, we need to be sure that it works well because of the duty of care owed to those savers who have made no active choice about saving but who have been defaulted by their employer in particular or by the state in general into schemes which they have simply never chosen. It is critical that those who are auto-enrolled remain so and that we do not see a significant opt-out rate, but also that the highest possible retirement income is derived from the savings that individuals and their employers make. That is the context for these regulations, and the history lesson from my noble friend Lady Donaghy is very helpful. People need to know that their pension pots are not being siphoned off in unreasonable charges and that someone in whom they can have confidence is looking after their interests.
My noble friend Lady Drake asked a number of very important questions, and I will add just a few. First, on the charge cap, Labour has been campaigning for that, so it would be churlish not to welcome it—and I very much welcome it. However, can the Minister please tell the Committee why the Government chose 0.75% and what plans they have to reduce that further? The latest impact assessment suggests that, following the response to the consultation, the Government considered just two options: the one set out in these regulations, and doing nothing. I agree that of those two choices, acting to cap charges is definitely the right one, but the case for a lower figure is very strong. Certainly on these Benches we support capping charges at 0.75%, but with the aim of reducing it to 0.5% over the course of the next Parliament. Does the Minister agree that that is where we ought to end up?
Secondly, I would appreciate some clarification about how the cap will work. The Minister explained that it will be set at 0.75% of funds under management or an equivalent combination charge, but can he explain a bit more how the combination charge will be calculated? Regulation 5 seems to suggest that there will be three options: a funds-under-management charge, a combination of a funds-under-management charge and a contribution charge, or a combination of a funds-under-management charge and a flat-rate fee charged to the member.
Regulation 6 sets out the limits if one of the combination options is chosen. Can the Minister tell us a bit more about why these were fixed as they were? Is it the intention that a combination option cannot yield more than the equivalent of 0.75% of funds under management? If so, how can the saver be assured of that? If that is not the case, why are the Government giving the option to choose a charging structure that could yield more than the headline rate of 0.75% of funds under management?
Whatever figure is chosen, for controls on charging to bite, savers need to understand fully what charges are being levied. As we know, defining pension charges is not an easy job. The Minister indicated that transaction charges are not included in the cap. The biggest problem is that, as my honourable friend Gregg McClymont pointed out when the regulations were considered in another place, we do not yet know the full range of transactions attached to pension schemes. The only way to deal with that is through full disclosure of all transaction costs, which is long overdue and to which the Opposition are committed. I would be interested to know the Government’s position on that.
Will the Minister tell me a bit more about the compliance regime? Whose job is it to check that the cap is not breached and what will the penalties be for a breach? As for the minimum governance standards, they are welcome as far as they go, but again I would like to ask about compliance. Is the intention that the main or only compliance tool will now be the chair’s statement? Paragraph 7.34 of the Explanatory Memorandum says that the Pensions Regulator will have the power,
“to issue a fine against the Board of trustees or managers”,
in the event of failure to prepare a chair’s statement as required by the regulations. Will the Minister give some indication of the likely level of fines?
Of course, charges can take different forms, and the Government have made a welcome move in recognising this. For a while, they chose to focus primarily on the annual management charge, but these regulations acknowledge that that is only one part of the picture. My honourable friend Gregg McClymont highlighted the need to focus on the total expenses ratio, which includes custody, legal accounting and administration, and which consequently tends to be significantly higher than the AMC. Do the Government have any plans to evaluate the impact of the regulations on the total costs levied on affected pension schemes and savers?
We need urgently to address the range of challenges facing pensions at the moment if we are to be successful in persuading workers to save for their retirement at the rate that they need to do. My noble friend Lady Drake mentioned the draw-down products, but Labour will take a range of other, tougher steps to protect savers—for example, from new products that damage retirement income. Indeed, a Labour Government will begin immediate consultation on plans for a cap on fees and charges for income draw-down products, with a focus on products bought from the saver’s own pension provider. However, I welcome the progress that has been made and I very much look forward to the Minister’s reply to these and all the other questions that have been asked.
Lord Bourne of Aberystwyth
My Lords, I am grateful for the participation of noble Lords in this debate. Let me try to deal with the points that have been made while saying at the start that, over the next decade, the default fund charge cap should transfer around £200 million from the pensions industry to savers. That is an important point.
I very much take the points made by the noble Baroness, Lady Donaghy, about the historical perspective and the fact that, across the House, we are trying to ensure a fair regime relating to charges. We need a balance to make sure that the industry is properly and fairly rewarded for the services that it is providing and that, at the same time, savers are not overcharged for the services that they are receiving. That has very much been the thrust of the reform and it is why the figure of 0.75% has been chosen, which will represent for most people a fall in the amount that they are charged for the service, as I indicated.
Let me turn to the contributions made by noble Lords. I very much welcome the welcome in general terms from the noble Baroness, Lady Drake, for these regulations, which, as I say, bring in governance arrangements for the default automatic enrolment, as well as a cap on charges. I am pleased that we have universal welcome in general terms for the regulations. I welcome the support that we have had from around the Room in trying to get right the legislation and the consequential regulations.
The noble Baroness—and I apologise if my answers are not necessarily in the order of her questions—asked whether once a default always means a default. In general terms, the answer is yes. The regulations set out where an arrangement is designated as a default for a particular employer by virtue of meeting the tests in the regulations. It will continue to be designated as a default regardless of whether it continues to meet those tests. That is the general position. However, I will write to the noble Baroness on some of the specifics that she raised, because the devil is in the detail and I would not want to mislead her on specific examples, some of which I was a little blindsided by. I will, therefore, write to her about some of the specific examples she brought forward.
The noble Baroness also raised value-for-money issues. The regulations are designed to ensure that we get value for money and that there is transparency on the transaction costs—a matter also raised by the noble Baroness, Lady Sherlock. A transparency regime will come in as a result of these regulations that will enable us to look at value for money in relation to transaction costs. We are committed to looking at that in April 2017 to see whether we should bring it into the cap. That is the schedule. Therefore, at the same time as we are looking to ensure that we have an effective cap, in general terms, on auto-enrolment, we are also looking more widely at the transaction costs, to see whether it is appropriate to bring those into the cap in April 2017. We are already looking at that issue as we move forward from these regulations.
I turn now to the active member discount, or, as the noble Baroness, Lady Drake, phrased it—with some justification—the inactive member premium. There is no intention that we should stop a discount for active members unless it is the deferred members—the inactive members—who are paying for it. As the regulations make clear, there is nothing wrong with providing a discount for employees, provided it is not being subsidised by deferred members. That is the intention of the regulations, and I think that it is delivered by them. Again, however, if I am wrong about that, or there are exceptions to that general principle, I will write to the noble Baroness and copy my letter to other noble Lords who participated in this debate.
The noble Baroness also raised the issue of decumulation, which, as she rightly says, is not covered at this stage by these regulations. That does not mean that the Government are not looking at decumulation; it means that we are not looking at bringing it in at this stage. We are, however, keeping it under review, because, as we say, we want to ensure a fair regime: a fair amount paid—or a fair cap—so that the industry gets its fair return on what it is doing but savers are not ripped off, to use the vernacular. We have that under review.
The matter of the penalties regime was raised by the noble Baroness and also by the noble Baroness, Lady Sherlock. First, there are regulations that provide for a statement by the chair of trustees and a mandatory penalty of between £500 and £2,000 if such a statement is not produced. Trustees will have to demonstrate compliance with the governance and charges requirements in the chair’s statement. I am not sure of the precise sanctions that apply; I think it is under Section 43 and Schedule 18 of the Pensions Act 2014. I think that is right, in respect of the regime. However, I will write to noble Lords on the regime relating to non-compliance with the regulations and what the sanctions are.
Secondly, the contribution of the noble Baroness, Lady Donaghy, gave a very fair assessment of where we are. The noble Baroness made the very fair point that smaller schemes, generally speaking, do not represent such good value as larger schemes. It would not be fair to say that that is universally true, but it is probably generally true. Consolidation is happening—the figures show that—but it is right that we ensure that there is effective protection across the piece. That is, therefore, something that we need to keep under review. I made that clear as the Bill was going through the process of becoming an Act. It applies in general terms but it is a point well worth making.
I am trying to remember whether there were other points raised by the noble Baroness, Lady Sherlock, which I have not covered. If there were, perhaps she would remind me of them.
Baroness Sherlock
I thank the Minister. He has picked up most of them or has said that he will write to me about them. However, I asked how the combination charging options would work, whether the intention was that, if a combination option were chosen, it would be no more than the equivalent of 0.75% of funds under management, and how savers would know about that.
Lord Bourne of Aberystwyth
I am most grateful to the noble Baroness for reminding me of that. It is fair to say that generally, although not universally, that will be the case. I will write to her about the exemptions because there will be some situations where the charge will be higher, but in the majority of cases it will be the combination charge, which will certainly be no more than the 0.75% cap.
With that, I once again thank noble Lords for their support for the regulations. I undertake to write on the points that I have raised and on anything else that I have missed. I commend the regulations to the Committee.