"Comply or explain" pension charges cap would give schemes much-needed flexibility, expert says

The proposal is one of three put forward by the Department for Work and Pensions (DWP) in its new consultation on the introduction of a cap on annual management charges (AMCs) on pension schemes used for automatic enrolment. Charges would be capped at 0.75% unless the employer could justify the need for higher charges to the Pensions Regulator. The DWP has also proposed a standard cap of 1% in all cases, reflecting the cap that applies to stakeholder schemes, or 0.75% in all cases.

Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that although a cap at the proposed levels "shouldn't be a problem" for the majority of pension scheme providers, the introduction of one had the potential to "stifle product innovation, as quality of service and superior investment performance come at price". However, he said that a cap at the right level could boost consumer confidence and so contribute to the success of automatic enrolment.

"The option of a 'comply or explain' cap has the advantage of retaining greater flexibility for providers that can demonstrate value for money, while ensuring that a relatively low cap applies as a default," he said. "Work needs to be done on developing a value for money test to ensure there is no detriment to pension savers."

The cap would initially apply to employers who start auto-enrolment from April 2014, according to the consultation. It would then be extended to those who started auto-enrolment earlier. Pension scheme charges have fallen in recent years, and the average charge on a new scheme is around 0.51% of assets under management, according to Government figures. However, the Office of Fair Trading (OFT) has estimated that over 186,000 pension pots with assets of £2.65 billion are subject to an annual charge of above 1%.

In its recent report on the defined contribution (DC) pensions market, the OFT decided against recommending the introduction of a cap on scheme charges for a number of reasons, including the "unintended consequences" of setting a cap too high or too low. Instead, the consumer protection regulator reaches an agreement with the Association of British Insurers (ABI), which is to carry out an immediate audit of all workplace pension schemes sold before 2001 and all those sold after that date with an AMC higher than 1%.

However, Pensions Minister Steve Webb told the Financial Times the day after the OFT's report was published that he would press ahead with a consultation on the introduction of a possible cap. Pinsent Masons pensions expert Simon Tyler said that there was "too much at stake" politically for the Government not to do so.

"The Office of Fair Trading (OFT) gave cogent reasons in its recent study of the defined contribution (DC) pensions market against the cap," he said. "It highlighted the potential unintended consequences: set too high, the cap risks becoming an industry standard; set too low, a cap can force providers to cut corners on quality."

"But politically, there is too much at stake for the Government not to introduce a cap. Lobbying groups and the media have successfully focused attention on the problem of high charges. Actual experience or fear of high charges can put savers off pensions for life, while a cap on charges can boost confidence and contribute to the success of auto-enrolment," he said.

The DWP is also seeking views on a number of possible measures to increase transparency in the pensions sector, so that smaller employers would be able to make an "informed choice" when selecting a pension scheme for their workforce. Among the issues consulted on are whether to legislate for additional disclosure of charges to members in annual benefit statements, and to employers when they select a scheme; whether disclosure requirements should extend to transaction costs; and whether to extend previously-announced bans on active member discounts, consultancy charges and adviser commissions.

"The Government believes that enough is enough on charges," said Pensions Minister Steve Webb. "People need to know they are getting value for money when they save into a pension and are not being ripped off by excessive charges. I'm confident that we will make the system fairer for anyone being automatically enrolled into a workplace pension and will finally address the issue of charges which has been neglected for far too long."