Written evidence from UNISON (PCT0013)

1.     Introduction

UNISON supports this inquiry into the costs borne by scheme members when saving into a workplace pension or savings fund. We are the largest union in the UK with members in the public and private sectors.

We hold the vice-chair and joint secretary office of the Scheme Advisory Boards for the Local Government Pension Schemes in England/Wales and Scotland. Our union was instrumental in proposing and developing a cost transparency solution for the 100 investment funds of the above schemes.

Over five years ago the Office of Fair Trading (OFT) launched a market study into Defined Contribution (DC) workplace savings schemes with the aim of examining whether, in the light of Auto Enrolment, competition was capable of driving value for money and good outcomes for workers.

One of the key findings of the OFT report was “DC workplace pensions are complicated products, both their costs and quality are difficult to observe and outcomes may not be apparent for some years. This makes decision making on value for money very difficult”.

So over five years on and the Government and Parliament have continued to struggle with this key problem, very little seems to have been learned from the OFT’s report; from international experience or of the ground breaking work on pension fund cost transparency led by our union within the Local Government Pension Schemes in England, Wales and Scotland. Details of which can be found here http://lgpsboard.org/index.php/structure-reform/cost-transparency

Since the OFT report millions more workers have been auto-enrolled into a workplace pension, or a savings plan, we do not support the view that defined contribution schemes result in a pension, they are individual investment funds.

The inquiry should also recognise that the vast bulk of assets held by workplace pension schemes are in defined benefit (DB) funds. Both scheme members and sponsoring employers of DB funds suffer detriment from the lack of cost transparency in the investment process.

2.     Summary of key issues of an opaque investment system

• No purchasing decision is made by people without knowing the costs, including an indicator of future or ongoing costs for large capital items like fridges or cars. Moreover, a car or a fridge will offer an indicator of efficiency (allowing an assessment of future costs) in their energy or fuel efficiency ratings, our pension funds have no such measure.
• The vast bulk of UK pension assets are in defined benefit schemes. Sponsors and members are bearing the cost of an opaque and inefficient investment system, while asset managers and others make record profits. 
• Pension funds incur costs and fees to administer retirement savings and manage investments: more than 90% of the total costs paid by pension funds are linked to asset management. Those costs are not transparent or understood.
• In a DC scheme these costs eat away at retirement savings reducing the amount workers have to live on as all of the costs and charges are made against the individual savings fund.
• Incremental reductions in costs, which are facilitated by cost transparency, can have a material upward impact on the performance of pension funds and the ability to deliver retirement payouts. 
• Without cost transparency trustees cannot discharge in full their fiduciary duties of investing in the best interests of scheme members and resolving any potential conflicts of interest in the scheme member’s favour. How are they to judge that the investment strategy they have chosen is a successful one or could be improved without having full cost transparency and an accurate measure of investment return performance?

3.     Summary of the current transparency situation in the UK

• Government policy is conflicted, transparency for the funds in the LGPS, partial transparency for DC funds, no transparency for DB funds
• There have been some improvements but none have yet to deliver cost and performance transparency.
• The imposition of a charge cap on default funds used for automatic enrolment. But it’s not known whether the cap is too small and it does not apply to any other fund.
• Requirements for DC pension disclose ‘slippage costs’ started being phased in from April this year. But this does not cover illiquid assets, such as commercial property, that some schemes have started to invest in.
• The development of a disclosure regime under the Institutional Disclosure Working Group (IDWG), established after the FCA’s ‘asset management market review’. This built upon developments in the Netherlands and in the LGPS.
• Significant effort by the Railways Pension Scheme to improve disclosure and examine costs to improve investment performance. https://www.bbc.co.uk/news/business-42790904
• And the Scheme Advisory Board’s (SAB) of the LGPS in England, Wales and Scotland who have introduced a ‘Code of Cost Transparency’ for asset managers and others. The SAB’s are currently collecting cost data on public market investments and will adopt the IDWG template when published. Analysis of this data will begin in April 2019.

4.     Reform is urgently needed – our recommendations

• Adopt a version of the cost transparency and pension fund efficiency system of the Netherlands.
• A compulsory regime of reporting on costs and charges in both DC and DB pensions using the IDWG template as a basis for the disclosure to scheme members and a regulator. This needs to be supported by an independent verification process for submitted data to ensure accuracy and returned in a time period or as requested.
• Government should establish an efficiency target for pension funds so that the Pension Regulator can analyse and enforce improvements in pension fund investment performance by merger or other methodologies.
• An overhaul of Independent Governance Committees to give members a fiduciary duty to act in members’ interests, requirements for committees to have greater numbers of those with a consumer advocacy background, and greater powers to compel providers to act.
• Continued moves to drive further consolidation in UK pension funds so they are better able to negotiate good deals with asset managers and others. But primarily so they can have cash flows to enable them to move asset management in-house.
• At a minimum, once pension funds have established their full costs base, they should market test fund managers and others to see if they can lower their costs.

5.     UNISON survey of members on costs and investments of their pension fund

In advance of this submission we randomly surveyed UNISON members to establish what they knew of their pension fund costs and their pension fund investments.

921 members responded. They answered in the following way.

• When asked what pension scheme they were in 48% said a defined benefit scheme and 42% said they were in a defined contribution scheme.
• 82% said they did not know what charges were made against their pension fund.
• 85% said their pension fund did not explain to them the impact that costs and charges have on their pension fund.
• 82% said that they did not understand costs and charges reduce the value of their pension fund.
• 86% said they had no idea how their money was invested.

6.     Transparency of Pension Fund Costs and Fees – Why is it Important?

There is no purchasing decision that we as consumers make without knowing the costs, including an indicator of future or ongoing costs for large capital items like fridges or cars. Moreover, a car or a fridge will offer an indicator of efficiency (allowing an assessment of future costs) in their energy or fuel efficiency ratings.

In countries outside of Australia and the Netherlands, only a fraction of the costs are ever voluntarily reported to pension fund trustees by the commercial companies, such as the fund managers or custodian banks that manage pension fund assets.

Costs are incurred when pension funds hire commercial asset managers as well as through the process of buying and selling assets. But rarely are they known in full.

Cost levels should always be discussed or judged in relation to the return on investment by each asset class and by the investment style used. Indeed, 'Pennywise and pound foolish' and 'no pain no gain' are classic sayings that indicate that a judgment based purely on curtailing costs is inadequate.

This is specifically the case with asset management. Thus, encouraging overall cost reduction is not our main goal. Rather, we hope to promote the analysis of costs for each asset invested to ensure the full return or loss on that investment can be understood and addressed.

Nonetheless, transparency around costs can have a significant impact on the ability of funds to pay out retirement savings. A study by the Netherlands Authority for the Financial Markets found that a reduction in costs of 0.25% would result in a 7.5% increase in collective pension assets over 40 years.[1] 

Thus, understanding the difference between the investment returns before costs are applied and after is crucial. This is known as gross returns and net returns.

However, many costs are deducted by asset managers from the returns (or losses) they report to pension funds. Pension funds will report asset manager’s fees but - apart from Australia and the Netherlands - they do not report other associated costs, such as the costs of buying and selling assets, performance fees and many others.

Lack of cost disclosure means that their impact on investment returns cannot be understood. These costs can become an unnecessary burden on investment performance and reduce the money available to pay pensions. Evidence suggests that cost opacity in countries and jurisdictions that do not have an effective transparency framework are indeed affecting the level of retirement savings payouts. In 2017, the UK’s Financial Conduct Authority reported the following findings in its Asset Management Market Study:

• Price competition is not working as effectively as it could be: there is weak price competition in several areas of the asset management industry, particularly in retail active asset management services. This weak competition is coupled with high levels of profitability - average profit margins for sampled firms were 36%.[2]
• Actively managed and passively managed funds did not outperform their own benchmarks after fees: These findings apply to both retail and institutional investors. There is some evidence of a negative relationship between net returns and charges - suggesting that when choosing between active funds investors paying higher prices for funds, on average, achieve worse performance.[3]
• Lack of clarity around objectives charges: there is more than GBP 109bn in ‘active’ funds that closely mirror the market (also known as closet indexing) and that are significantly more expensive than passive funds.[4]

This means that pension funds may not be operating as efficiently as they could, placing economic strain on employer sponsors and plan members. Often plan sponsors will cite the high costs of their DB benefits without fully understanding the cost base of the fund. They seek to reduce benefits or increase member contributions as they assume that all the costs of investing are known.

With understanding of costs remaining limited amongst many market participants, greater educational efforts are needed. In the current environment of volatile markets and low interest rates, all avenues must be explored to increase plans’ funding levels and create better outcomes for members.

Put simply, costs can and do have a significant impact on investment returns; without controlling them the efficiency of the pension fund – both DB and DC – cannot be optimised.

7.     International experience

In the Netherlands as of July 2018, the regulation which requires pension funds to submit standard data on fees and costs, which is aggregated and published by the Dutch National Bank, remains unique. The Financial Assessment Framework (FTK) for cost reporting has been a recommended practice by the Dutch trade body, PensioenFederatie, for around seven years, but since 2015, schemes have been legally required to report on their costs under the FTK to the regulator - DeNederlandscheBank (DNB).

The framework has enabled pension funds to evaluate and break down the total costs, including transaction costs, associated with running a scheme. Schemes in the Netherlands saw investment costs fall by more than a third in just one year under its compulsory cost reporting framework, according to research carried out by Kas Bank and published recently in Professional Pensions.

While cost transparency is undoubtedly having an impact, consolidation is also playing a part in helping schemes to use their increased scale to drive efficiencies. The Dutch pension market has reduced from 454 schemes in 2011 to 297 in 2016, and 268 in 2017.

In Australia, defined contribution superannuation (pension) funds are required to disclose specific information on investment fees and costs to members but this information is not collected centrally by the regulatory authority. A fee and cost mapping table was produced by an Industry Working Group in response to Regulatory Guide 97 (RG97), which mandates fees and cost disclosure.

Australia’s defined contribution pension arrangement (known to Aussies as “super”) is the largest in the world, with assets of A$2.6trn – 144 per cent of GDP. This is a system built from scratch in the early 1990s via mandatory employer contributions employers to set aside 3% of all but the very lowest-income workers’ wages. The payment has since crept up to 9.5%, and, by law, will rise further in 2021.

With assets of about A$2.6trn their workplace savings system has grown into one of the largest in the world and is viewed generally as a success. That was until December 2017, prompted by a spate of banking scandals, the government set up a royal commission to investigate malpractice in the financial sector. 

The regulators report on the savings system has been damming. Those involved in delivering auto-enrolment here in the UK always saw super as an inspiration.

That is why the evidence from a triad of heavyweight official enquiries underway – Australia’s Productivity Commission investigations into banking and superannuation, and a Royal Commission into banking is so important for the select committee inquiry.

In Australia, every pension fund is governed by trust law: a legal requirement to put members’ interests first at all times. But what is being revealed is that trust governance, while necessary, is not sufficient, especially where pension funds are commercial entities.

As senior counsel for the Royal Commission put it: “Trustees are surrounded by temptation, to preference the interests of their sponsoring organisations, to act in the interests of other parts of their corporate group, to choose profit over the interests of members, to establish structures that consign to others the responsibility for the fund and thereby relieve the trustee of visibility of anything that might be troubling. Their duties oblige them to resist all of these temptations. What happens when we leave these trustees alone in the dark with our money? Can they be trusted to do the right thing?”

Disclosures of misconduct by banks and other commercial providers have caused a sensation as they did across the world in 2008/9. Revelations so far include dead clients being charged for advice, not dead clients being charged for advice they never received, and alive clients receiving conflicted advice from providers out to make money.

Australians had increasingly been voting with their feet even before these official enquiries, moving to not-for-profit funds because of their superior performance. The top 10 performing pension funds across all time periods are from the not-for-profit sector.

In the USA, private sector pension plans are subject to federal regulation under ERISA and the Internal Revenue Code, whereas public sector pension plans are subject to state law. Some states have introduced legislation requiring public pension funds to disclose fee data. In 2016, the Institutional Limited Partners Association (ILPA) - a private trade group - introduced a fee reporting template that details fees, expenses and carried interest, but adoption of this template is voluntary.

401(k) lawsuits are now being brought more aggressively against retirement plan advisers, with the chances of getting sued are more common now than five years ago according to press reports in the USA. Lawsuits against retirement-plan sponsors began appearing en masse in 2006, when law firm Schlichter Bogard & Denton sued several large corporations with multibillion-dollar 401(k) plans. http://www.investmentnews.com/article/20180417/FREE/180419918/401-k-lawsuits-being-brought-more-aggressively-against-retiremen

Most litigation up to this point has targeted only the largest plans as well as service providers such as record keepers, often for breach of fiduciary duty due to excessive 401(k) fees. UNISON believes it won’t be long before scheme members are forced to litigate to get to the bottom of the costs and charges levied against their workplace investment funds.

Problems in Chile, the Select Committee should be mindful of the protests that have erupted in Chile over the DC system introduced by the Dictatorship of Augusto Pinochet. There have been mass demonstrations on the streets of Santiago as a result of the failure of the current system.

“Chileans are raising their voices against the private pension system that has been in place since the military dictatorship of Augusto Pinochet. Over the past year, tens of thousands of Chileans have taken part in demonstrations organised by the No More AFP movement, calling for an end to the Pension Fund Administrators (AFP) and the establishment of a social security system providing decent pensions”. https://www.equaltimes.org/chileans-protest-against-private?lang=en#.W4Z6mjQvzcs

For many years, institutions like the World Bank held up Chile’s defined-contributions pension system as an example to follow, and it has been copied by more than 30 countries across Latin America, Southeast Asia and Eastern Europe, but its legitimacy is in question, and the government is promising reforms to try to shore up the system.

Many also complain that a lack of competition has allowed the private investment companies, known as AFPs, that manage the pension funds to earn disproportionately high fees. Investment returns have averaged more than 8% since the system was founded but after commissions, net returns are closer to 3%, according to a government commissioned report.  http://comision-pensiones.cl/Documentos/GetInforme

8.     Our response to the inquiry’s questions

1. Do higher-cost providers deliver higher performance, or simply eat into clients’ savings?

It is impossible to answer this question until scheme members and regulators receive full declaration of all the costs incurred by pension savers, in administration, investment and transaction costs. This information has to be provided in a consistent format to allow a judgement to be made on investment performance.

The Financial Conduct Authority in its Asset Management Market Study interim report found that “while there is no clear link between price and performance, on average the cheapest funds generated higher returns (both gross and net) than the most expensive funds”.[5] In its final report of the same market study it said: “We find some evidence that more expensive active funds underperformed cheaper active funds when considered net of fees.”[6]

2. Is the Government doing enough to ensure that workplace pension savers get value for money?

The government has been under pressure since the OFT report of 2013 in respect of pension funds regulated under the DWP. Despite this very little progress has been made. UNISON has pressed the DWP Ministers and Officials to consider the evidence from the Netherlands, where asset managers who operate in that country as well as the UK, have accepted the introduction of a cost collection methodology.

DWP officials continue to consider that scheme members bear no risk from opaque costs and charges within DB schemes commenting that the sponsors are responsible for maintaining the financial health of their fund. This approach is quite frankly a dereliction of duty, for if sponsors are unaware of the costs being imposed on their fund they cannot request any adjustments to be made that would improve the efficiency of the investment performance.

It is worth noting that no Director of Finance would survive in their post if they were unable to inform their shareowners how much it costs to run their company.  If as a result of transparency trustees of a fund were able to reduce costs, sponsors contributions may fall and they would have more money available to increase investment, jobs and or workers pay.

This is the key consideration for any government, that the more efficient a pension system is the more money would be released for the benefit of the general economy. To do nothing to address cost transparency is in fact a failure of a government’s duty of care to its employers and its citizens.

The Select Committee should consider the developments in the Local Government Pension Scheme where Ministers have embraced cost transparency and ask why is there a conflicting policy outcome between the 100 pension funds in England, Scotland and Wales and the DWP. The Scheme Advisory Boards are currently collecting cost data for public market assets and will adopt the IDWG cost reporting methodology when published.

They will shortly be creating a cost Utility that will check ensure that fund managers have submitted data, then check it for accuracy and finally provide performance analytics in order to establish the efficiency of the whole system, as well as by asset class. This is ground breaking work in this field as there is no other jurisdiction in the world that approaches costs and performance in this way. It should be applied across the whole pension system within the UK.

3. What is the relative importance of empowering consumers or regulating providers?

The UK pension system suffers from information asymmetry both regulators and consumers are unaware of the costs being levied by the finance sector against worker’s investment funds. Trustees are unable to ensure that the law is applied, primarily the obligation to invest in the best interests of scheme members and to resolve any potential conflict of interest in their favour.

How is it possible in 2018 for workplace savers not to find out how much it costs to be a member of their pension scheme? Or compare across the system to see if their trustees or provider are indeed able to ensure that their fund is efficient and delivering best value?

The whole pension system is in effect the servant to its master the financial services sector, regulators who should be able to address this issue have not acted in a way to support the workplace saver. Scheme members are unable to judge whether the pension system is working for them as they are unaware that the whole system is riddled with conflicts of interest, opaque charges and inefficiency. 

Workers assume that someone is looking after their interest; unfortunately that assumption is entirely misplaced. The answer lies in the nature of the workplace savings product.

The product is long term – does anyone know for sure whether a pension has been a good investment for, say, 40 years. After all, 30 good years could be undone by one terrible investment event such as the 2008 crash.

As such, it is not rational for individuals to engage with pension choices as they do with buying the weekly shop, phones, TVs, computers, cars and so on? Workplace savers will not be encouraged on mass to become investment experts there is no point in trying to make them do so.

What they need is a government that will recognise the deficiencies of DC saving, the lack of scale, the lack of transparency and the inability to make meaning full analysis of investment performance.

4. How can savers be encouraged to engage with their savings?

Scheme members quite rightly assume that the trustees and other providers are acting in their interest. Unfortunately this is not the case and the government has failed to address this situation.

Individual DC savers will never be able to become investment experts or be able to address the booms and slumps of markets. The only way to assist them would be to move DC to CDC.

The UK’s adoption of a DC system has all been in the interests of employers who confounded by the assumed costs of DB have now fled to the comfort of a regular low cost pension payment. No attempt was made to analyse the core reasons for costs in DB schemes, the popular assumption was that workers were living too long.

Instead of an examination of the structural problems, lack of scale, opaque costs and accounting methodologies policy fell to the poor assumption of ‘longevity’, workers living too long.  This has been to the detriment of the worker and to the economy in general.

5. How important is investment transparency to savers?

The Select Committee should ask the question what other consumer market would tolerate opaque fees and charges. No other consumer purchase would be allowed with opaque pricing. The world of investment fund pricing is full of jargon and mistruth.

Transparency of costs and the measurement of investment performance cannot be achieved in the current regulatory structures. There is no commonly agreed methodology to use to establish costs and performance for every asset class and service that pension and investment funds use.

Without this savers are parting with their money completely unaware of the impact that these costs and charges have on the size of their investment pot.

6.  If customers are unhappy with their providers’ costs and investment performance/strategy, are there barriers to them going elsewhere?

The government was consistently dismissed the introduction of a 'pot follows member' system. And even if it were introduced how would members know what fund is delivering the lowest costs and best returns?

There is no system for members to examine such an arrangement. The problem lies with the UK pension system, too many funds and no cost transparency. In Australia where it is easier for members to obtain cost and performance data and there is a system for members to move between funds they are increasingly moving to not-for-profit funds because of their superior performance.

7. Are Independent Governance Committees effective in driving value for money?

Independent Governance committees are institutionalised in favour of the provider and by the absence of robust data by which they can be judged by their members. At the heart of the problem with the IGC system is their lack of independence and a fiduciary duty to scheme members.

Campaign group ShareAction, in its review of the 2017 IGC reports, stated: “Some IGC reports made vague, high-level statements on provider performance and did not back them up with detail or data. We felt it would be hard for a consumer or consumer body to understand from these reports whether scheme member interests were being protected by the IGCs, and if scheme members were getting value for money from the various providers.”[7]

These committees are appointed and financed by the providers they are meant to supervise. So far the government has resisted all calls to introduce scheme member representation or independent evaluations of value for money.

All pension schemes should be overseen by a body whose members have a clear duty to act in members’ interests and with a membership that is at least 50% those with a member or consumer background.

8. Do pension customers get value for money from financial advisers?

It is impossible for financial advisers to offer value for money because the whole pension and workplace saving system is riddled with conflicts of interest and opaque charging. In the final analysis they have to guess on what constitutes a well performing fund.

August 2018