Written evidence from Association of British Insurers (ABI) (PCT0050)

Introduction

The Association of British Insurers (ABI) is the voice of the UK’s world leading insurance and long-term savings industry. A productive, inclusive and thriving sector, we are an industry that provides peace of mind to households and businesses across the UK and powers the growth of local and regional economies by enabling trade, risk taking, investment and innovation.

The UK insurance and long-term savings industry is the largest in Europe and the fourth largest in the world. It is an essential part of the UK’s economic strength, managing investments of over £1.7 trillion and paying nearly £12bn in taxes to the Government. It employs nearly 325,000 individuals, of which around a third are employed directly by providers with the remainder in auxiliary services such as broking.

The ABI welcomes the opportunity to submit evidence to the Work and Pensions Committee.

Executive summary

The long-term savings industry agrees that savers must be able to trust their providers to offer them good value for money. Ensuring that pension costs and charges are fair and transparent is fundamental to improving outcomes for savers and maintaining trust in the Automatic Enrolment Programme and long-term savings more broadly.

This issues of costs, and cost and charges transparency, have received significant attention from the industry, the Government and the regulators in recent years, and further work is underway to improve the disclosure of transaction costs and investment strategies. Once complete, these measures should provide both savers and governance bodies with comprehensive information about all of the costs borne by members.

In the initial phase of the Automatic Enrolment programme, the Government and the regulators made a number of legislative and regulatory changes to workplace pensions schemes focused on costs and charges:

banning member-borne commission;
introducing a charge-cap of 0.75% per annum for administration costs, and standardising charging structures;
requiring firms operating workplace pension schemes to set up independent governance committees (IGCs) responsible for scrutinising the value for money of their schemes; and
requiring all transaction costs to be disclosed to governance bodies.

Significant improvements have also been made with regard to charges for legacy workplace schemes, following the work of the Independent Project Board (IPB). A report published by the IPB in 2016 found that, of the £67.5 billion of assets in workplace pensions schemes examined, one third (or £25.8 billion) of the savings represented were potentially exposed to charges of more than 1%.[1] Since 2016, through the combined work of providers, IGCs, the Financial Conduct Authority (FCA) and Department of Work and Pensions (DWP), this figure of £25.8 billion has now been reduced by over 90%.[2]

Finally, following the introduction of the freedom and choice reforms, the FCA banned exit fees over 1% for those over the age of 55 to ensure people did not encounter barriers to taking advantage of the freedoms.

As a result of these interventions, the administration costs associated with workplace pensions used for Automatic Enrolment in the UK are generally low: members of qualifying contract-based schemes paid 0.54 per cent on average, well below the charge cap of 0.75% or an equivalent combination charge set by Government.[3]

Transactions costs are the costs associated with buying and selling assets on the markets. These costs do not go to providers but to third parties, including the Exchequer in the case of stamp duty, and these costs are outside of the charge cap. We believe that transparency of these fees is essential to maintaining public trust in the Automatic Enrolment Programme and long-term savings more broadly, and there are a number of regulatory changes taking effect in 2018: MiFID II, the FCA’s workplace pensions disclosure rules, and the FCA’s work through its Institutional Disclosure Working Group. However, we do not currently see widespread consumer demand for detailed information on their pensions transaction costs – quite the contrary: consumers want concise information with as little technical detail as possible.[4] We therefore believe that this information should be proactively provided to governance bodies, who will be better placed to interpret this information, and provided to interested savers on request, so as not to overwhelm and disengage the wider population. We also have some reservations about the methodology chosen by the FCA for implicit transaction costs.

More widely, while transparency of costs is important, we believe the authorities should also focus on value so as not to drive down the quality of offerings by constant pressure to reduce charges further. For example, effective engagement of scheme members has costs but will be positive for people’s retirement outcomes. Further improvements to the retirement outcomes of savers will need to come from improved engagement. This is because the magnitude of the shortfall in savings, particularly for medium to high earners, dwarfs the impact of fees. Encouraging consumers to take more ownership of their pensions is therefore one of the sector’s highest priorities. This will require the Government, the industry, the regulators and governance bodies to take a broader view of value for members in future, that considers costs alongside other factors such as investment returns and strategies, customer service, the quality of communications and good governance and management of schemes and products.

The pensions dashboard initiative, which will allow consumers to see all of their pension entitlements, including the State Pension, in a single online place of their choosing, will help transform consumer engagement with pensions. We welcome the Government’s recent statement reiterating its support for this project and look forward to engaging with the Government on its feasibility report. The ABI and its members are also working on interventions to help consumers engage with their savings and plan for later life, including work to simplify language, the introduction of midlife MOTs and a tool to help customers to navigate retirement decisions.

Inquiry Questions

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

When considering what ‘higher performance’ looks like, we would encourage the Work and Pensions Committee to take into account factors such as customer service, communications, good governance and management of schemes and products, in addition to the cost, investment returns and strategies.

An extensive programme of research undertaken in 2017 on behalf of a group of 11 IGCs, with the support of their respective UK workplace pension providers sought to develop a common understanding of what members see as important when assessing value for money. This research found that perceptions of what value for money means focus around ‘good returns’, but that consumers take a broad view of this concept. In the online survey this was the top rated attribute; but the workshops revealed this is much broader than investment returns and is perceived by members as achieving a good outcome at retirement, underpinned by the amount of total contribution going in and quality of the pension provision and member experience.

Workplace pension schemes offer differing pricing. Scheme pricing takes into account a number of factors, including the size of workforce, nominal contributions, age profile of workforce, and workforce turnover. Once these factors are taken into account, a lower cost product should reflect a reduced offering being made. This reduced offering could take the form of a simplified investment proposition and streamlined/simplified customer service and communications.

The main cost of delivering pension products relates to the cost of investment. Generally, lower cost investment strategies favour passive investment over active. Whilst passive investments form a legitimate component of most pension portfolios, these strategies tend to perform well in times of rising markets, as we have seen in recent years, but offer less opportunity to protect values or reduce volatility in more difficult market environments. There are some concerns regarding the impact that a lack of activist investors would have on the efficiency of capital markets as a whole.

Lower cost investment offerings might also lead providers to avoid particular asset classes, with property, infrastructure, corporate bonds and commodities having been highlighted as investment classes that would likely be removed from lower cost strategies. This reduces asset diversification and the resilience of portfolios to market shocks and may also undermine long term returns for savers.

Research highlights that customers value certainty and are uncomfortable with taking risk. This suggests that investing in a way that generates large downward adjustments or higher volatility not only risks impacting the investment growth delivered to customers, but more importantly could deter people from saving. Providers feel that it is important that a balance is struck between reduced charges, and investment strategies which allow a greater degree of opportunity for balanced and less volatile returns.

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

Prior to the roll-out of the Automatic Enrolment Programme, the Office of Fair Trading undertook a market study on Defined Contribution (DC) workplace pensions which identified a number of areas for improvement. Following on from this, the DWP and FCA undertook an extensive joint programme of work to ensure that the schemes that people were being enrolled into were fit for purpose. This programme comprised of several elements with regards to costs and transparency, which are now largely complete, including:

Banning of member-borne commission.
Enhancing the transparency of costs and charges for members, including the introduction of a new methodology for capturing transaction costs, and new expectations on onwards disclosure of costs, charges and investments to savers.
Introducing a charge cap of 0.75% for all AE qualifying schemes. This cap includes all member borne costs other than transaction costs.
Creating IGCs to advocate for the voice of the consumer in the UK DC contract-based market.

Consequently, the costs and charges associated with workplace pensions used for Automatic Enrolment in the UK are generally low: members of qualifying contract-based schemes paid 0.54 per cent on average.

Significant improvements have also been made to charges for legacy workplace schemes, following the work of the Independent Project Board (IPB), led by the ABI and consists of representatives from DWP, the regulators and the industry as well as consumer representatives. A report published by the IPB in 2016 found that, of the £67.5 billion of assets in workplace pensions schemes examined, one third (or £25.8 billion) of the savings represented were potentially exposed to charges of more than 1%.[5] Since 2016, through the combined work of providers, IGCs, the FCA and DWP, this figure of £25.8 billion has now been reduced by over 90%.[6]

IGCs have also invested considerable research and thought into understanding what matters to members. The final approach taken by several Independent Governance Committees (IGCs) to determine value for money generally focused around the following key concepts: charges (including ongoing and one-off), investments, customer communications and engagement, quality of service and governance.

Given that the concerns around higher charges for workplace pensions have largely been addressed (and the few remaining concerns are under active consideration by industry and regulators) combined with the significant pensions gap seen in the accumulation phase and complex decisions faced by members nearing retirement, future consideration by the Committee of improving value for money should focus on how providers and the Government can encourage savers to take more ownership of their pensions through better engagement, service and governance.

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

There is not necessarily a trade-off between empowering consumers and regulating providers – indeed, a number of regulatory initiatives have the express purpose of empowering consumers, such as improving communications, standardising disclosure, and compelling schemes and providers to make data available in a common format to pensions dashboards or for the purpose of comparison.

During the accumulation phase, particularly for those who are employed on lower earnings, we believe that the Automatic Enrolment Programme, and the comprehensive legislative and regulatory arrangements outlined in the question above should provide an excellent starting point for savers. This will be particularly true once the contribution rate increases have bedded in, and the Government has implemented the changes to eligibility and band earnings signaled in the findings of DWP’s 2017 Review of Automatic Enrolment.

However, for those on moderate to high incomes, it is generally accepted that the minimum contribution rate of 8% set out under Automatic Enrolment will not be sufficient to provide an adequate retirement, with independent Pensions Policy Institute research identifying the need for a minimum contribution of 11-14% of band earnings in order for members to have a good chance of enjoying a comfortable retirement.[7]

Should the Government not increase contribution rates across the board in future, relying on inertia and cost-focused regulation alone will not generate good retirement outcomes; a shortfall in savings of several percentage points per year would remain. Engagement will therefore be necessary to increase voluntary contributions from members. The pensions dashboard could play a transformational role in improving engagement, as it is not realistic to expect savers to understand how much they are paying for their pensions and the effect of those charges, if they cannot locate their pensions or see how much they are contributing in the first place.

How can savers be encouraged to engage with their savings?

Encouraging consumers to engage with their pensions is currently the highest priority for the long-term savings sector. Whilst pension freedoms are undoubtedly popular, consumers are now in a position of having to make more complicated financial decisions than they have had to in the past.

The most effective way that consumers can be encouraged to engage with their savings is by giving them new or better ways to access information. There is currently a data revolution underway in much of the financial services industry, with the very latest of technology being employed to help consumers access data, that is legally their property, in innovative ways that support their financial wellbeing. The joint effects of open banking, Payment Services Directive II and General Data Protection Regulation are empowering consumers to engage with and take control of their finances and the long-term savings sector is eager to follow suit.

The pensions dashboard initiative (which the ABI has led on behalf of a cross-sector alliance of private pension providers, trust-based schemes and third party administrators) has proved almost universally popular, with other firms and trade bodies, consumer groups and politicians on both sides of the house endorsing it. Allowing consumers to see all of their pension provision in one place online removes one of the most significant hurdles that consumers face when trying to engage with their savings. It is crucial that the government works with industry to make this project a reality.

The pensions industry can do a great deal, but without legislative compulsion and the Government’s support, a pensions dashboard will not include the state pension or public sector pensions and would therefore not be truly comprehensive. Furthermore, a number of schemes, particularly smaller, trust-based schemes, will not take part voluntarily. A dashboard with partial coverage could present a long-term risk as consumers would be in danger of making decisions based on incomplete information.

As well as giving consumers better access to their data, the ABI and its members are also working on other interventions to help consumers engage with their savings and plan for retirement. Building on our work on the use of plain language, we are working with members to establish principles for tailored communication through the life course. Consumers require different messages at different points in their saving and retirement journey and establishing best practice in this area could prevent consumers from disengaging from their savings. We are also working with DWP and the Pensions Advisory Service to determine how a Midlife MOT can be implemented. Research from the Pensions Policy Institute suggests that consumers are most likely to engage during certain ‘teachable moments’ in their lives, and a midlife analysis of health, wealth and career is one of these.[8]

It should however be recognised that one of the greatest challenges to effective engagement is the low level of financial capability in the UK. Many consumers struggle with basic financial concepts making it hard for them to engage with the relatively complex world of savings. Whilst this is a cultural issue that needs to be tackled through education, there are actions that industry, government and regulators can take to help consumers.

Promoting easy to understand rules of thumb and user friendly choice architecture can help consumers understand what is in their best interests. There is however some concern among providers about what they are allowed to say to consumers before it crosses the line into financial advice. Ideally consumers would speak to the appropriate guidance body about their saving needs, but in some situations the provider is better positioned to provide this service. Further clarity on what can and cannot be said would be beneficial.

Automatic Enrolment has had a dramatic effect in reversing the decline in the savings rate, and it is right that industry and government are proud of this work. Employers should also be commended for the near universal compliance we have seen in rolling it out. The next step is to reconnect people with their savings, giving them access to their data and the appropriate nudges to ensure that they get the best out of them.

How important is investment transparency to savers?

The ABI strongly supports the disclosure of costs and charges, including transactions costs. We view this transparency - making information available - as essential to maintaining public trust in the Automatic Enrolment Programme, and long-term savings more broadly. However, we do not currently see a demand from most customers for more information on their pensions, and we therefore believe that any information that is provided proactively needs to be proportionate and tailored to the audience so as not to overwhelm and disengage savers.[9]

Improving consumers’ understanding of the fees that they pay for their pensions, both gross and net of investment returns, will improve competition in the market, and therefore consumer outcomes, as well as improve the reputation of long-term savings. The primary focus of this should be on explaining the compounding impact of both charges and investments over time. After this has been taken into account, consumers will then be in a position to assess whether the additional elements of their pension (such as customer communications, level of service, trust in the provider, or existence of other valuable guarantees or benefits) are warranted. Improving and standardising pensions data across the industry and, in time, making it available via pensions dashboards, could play a critical role in helping consumers to understand this important information.

The ABI also supports the disclosure of information on where and how customers’ pots are invested, so that customers understand that the value of their entitlements can go up and down, and also ensure that their money is invested in a way that aligns with their personal values.

However, we believe that information on transaction costs is more appropriately directed at trustees and IGCs, who will have the expertise, resources and context to make a meaningful assessment of the value for money offered by schemes. We believe that this information should be made available to individual consumers should they request it, as engaged customers have a right to understand how their money is being managed.

The FCA introduced a consistent methodology for capturing transaction costs in January 2018, following significant delays.[10] Providers and asset managers are currently investing in significant infrastructure changes to ensure that real-time information from financial markets is captured. The ABI has worked alongside the IA and members to develop a framework for ensuring that the relevant investment cost information, including transaction costs, is passed from asset managers to providers in a consistent and comprehensive way.

When considering the disclosure of transaction costs, it is also useful for policy makers to maintain a distinction between costs incurred under the charge cap, (which are certain, predictable, understandable and accrue to providers) and transaction costs (which are uncertain, difficult to communicate and all of which accrue to third parties in the supply chain including brokers, custodians, other investors and taxes paid to the Government).

Of particular concern to providers is the fact that the methodology for quantifying implicit transaction costs chosen by the FCA (also known as the ‘slippage cost’ methodology) can generate positive costs (or net benefits) to consumers. This is conceptually difficult for consumers to grasp and may detract from the focus on the costs incurred under the charge cap, which should be of primary interest to price-conscious consumers.

Broadly speaking, providers are incentivised to ensure that the transaction costs they incur generate longer term returns. This is because incurring transaction costs that do not deliver greater returns will undermine the net investment returns to members, and therefore, both the value for money offered by their products and the profits that providers are able to make themselves (which are broadly related to the assets under management). Interested members may be surprised to learn that stamp duty is likely to make up the largest component of transaction costs incurred in both passively and actively managed funds.

The DWP has also recently regulated to give effect to greater disclosure to customers of both costs and underlying investments for trust-based pensions [11], and the FCA is expected to consult on corresponding rules for contract-based schemes. We believe that the approach taken by the DWP strikes an appropriate balance between enabling members of schemes to be able to receive the relevant information and managing the costs to providers and risks of overloading members with unnecessary information and call on the FCA to ensure consistency across the pensions sector.

We would also emphasise that any further changes to costs and charges disclosure should be consistently applied across retail investments. This is because a piecemeal approach (as taken under PRIIPs, MIFID and UKDC pensions) is unhelpful to consumers, who are unlikely to understand the nuances of particular products or regulatory regimes.

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

There are a number of additional factors beyond costs and investment performance / strategy that may drive customers to choose to switch provider, including a desire for better communications, improved customer service, or to consolidate their savings in one place. Savers should be encouraged to shop around for savings products that meet their needs, and providers and policy settings should facilitate this. Although there have been major improvements in the last decade, there are still a number of barriers which could prevent a customer from switching where they are dissatisfied with their provider or pension scheme, which are outlined below.

The key barrier outstanding barrier to improving customer outcomes, particularly for older products and/or those with smaller pension pots, is low customer engagement. Providers have made a significant investment in seeking to trace and re-engage customer in the recent past, and the ABI recently published a Gone-aways Framework [12] to highlight good practice across industry. In general, tracing of gone-away members is very effective, but often gone-away members will not respond to providers (and update their details and / or access their benefits), due to wariness of scams and – sometimes - a lack of familiarity with the provider due to changes in company names and branding. The FCA and DWP’s findings from the Joint Review of Industry Progress against the Independent Project Board Recommendations in December 2016 highlighted that the industry has made significant progress in addressing outcomes for customers of legacy workplace pensions schemes, but highlights the barrier presented by customers who do not respond to communications as a specific ongoing issue for the industry.

Providers would like to work with Government agencies to find a way to confirm whether the traced address matches Government records for the same individual, so that they can update their own customer records.

ABI members are actively trying to engage all their customers, but a further barrier exists to improving customer outcomes: where a provider identifies that a fund or product is not likely to be suitable, they are often unable to make wholesale changes to move customers to simpler products without taking on significant legal risk. This is because providers are unable to ensure that all customers will be in an better off position after they have done so, as they have an incomplete understanding of individual customers circumstances and future investment returns, and many products have benefits that may be lost by such a move. To deliver fair outcomes for customers, we would like to work with the Government and the FCA to find a solution to this issue.

The process for transferring pensions can present a practical barrier for a number of consumers, and the timeliness and ease of transferring can vary significantly across the pensions sector. The use of the automated transfer services, such as Origo’s Options service, can generate significant reductions in transfer times: from over 50 days to 8 calendar days.[13]

However, the uptake of such services varies significantly across the pensions sector. This in part reflects differences in expectations from regulators. For trust-based pension schemes, the maximum time periods for transfers are set out in legislation and the transfer must generally take place within six months from the start of the transfer process. Additionally, DWP regulations state that trustees must ensure that core financial transactions for DC pension schemes are processed promptly and accurately. The DC Code issued by TPR also provides guidance on what constitutes ‘prompt’ and how ‘prompt’ processing might be achieved. In contrast, existing FCA rules require that a re-registration request should be executed ‘within a reasonable time and in an efficient manner,’ but do not set a hard statutory limit for the timeliness of these processes. However, the firms operating in the sector generally feel that the FCA’s expectations for transfers are considerably more ambitious than DWP’s and TPR’s.

The Transfers and Re-registration Industry Group (TRIG), comprising representatives from ten major industry trade bodies and led by the ABI, has published an industry Framework for firms to work on to deliver fast, efficient transfers of investment products and assets between different financial businesses and pension schemes. As well as the Framework, TRIG is publishing an RFP for organisations interested in participating in the ongoing governance of this standards Framework. The FCA has recently expressed support for this project, and we would urge the DWP and TPR to prioritise improvements to transfers in order to achieve better consistency of customer experience regardless of the legal basis of the scheme.

In order to give effect to the Freedom and Choice reforms, early exit charges have also been capped at 1% of the value of existing contract-based personal pensions, including workplace personal pensions, for those over the age of 55 from 31 March 2017. Early exit charges that are at less than 1% may not be increased, and firms are no longer able to apply an early exit charge to new personal pension contracts. Whilst exit fees still exist for those under the age of 55 for some older products, reflecting the costs of advice the customer had, a number of large firms have also undertaken proactive work to remove exit fees to older products, as part of regular product reviews that firms have a duty to conduct to ensure value for money is being delivered, through the ongoing work undertaken with the FCA following on from the Legacy Thematic Review.

In many instances, particularly for older products, the contracts entitle the customers to valuable benefits, such as guaranteed annuity rates. In recognition of this fact, individuals are legally required to take regulated financial advice if they have a final salary or career average pension (known as a ‘defined benefit’ pension) worth more than £30,000 and want to transfer it to a defined contribution pension scheme. This requirement also applies where a customer has a defined contribution pension worth more than £30,000 with a guaranteed income in retirement. We believe that this requirement is appropriate and would encourage consumers to take guidance, and also consider speaking to a financial adviser if their pension is worth £30,000 or less.

Are Independent Governance Committees (ICGs) effective in driving value for money?

The ABI was supportive of the establishment of IGCs, having initially proposed them as a means of addressing some of the concerns raised by the Office of Fair Trading in its 2013 market study of Defined contribution workplace pensions.[14]

As discussed in our response to question 2 above, many of the issues that IGCs were initially created to focus on (in relation to higher charges for legacy workplace pensions) have now been resolved.

The broader market and regulatory settings have also evolved since the introduction of IGCs. The introduction of the Senior Managers and Certification Regime will strengthen accountabilities within firms for delivering good customer outcomes. A number of providers have also revised their internal governance, through their work with the FCA on long-standing customers.

The FCA is also currently undertaking wider policy work on IGCs for workplace pension schemes to look at the possibility of extending their remit to consider social investing issues. This wider work includes possible changes to the rules for IGCs to improve governance and value for money for consumers. The industry will continue to engage constructively with the FCA and DWP on this work, to ensure that future changes are well informed and continue to promote customer interests.

Do pension customers get value for money from financial advisers?

Pension customers generally get good value from advisers. There are a wide variety of pension customers with different needs, levels of saving and intentions. In addition to this there are a variety of services that could be offered by an adviser and various combinations of them, therefore any answer to this question will to a certain extent deal in generalities.

It should, however, be noted that only 12% of consumers over the age of 40 use a Financial Adviser.[15] This is a structural issue that has been known to government for some time. Although automated advice has the potential to reduce the cost of advice and make it available to a wider population, the cost of financial advice when compared to the average level of pension savings make it impractical for most savers.

Whilst several policy solutions for this issue were suggested in the Financial Advice Market Review, there is little evidence to suggest that the gap has narrowed. One of the key recommendations of the FAMR was the creation of a pensions dashboard. A significant portion of the costs incurred by consumers in relation to financial advice is due to administration, including manually confirming pension entitlements with providers and trust-based schemes. National IFA firm LEBC suggest that the creation of a dashboard could save the equivalent of £400 per pension a person has, potentially making a meaningful impact on the cost of advice.[16]

The focus should be on the quality of advice and the services offered, and the incentives of advisers. As stated in our answer to question four, the level of financial capability and knowledge in the UK is very low. In this environment it is beneficial for consumers with little knowledge of the pension system to speak to an expert who can help them think about their retirement goals and consider what options they have with the assets they have accrued.

We do however have some concerns relating to the regulation of smaller firms by the FCA, including advisers and use of risky unregulated investments in SIPPs. High profile cases such as British Steel Pensions has shown evidence of poorly run adviser firms charging high fixed percentage fees for inappropriate poorly protected investments, this does not represent value for pension customers. As with all services, the main indicator of the quality of the service is the quality of the firm, and while there are undoubtedly many adviser firms providing high quality advice, there are some who represent a risk to pension customers. It is vital that the FCA remains focused on this risk.

September 2018

[1] https://www.fca.org.uk/publication/research/remedying-poor-value-legacy-workplace-pension-schemes.pdf