After months of speculation, the announcement by the government at the end of March that it will impose a 0.75% charge cap on all defined contribution schemes used for auto-enrolment pension schemes at least drew a line in the sand for the pensions industry.
While a resolution to the matter is to be welcomed as pension providers can now start to make plans, the size of the task ahead of them is not to be sneezed at. According to Hargreaves Lansdown, a third of all default funds need to be changed by April 2015.
A focus on the exact cost of providing a pension should be welcomed. The DC industry has come of age in an ad-hoc manner with a no overall standards applied to the cost structure making comparing and contrasting different products virtually impossible. The introduction of a charge cap has at least made the industry recognise it needs to come up with a more helpful way to collate and compare different charges.
But cost is far from the only variable in a pension scheme. In some ways it is slightly odd that cost of pension provision is such a hot button issue for politicians and pressure groups. After all, compounding has always applied to both investment returns and costs, so why isn’t such an intense focus applied to whether pensions will provide good returns?
The financial crisis has a role to play: all of the financial services industry is viewed with deep suspicion by the public. Viewed through this prism it’s clear why politicians want to ensure that their auto-enrolment policy is viewed as squeaky clean.
As the implementer of a policy to provide a long-term benefit like a pension to huge swathes of the working population, it’s understandable that the government wants to ensure it is providing value for money.
While cost transparency should be welcomed, the case for charge cap is less clear. Most industries that are exposed to such intense government scrutiny are ones where there is not sufficient competition to ensure free and fair pricing – for example, the energy suppliers.
But despite the problems with DC schemes, the pensions industry is not the same as the energy supply market – even if transparent pricing is hard to come by, there are a far larger number of players offering a wide range of different products.
The other problem is the intense focus on cost at the expense of all other metrics. Any supermarket shopper can tell you that cost is not the same as value. Standard oranges may be cheaper than organic ones but if they are sour and inedible while the more expensive ones are sweet and juicy, buying cheaper citrus is actually a waste of money.
But determining value in pensions is much trickier than in citrus fruit. While all you have to do to determine whether an orange is good value is to simply peel and eat, finding out whether a pension is good value is akin to buying orange seed futures on the market, waiting for their physical delivery, planting them in the ground, watching for the tree to come to maturity and then sampling the fruit. It’s less a case of jam tomorrow and more one of marmalade eventually.
Investment consultants take a more pragmatic approach discover the value of particular investment strategy – they look at total performance net of fees, in order to discover if supposedly innovative strategies are really delivering value.
But while that can help you determine whether a fund has performed well in the past, it’s much harder to determine whether it will continue to do so in the future.
How you determine the value of product that you will not receive for several decades and will be shaped not only by its cost but by interest rates, inflation and investment returns is a problem that has no simple answers.
But there has to be a better way that focusing on cost alone: one that won’t leave a sour taste – there’s little point in having a cheap DC pension if it doesn’t deliver a decent retirement income.