Defined Contribution scheme charges and governance to come under increased scrutiny

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The Office of Fair Trading ("OFT") has published its "defined contribution workplace market study". It is a complex document, running to 175 pages, but two strong messages emerge. Charges under Defined Contribution (DC) schemes need to be better controlled, and governance standards need improvement.

There has been plenty of comment in the media recently about the effect of charges on eventual benefits from DC schemes, both trust based and contract based. Auto enrolment has caused increased attention to be focussed on this issue. The Government is concerned that auto enrolment should not simply lead to improved results for providers and benefit consultants, at the expense of member benefits. The current position is complex. While the introduction of stakeholder pensions led to a maximum Annual Management Charge of 1%, and nowadays rates considerably less than 1% are available, there are many older schemes in existence with higher charging rates. The charges can also be applied in different ways; the report identifies eighteen different names of charges that may be applied.

A particular concern raised in the report relates to active member discounts, which is essentially a disguised method of applying higher charges to members who have left the employer's service.

The reference to scheme governance reflects a concern that some employers will not wish to devote resources to ensuring that the scheme they use to comply with their auto enrolment obligations offers good value for money. Rather, they may opt for the scheme that costs them the least.

The report proposes the introduction of minimum governance standards for all pension schemes. One step already agreed is that the Association of British Insurers has agreed that its members will introduce Independent Governance Committees (IGC) to be embedded within all providers of contract based and bundled trust based schemes. The report recommends that the Government should legislate to require minimum governance standards, based on the main elements of the IGCs, should apply to all pension schemes. This ties in with recent recommendations from the Pensions Regulator about DC governance.

Another key recommendation is that costs under DC schemes should be reported on a common basis, to make comparison easier for members. Investment transaction costs are to be excluded, because the OFT feared including them might discourage investment managers from carrying out transactions.

The report specifically rules out introducing a cap on charges, on the basis that this might end up as a ceiling amount charged by every provider. Pensions Minister Steve Webb has already commented that there may be a case for a cap, despite the OFT's view.

It will be interesting to see the extent to which the report's recommendations are adopted. In the meantime, greater focus on costs and governance generally must be good news for scheme members, albeit perhaps leading to higher costs for some employers.