Focus on costs shifts to DB schemes

Politicians on both sides have been waging a very public war on the cost of pensions after successive reports showed the crippling impact of charges on the size of pension pots.

In March the government acted and auto-enrolment pension schemes will not be able to set annual management charges above 0.75%. All the noise has been around ensuring defined contribution savers get value for money.

But new research commissioned by the Pensions Regulator has revealed the huge range of costs being paid by defined benefit schemes, with some paying ten times as much per member than similar-sized funds.

Unlike auto-enrolment schemes, DB pensions have been around for decades and have millions of members, so why have these funds escaped a similar scrutiny?

Sponsors should be up in arms about this

The answer is that in DB schemes all risk and inefficiencies are borne by the plan sponsor. No matter what – be it market downturn, the changing cost of compliance or poorly negotiated investment management fees – the member does not lose out.

“Sponsors should be up in arms about this”, said David Blake, director of research body the Pensions Institute, “it’s them that bear the costs, not the member – the Regulator is more concerned about value-for-money in DC”.

Pension managers and trustees may well find themselves under pressure to squeeze service providers once the results of the survey reach finance directors. Not that investment managers, administrators and consultants will be in a rush to do so.

Big is beautiful, small is variable

It came as no surprise to find economies of scale in action. “If anyone still doubted that ‘big is beautiful’ for pension funds, then this report should put that doubt to bed”, commented Sorca Kelly-Scholte, managing director of client strategies and research at Russell Investments.

Schemes pay an awful lot more money for the same services

The survey, of 316 corporate funds, found the average small scheme (less than 100 members) paying £1,054 in annual running costs compared to just £182 per member at schemes with over 5,000 members.

A more interesting finding was the incredible range of per member cost in the small schemes, with some running as efficiently as much larger funds, at less than £100 per member, and others touching the £2,000 mark.

Kim Gubler, director at Kim Gubler consulting, said she wasn’t at all surprised in the variation. “Schemes pay an awful lot more money for the same services”, she said, “they are often in an old contract, weighted towards time cost.

They are almost gentlemen’s agreements so you can’t even tell what people have been paying

“Some trustees want to spend a lot of time on the phone with their actuaries. Sometimes we can’t even find the original agreements because the schemes are that old, they are almost gentlemen’s agreements so you can’t even tell what people have been paying.”

Commentators agree that a fundamental lack of transparency makes it difficult of schemes to keep a track of fees. “For small schemes transparency is paramount as pension administration is often their biggest area of cost (see graph, right)”, said Bob Scott, a partner at LCP.

“Until increased transparency enters the investment management industry we recommend that trustees arms themselves with the knowledge to understand the fees they are paying.”

Nick Secrett, pensions investment director at PwC, warned that “too many schemes are running over-complicated and expensive investment strategies which are not providing value for money.”

We should instead start form the notion that all cost must be justified

But Russell’s Kelly-Scholte commented that the charges debate is too often held out of context: “What’s missing for me in all the debate about costs, particularly as it pertains to investment, is this question of value added.  It starts from the notion that all cost is bad. We should instead start form the notion that all cost must be justified.”

More worrying even than fees, is the revelation that so few schemes of any size could report all the costs they incur. At large schemes, those with between 1,000 and 5,000 members, just 45% could provide a total cost figure, and they were the best performing of any size of scheme.

Schemes are still not treated like businesses, despite being much larger than many companies

The first step to controlling costs is knowing what they are. Gubler said part of the problem was that schemes are still not treated like businesses, despite being much larger than many companies. She advised schemes to think about efficiency costs in the same way as sponsor contributions.

She’s right – after all, the more employers spend on investment, administration, lawyers and the rest, the less there’ll be left in the pot next time trustees need a top up.