Keeping control of pension scheme running costs can be challenging for trustees and employers. The amount a defined benefit (DB) scheme pays will vary depending on its design and complexity – with some costs more obvious than others – so understanding what you are paying is the first step in keeping costs down. Trustees and their advisers, working together, can enable the schemes in their care to achieve better outcomes at lower costs.
At the heart of the problem of cost management is visibility. It can be hard to drill down to account for every penny as charges are often opaque. Indeed, such is the complexity that it can be hard to see how much is being paid to each supplier, let alone having clarity on the total cost of running a pension scheme.
Charges arise from many different quarters. Investment fees, usually bundled up, are far from straightforward. There are also custody, actuarial, third-party administration and covenant advice fees to name but a few. In recent years, inflationary pressures have made it more important than ever to contain costs. But how best to do so?
The first step is to understand your total expenditure. How much information is provided about annual investment management fees, for instance? Alexandra McClelland, Senior Investment Consultant at Isio, explains: “Virtually nobody receives an invoice for the total annual investment management charge. Often it is carved out of the investments as a percentage, meaning this is one area where visibility can be particularly poor, and yet this is usually the largest single cost for a pension scheme.”
Operational consolidation pays dividends
Operational consolidation – which involves a pensions service provider running DB schemes collectively, bringing them all up to best-in-class levels of efficiency and service – can be the solution to greater cost certainty. In particular, it can mean that scheme running costs are outlined together at outset, often providing greater visibility over total scheme running costs.
Operational consolidation also enables smaller pension schemes to retain their own individuality, while benefiting from big scheme efficiencies such as economies of scale and lower investment charges. Scheme administration can be more reliable and efficient too, with best-in-class processes resulting in a smoother member experience. Access to better technology can also mean that decisions are much better informed. “Availability of real-time funding modelling makes funding levels more visible, which enables faster trustee decision-making” adds Paul Yates, Director at Isio.
But it’s the prospect of significant financial savings that really captures the attention, as Yates explains. “When schemes consolidate, ongoing operational costs can reduce by as much as 30%. This sizeable figure comes from a combination of things. It could be curbing investment fees or lower advisory charges from a more efficient servicing model.”
The level of investment management savings depend on a scheme’s current set of charges, says McClelland. “Schemes who haven’t recently re-visited their investment strategy or benchmarked their costs may have more to save, but all profiles of schemes can benefit. Even for schemes with de-risked investments, we can still negotiate savings. We have not yet seen a small or mid-sized pension scheme where we haven’t been able to offer them some sort of discount on investments.”
Efficiencies can sometimes be achieved by changing the asset allocation, for example. By aligning the right investments for the scheme with a lower-cost asset base, you can solve two problems at once. McClelland points out: “Private equity and other alternative investments can carry high annual charges and can be complex to understand. Yet they may not always be the most appropriate investments.”
Size is crucial. “Many small to medium sized pension schemes could reduce their investment management charges by 40% to 50% on consolidation,” says McClelland. But, she cautions, “It’s important for schemes to be sure that they are comparing apples with apples, which can be tricky in an area where charges are taken from different sources.”
McClelland says Isio can help with industry benchmarking. “Do you know where your costs stack up versus others? Do you know what is included in the core fees you pay to your advisors? Is that everything you need to fulfil your duties as a trustee or employer, or do these often appear as additional charges?” she asks. “Having a conversation with a consolidation expert can often help point you in the direction of where to look for this information, and where your scheme’s costs may be versus others.”
Long-term benefits
The DB sector may be dominated by legacy schemes, but the landscape they operate in is moving fast, with funding levels, regulatory change and insurer appetite all shaping long-term strategic options.
Risk Settlement is one option that has become increasingly realistic for many schemes over recent years. Indeed, research from the Society of Pension Professionals found more than half of DB schemes expect to complete a bulk annuity deal over the next five years. But recent funding level increases – coupled with proposed reforms to make it easier to use surpluses to make payments to employers and scheme members – has led others to see run-on as the endgame option of choice. Launched recently, Isio’s PRO (Purposeful Run On) offering is an innovation which caters to such schemes investing beyond full funding.
Wherever a scheme is on its journey plan, the benefits of operational consolidation are clear, says Yates. “By reducing cost and improving operational efficiency, decision-makers are well-placed to pursue different strategic end games. But you need to be with the right operational consolidation partner who can provide you with the right advice, at the right price, to get you to that destination. It is something every small and medium-sized scheme should be looking into.”
If you would like to hear about the impact of the new Labour government and new funding code on UK pension strategies, be sure to register for the upcoming Clarity on Pensions event on October 8th.
Isio
We are an industry-leading challenger, providing diverse expertise spanning Pensions, Investment, Benefits and Wealth giving clients an integrated experience. With a unique mix of trustee and corporate clients, we are grounded around a vision which strives to deliver greater financial confidence for everyone.
