Waiting with bated breath

It is now almost four and a half years since Adair Turner laid out the Pension Commission’s recommendations for a new policy direction for both State and private pensions.

In that time the world has moved on considerably. The UK is slowly and precariously emerging from recession, and there is a huge political need to reduce our nation’s borrowing. However, in the meantime Turner’s plans are continuing apace. Automatic enrolment has the legislative sign-off and the NEST scheme is currently being developed.

At the time of writing, we are expecting an imminent announcement from the Department for Work and Pensions (DWP) on the charging shape for the NEST scheme. PADA held a consultation in early 2008 and narrowed down the choice to a flat annual management charge or a combination of a contribution charge and a (lower) annual management charge.

Those who favour a flat annual management charge structure argue consumers prefer its simplicity. However, the combination charging structure has major benefits for the financial stability of the NEST scheme, as it requires far less borrowing in the early years. Recent economic events have further strengthened this benefit. Although NEST will be a Government-sponsored scheme, rather than a Government-backed scheme, the aim is all costs will be recouped through charges over the ‘long term’. However, in the meantime the costs for setting up the scheme have to be ‘found’ from somewhere, and that somewhere is the taxpayer through loans or gifts. This is at a time when the cost of capital or Government borrowing has increased as a result of the financial crisis.

The FSA and the financial services industry are now placing far greater emphasis on making best use of limited capital and on fully understanding and managing prudential risks. Although NEST will be an occupational pension trust, and not subject to FSA regulation, there is a strong argument it should follow the same prudential disciplines as promoted by the FSA.

So, the financial case for a combination charge seems clear-cut but the right charge shape also has to be fair to members.

NEST is targeted at low and medium earning employees, and during the initial period a wide spectrum of differently aged savers will join. However, over time more of the new entrants will be those joining the workforce for the first time and therefore younger people. As the combination charge is more favourable to those who save for a longer time it will, over time, represent better value to a greater number of NEST members than a single charge.

It’s also important that the charging shape doesn’t put people off saving. At a time when the Retail Distribution Review is leading to more pension schemes moving to new ways of charging for manufacturing and advice, a combination charge will hardly look out of place.

I hope the DWP makes the charging shape decision based on financial stability. For public interest reasons, having a financially strong and robust ‘national’ pension scheme is a necessity. If it wobbles or falls, then the fallout from such a public scandal could seriously damage the image of pension saving.

Rachel Vahey is head of pensions development at AEGON Scottish Equitable