1. This paper sets out proposals for the initial minimum standards for stakeholder pension schemes. It is the first in a series of consultation papers on the detail of stakeholder pension schemes that will be issued over the next few months.

2. A summary of the proposals is at Annex 1.

3. The Green Paper set out details of proposals for the framework for stakeholder pension schemes. These are being taken forward in the Welfare Reform and Pensions Bill which is currently before Parliament. The Green Paper also made it clear that there were several areas where we would be seeking further views before the detail was decided. These areas are:

· minimum standards

· trusts and alternative governance structures

· employer access

· advice and information

· the regulatory regime

· the tax regime and rebates

· the potential for a clearing house facility

4. There are a number of connections between these areas. Decisions about the advice regime, for example, are likely to affect minimum standards on charges. For practical reasons, however, we need to consider these areas in sequence. As far as possible, the aim is to deal with issues in a logical order, although in some cases it may be necessary to return to some issues later in the process before reaching a final decision.

5. The timing of this further consultation is a response to concerns that details of the proposals should be finalised as soon as possible, in order to allow sufficient time for schemes to develop to meet the planned introduction date for the first stakeholder pension schemes in April 2001. The aim is to make quick progress, to allow the necessary secondary legislation to be consulted on in draft by around the end of 1999.

6. We are very grateful for the contributions that have already been made in response to the initial consultation on stakeholder pension schemes in 1997, and the recent Green Paper. It is vital to the successful delivery of stakeholder pensions that effective consultation continues as the details are decided.

7. Please send your comments to the following address:

Stakeholder Pensions Policy Team (1)
Department of Social Security
3rd Floor
The Adelphi
1-11 John Adam St
London WC2N 6HT

You can also respond by using the following e-mail address:

P.Cornwell@ade003.dss.gov.uk

8. Comments should reach us by 30th June 1999. Responses will normally be available to the general public on request, unless you specifically ask us to keep your views confidential.

9. Further copies of this paper are available from the above address, or by telephoning 0171-962-8871.

Basis of charges

21. The Green Paper identified a charge on contributions or a charge on the fund value as the two main options for a single charging structure. Responses have not suggested any alternative options. In commenting on the relative impact of the two forms of charge, Green Paper respondents identified the following main features of charges levied in those two ways:

22. A percentage charge on contributions:

· provides more revenue for the scheme in the early years of its operation, compared with a charge on fund value;

· means some cross-subsidy from high contributors to low contributors;

· provides an incentive for schemes to maximise contributions, rather than investment returns for example;

· does not provide schemes with any revenue where scheme members suspend contributions.

23. A percentage charge on fund value:

· produces little revenue in the early years of a scheme, or when an individual joins a scheme; this increases the length of time needed to recoup the initial capital invested in setting up the scheme;

· means some cross-subsidy from those with larger individual funds to those with smaller funds;

· produces an incentive for schemes to maximise the value of their funds, either by maximising investment returns or by transfers-in from other schemes;

· continues to provide schemes with some revenue from dormant accounts.

24. The arguments are not clear-cut. After considering these issues, however, we propose that charges should be levied on fund value. In particular, such an arrangement provides a useful incentive for schemes to maximise investment returns and means that those who suspend contributions to a scheme (either temporarily or permanently) should not impose an excessive burden on other scheme members. This was also the approach favoured by the great majority of Green Paper responses which indicated a preference.

25. We recognise that charging in this way will be challenging for schemes, as the costs involved in setting up and running a scheme are likely to be weighted towards the early years of the scheme’s operation. There will clearly need to be some initial capital investment by the sponsors and providers of schemes, which may take a number of years to recover.

A limit on charges

26. The Green Paper indicated that we expected to set a limit on the permitted level of charges. This proposal has been supported by many responses to the consultation. But there have also been some concerns expressed. In summary, the main reasons for opposing a limit on charges were:

· any limit is likely to be too high for some types of schemes and too low for others; a limit would effectively exclude from the market some types of scheme, such as those promoted by home sales representatives, where costs were inevitably higher; a limit set at a low level would also make it more likely that schemes would be forced to rely on passive investment management;

· a limit would also adversely affect the ability of schemes to give advice (except through a separate charge, which would be likely to deter many of those who should seek advice);

· the prospect of a limit will deter companies from undertaking planning work needed to set up schemes until they are clear what the limit will be;

· a limit will tend to distort the normal competitive operation of the market, with a risk that charges will congregate at the limit.

27. We recognise there are risks in setting a limit. And there is clearly a difficult balancing act between pitching the limit at a level that is low enough to ensure scheme members are not over-charged unnecessarily, but which also allows schemes to offer a reasonable level of service to members. It will be important to monitor the impact of the charge limit, particularly how it affects the ability of stakeholder pension schemes to reach the target groups whom the schemes are intended to cater for.

28. But we think that the reassurance of a set limit will be seen as a valuable safeguard by many potential members of schemes and will provide an important degree of confidence in stakeholder schemes. The figure proposed here is, of course, a maximum charge. We expect schemes will want to beat, not just meet, the limit.

What the charge limit covers

29. In specifying the type and level of charge, it is also important to be clear about what the charge covers and, by extension, what aspects of scheme membership or services may be charged for separately.

30. Our intention is that all normal aspects of scheme membership, connected to the provision of benefits in the form of a pension, should be covered within the limit.

31. Schemes would therefore be expected to cover within their regular charge the following costs associated with scheme administration and scheme membership:

· costs associated with establishing and running the administrative structure of the scheme, including payments and administrative/professional support to trustees;

· the investment of scheme funds;

· providing required basic information to scheme members and potential members, and responding to queries;

· other costs incurred in promoting the scheme to employers and/or potential members;

· providing basic explanation and advice;

· setting up individual accounts;

· receiving contributions (subject to the minimum contribution rule set out below);

· processing and payment of transfers both into and out of the scheme;

· payment of the scheme levy;

· making reports to regulators;

· tax administration;

· handling disputes and complaints.

32. The general rule would be that schemes would only be able to levy a charge additional to the specified limit where that reflected the provision of a service or a cost outside of this list. It is of course difficult to ensure that such an approach produces an exhaustive list. An alternative approach would be to define those things for which a separate charge may be levied. We would welcome views on how this approach to restricting charges would best be achieved in the regulations.

33. One effect of this will be to ensure that no additional costs can be levied in respect of pension transfers, nor in respect of members who stop or restart contributions to the scheme. Where schemes levy the charge on a fixed annual date, we intend that, in the case of a transfer out of a scheme, schemes should be able to make a proportionate charge to reflect the charges accrued in the period since that date.

34. The costs of establishing an appropriate governance arrangement would also be met from within this charge. The Government recognises that particular forms of governance may result in some additional costs to schemes, but expects such costs to be relatively small and likely to be offset by the benefits in terms of scheme performance and in encouraging members to join such schemes.

35. A further issue is whether all scheme members should face the same charges. It is possible, for example, that schemes might levy a smaller charge once an individual’s fund reaches a certain level, or that higher contributors might be offered lower charges. While this could provide some useful flexibility for schemes, it could also add to the complexity of charges and make comparisons between schemes more difficult. We would be grateful for views on whether schemes should be required to levy the same percentage charge on all scheme members.

Advice

36. Many responses to the Green Paper consultation raised the issue of advice on stakeholder pension schemes and how any such advice should be paid for. Proper information and advice for those who need it will be an important part of the decision-making process for individuals considering a stakeholder pension scheme. This includes not only the decision whether to join, but also subsequent decisions such as how much to contribute and whether or not to contract-out of SERPS or the new State Second Pension.

37. It is inevitable that many people thinking about joining a stakeholder pension scheme will need specific advice. In other cases, a basic level of information and explanation may be sufficient to allow a reasonable decision to be made. Some people may be more comfortable about taking any decision where they have the opportunity to discuss and ask questions, either face-to-face or via the telephone.

38. The key issue is how any such advice and/or explanation should be paid for. The two main alternatives would seem to be:

· to require that the basic scheme charges should not cover costs of individual advice, leaving individuals to meet the additional costs themselves (either as a one-off fee, or as an additional charge to be recovered gradually from the member’s pension fund)

· to include the costs of a certain level of advice within the scheme’s overall charges, subject to the overall limit

39. The main difference between these approaches is in the extent to which advice is seen as an integral part of the package offered by a scheme and, therefore, in the extent to which it is paid for by either by the individuals who use it, or by the scheme members as a whole.

40. The Government believes that some basic advice costs should be covered within overall scheme charges. Charging separately for such advice creates a significant risk that people who should take advice will choose not to, in order to avoid the specific cost. On the other hand, including the cost of full individual advice in the charge for all scheme members could impose an unnecessary cost on many potential members who do not require that level of advice. This implies that in setting the overall charge limit for stakeholder schemes, it will be necessary to include an allowance for basic advice costs and to define clearly what this should cover.

41. The information and advice regime for stakeholder pension schemes will be the subject of a separate consultation paper, which will consider these issues in more detail. We propose, therefore, to review the allowance that should be made for the costs of advice within the regular charge when that consultation is completed.

With-profits investments

57. A number of consultation responses have argued that the "with profits" form of investment could provide a useful basis for some stakeholder schemes.

58. The element of guarantee offered by with profits investments, in particular that the value of a member’s fund cannot fall, may be attractive to many potential members of stakeholder schemes.

59. Some of the features of with profits policies, however, raise issues in the context of proposals for stakeholder pension schemes where the aim is to ensure that charges are both limited and transparent. In particular, such arrangements typically leave the insurance company with discretion in allocating a significant part of the investment returns to the policy holders. While this is not in itself necessarily a problem:

· it leaves an element of uncertainty (since the final pension fund can depend heavily on a "terminal" bonus);

· it means that not all of a member’s fund and investment returns (net of charges) are necessarily credited to his/her own account;

· such policies typically include provision for a "market value adjustment", which can be used to reduce transfer values in periods when the market value of investments have fallen.

60. Some responses to the Green Paper argued that, for with profits arrangements to be acceptable in stakeholder pension schemes, all investment returns should be allocated to members of the scheme i.e that there should not be any allocation of funds to a separate discretionary reserve. We understand that with profits policies which operate on these lines have already been developed. The Government sees a number of attractions in making this a requirement for stakeholder pension schemes which choose to offer a with profits arrangement, since it would ensure that all investment returns benefit the scheme members and reduce the uncertainty associated with the terminal bonus in conventional with profits policies.

61. We would welcome further views on whether with profits arrangements should be allowed in stakeholder pension schemes, and whether the restrictions outlined above should be imposed. We would also welcome views on the necessity of allowing for a market value adjustment in such schemes and how far that adjustment would adversely affect the transparency of the arrangements.

68. Schemes will need to register as stakeholder pension schemes prior to operation. This will involve a declaration from the trustees (or other prescribed person(s) in a scheme set up with alternative governance) to state that the scheme complies with the minimum standards and other regulatory requirements. Trustees of schemes which fail to meet the standards can be fined. As a last resort, schemes may be removed from the register.

69. Some organisations have suggested that the minimum standards for stakeholder pension schemes could be adopted, on a voluntary basis, by some existing personal pensions as a way of identifying personal pensions which meet those standards. The Government would be concerned that such an approach might lead to confusion between genuine stakeholder pension schemes and personal pensions which meet the minimum standards for such schemes. But it is likely that once the stakeholder pension standards are in the public domain, they will become a de facto standard against which other pension schemes may be measured. We would be interested in views on whether and, if so, how far the Government should promote the voluntary benchmarking of other pension products, based on the standards set out here.

ANNEX 1

CONSULTATION PROPOSALS ON MINIMUM STANDARDS FOR STAKEHOLDER PENSION SCHEMES

Charges

· a single percentage charge on the value of the fund, to cover all normal operating costs

· total charge to be limited to 1% pa

· charges to include costs of basic explanation and advice, subject to later consultation

· any additional services to be paid for separately, but must be discretionary

Minimum contributions

· no higher than £10, either for regular or one-off contributions

· no minimum frequency of contributions

Investment

· should be a clearly defined default investment choice

· with profits investments should allocate all funds to scheme members

Information

· as for other money purchase pension schemes

Transfers

· no additional charges for transfers into or out of stakeholder schemes

· schemes must accept transfers of pension rights from other schemes, insofar as this is consistent with the requirements for tax approval

Tax approval

· schemes must be tax-approved by the Inland Revenue