The AFM investigation report entitled 'The costs of pension funds deserve more attention'

12-04-2011

Better cost management will allow small and medium-sized pension funds in particular to increase their pension assets significantly in time. Most pension funds currently have insufficient insight into their costs, while these costs have a major impact on the pension assets. This is evident from an exploratory investigation performed by the Netherlands Authority for the Financial Markets (AFM) into the amount and impact of costs related to administration and investment at pension funds. Many funds are already developing sound initiatives to save on costs, but sometimes encounter practical and statutory obstructions in this process as well.

Impact of costs

A cost reduction of 0.25 percentage point will result in 7.5 % more collective pension assets, within a term of forty years. This is in line with previous third-party investigations. The higher the pension assets, the higher pension payments can be. The extent to which cost savings can be realised depends on the situation at each pension fund. Assuming that the future space for premium increases is limited, this means that the importance of low costs and pension fund accountability for costs only increases. Proper insight into the costs and impact on the pension fund will help pension boards and administrators to make sound decisions between costs and income. The AFM considers that participants should also be informed of the costs, because these have such a major impact on the ultimate pension payments.

Insight into costs

High costs can be a consequence of inefficient pension administration and/or a scheme that is too complex. In addition, many pension funds have too little insight into the investment costs. The investigation shows that the actual investment costs are on average two to three times higher than included in the annual reports: consequently 1.5 to 3 billion Euros is not reported as costs each year. This is caused, inter alia, by the fact that external asset managers offset their costs in their net returns. These costs are therefore not visible for many funds, which makes it difficult to properly assess the actual investment performance. The largest pension funds do have good insight into the investment costs because they can exert pressure on their asset managers to provide full transparency. This is often less easy for smaller pension funds.

Cost management

The costs of administration at the smallest pension funds are on average 12 times higher than at the largest funds. It is therefore mainly the small and medium-sized pension funds that can save costs by consolidating funds and by simplifying schemes. A number of funds did so and this shows that these measures have significant results in practice as well. These examples deserve to be followed by other funds. However, funds can still sometimes run into practical and statutory obstructions that they cannot resolve on their own.

Removing obstructions

The AFM calls on all parties involved to play an active role in increasing the insight into costs and lowering costs. Pension funds have to ensure that they gain (better) insight into their costs and investigate where costs savings are possible. Obstructions for far-reaching consolidation or other possibilities to save costs should be made open to discussion. The AFM also encourages asset managers to provide full insight into their costs. It is important for the confidence of participants that funds demonstrate that the management and administration of pension schemes are performed efficiently and that they can explain why certain high costs are responsible. The AFM also considers transparency with respect to costs towards participants of great importance. This could be done, for example, by means of the annual report and a Pension Information Leaflet.

Investigation

The AFM based this exploratory investigation on data from DNB, public data such as annual reports, public studies and interviews with market parties.

Pension insurance

The investigation focused primarily on the costs at pension funds. In recent years, the AFM has published several reports on defined contribution agreements (pension schemes of insurers). The total image that arises from these investigations gives cause for concern. Available defined contribution agreements often entail considerable risks. The information on costs is unclear and the quality of advice provided to consumers is far below par. This means that participants in defined contribution agreements have insufficient insight into their future pension and often have expectations that are too optimistic. Insurers have taken steps to increase cost transparency. The AFM calls on them to continue down this road and to actively strive for reducing the costs of pension insurance.