DC Debate Q3: From platforms to post-freedom changes

Should employers and schemes be encouraged to offer in-scheme drawdown? 

John Reeve: I do not think employers or trustees can be expected to offer in-scheme drawdown given the complexity and costs that are likely to accrue if they were to go down this route. The costs for many schemes will be prohibitive, and I would prefer to see that money going into the member’s pot.

We need to help members rather than throwing them into the retail world

Laura Myers, LCP

Instead, I would like to see the industry work to ensure drawdown options that are cost effective, easy to access and available outside individual schemes. Simple, seamless, in-specie transfers to a drawdown vehicle with the option to consolidate pension pots should be available to all members. This is something the industry should be able to achieve quickly and easily.

Helen Ball: If you are a member, then you might say yes – it could create an easier path to drawdown, particularly if this comes with a ready-made guidance tool and ongoing support regarding future financial decisions. That, in turn, could mean members are less likely to take the cash lump sum all in one go (with their related tax charges) at retirement.

However, if you are an employer, it could be a mixed blessing. Paternalistic employers might say this makes the prospect of members falling prey to scams and high charging drawdown vehicles less likely to happen in practice. On the other hand, it will inevitably involve changes to scheme administration (which usually come at a cost) and create an ongoing link between an employee and the scheme/employer which, in most defined contribution schemes, was never intended to continue beyond retirement date.

If that has not been budgeted or planned for, then it does not appear that many schemes, other than perhaps the largest DC schemes and mastertrusts, will find in-scheme drawdown attractive.

Maiyuresh Rajah: It is understandable that many plans are reluctant to offer in-scheme drawdown, but it is also worrying that the retail alternatives can often be costly, complex and confusing for members. Members will benefit most from a small number of ‘paths of least resistance’ to help guide them in the right direction.

It is important for trustees and independent governance committees to take more ownership of this journey for their members. Our research suggests that many members struggle to make a decision and are confused by the options available. If a number of straightforward, good-value, well-governed, institutional-quality post-retirement defaults, or even a single default, were available for retirees, many consumers would end up with better outcomes.

Laura Myers: While the risk puts people off, there are benefits to in-scheme drawdown, such as the easier way for members to access their money flexibly, and also the potential fee reductions as the assets stay in the scheme after retirement, which means the scheme grows larger and can negotiate fees for all members, not just those in drawdown.

Overall, while I don’t feel it is the right solution in the UK, we need to help members rather than throwing them into the retail world. Therefore I would encourage all DC schemes to look at partnering with a drawdown provider to firstly see if they can use the pension scheme’s assets to get members in retirement a better fee deal than in the retail market, and to also improve the education provided to members as they move towards retirement.

Simon Chinnery: If employers and trustees have the capabilities, governance, scale and appetite for at-retirement responsibilities, then by all means.

However, we have found that a lot of the time trustees and employers do not wish to have the associated risks of keeping tabs on ex-employees and managing their assets long into retirement.

Mastertrusts can be a great way for schemes to pass over responsibility to a well-worn governance umbrella.

Andy Cheseldine: 

Why would you? Those schemes that believe they can offer an effective service and feel it is in members’ interests to do so are already considering options. In most cases these include offering a full cash-out and, in some cases, a limited flexible drawdown service, perhaps spreading payments over a couple of tax years.

Some are even offering a longer-term flexible-access drawdown product, but most remain concerned about the risks of doing so, for example how to deal with cognitively impaired member choices or simply financially vulnerable members.

How do investment platforms need to change for today’s DC world?

Reeve: To my mind, key deliverables in the future will be:

• Ability to move with the new technology – whether this is phone, watch or whatever comes next;

• Seamless transition from accumulation to decumulation, especially drawdown;

• Clarity of information regarding the underlying funds – investment strategy as much as past performance;

• Easy to use, especially in terms of making additional – possibly very small – contributions.

Key among these, and possibly the most difficult, is the last. There has been a lot of discussion about the use of apps and gamification to improve savings. Platforms are going to have a big part to play in the development of these.

The idea of ‘rounding up your shopping bill to the next £10 and saving the balance’ is a great plan if the platform can take, invest and report on the payment instantly and cheaply.

Ball: DC platforms are useful tools, although careful management and greater transparency over the resulting layers of costs and charges is needed, particularly over default arrangements, which are subject to the charge cap.

The risks of the structure underlying the platform need to be properly understood

Helen Ball, Sackers

Trustees should also consider asset security and how a platform affects the relationship between the trustees and the ultimate holder of the assets. There is no direct legal relationship, and so the risks of the structure underlying the platform need to be properly understood. In many platform structures, there could be some gaps in Financial Services Compensation Scheme coverage, and it will be interesting to see whether these could eventually be plugged by changes to the Prudential Regulation Authority rules as the value of funds held on platform structures increases.

There is also less control where funds are changed or assets moved from one fund to another in a platform environment, because the platform provider is an additional party that needs to be involved in such discussions.

Again, as the value of DC funds increases and as schemes start regularly moving DC funds as part of their triennial investment review, it would be useful to have some common understanding of what the market agrees should be included in such transfer arrangements and where certain responsibilities and risks should lie.

Rajah: In order to be successful in an environment of ever-changing regulation, investment markets and member needs, it will be important for platforms to be able to adapt and support the development of innovative solutions that are aimed at helping members on the journey to and through retirement.

Key examples include an ability to support target date funds, provide access to emerging approaches such as smart beta strategies, and potentially be able to provide access to illiquid private markets strategies as well as the typical low-cost index funds.

Myers: While platforms provide DC schemes with many benefits, the main hindrance is the platforms’ requirements for DC funds to be valued and traded daily. As a result, DC members are missing out on the illiquidity premium their defined benefit cousins enjoy, which provides them with relatively higher and more stable expected returns over the long term.

These dealing and pricing requirements are not driven by regulations, but by the operational systems that DC platform providers and administrators use. This clearly makes it extremely difficult for alternative asset managers to offer a product suitable for the DC market, as the majority of illiquid assets may only be valued weekly, monthly or even every six months. I hope there will be changes in this area soon.

Chinnery: A well-managed investment-only platform should be able to accommodate fund reregistration, restructures and bespoke multi-fund solutions. This will often be much more of a challenge with legacy bundled platforms that can struggle to meet the demands from clients and consultants for flexible and blended investment solutions.

Cheseldine: I think the institutional platforms do a pretty good job as it is. Because of their economies of scale they allow access to funds that would be out of reach on a direct basis – and typically at a reasonable cost.

That is not to say they could not be improved. Lower costs, as long as they are sustainable, are clearly in members’ interests, and greater transparency would help. Many are already looking at varying the build of underlying funds to use the optimum structure (life fund; undertakings for collective investment in transferable securities; société d’investissement à capital variable; tax transparent fund etc) for specific asset classes. This decision needs to take account of tax benefits, governance, security and dealing costs, among others.

Are schemes better off bundled or unbundled?

Reeve: Anyone setting up a new plan or reviewing the delivery of their existing plan should start by asking what they are trying to achieve. Are you looking to merely meet your auto-enrolment responsibilities? Are you looking to provide best-in-class pension provision for your employees? What do you mean by a good scheme? What do your employees expect/want?

The answer to these questions and many more will point you in the direction of what type of scheme best meets your needs and those of your employees. Once you know what you are trying to achieve, you can make a decision with regard to bundled and unbundled arrangements. However, this is only one of a number of considerations. You will also need to consider trust v contract, individual trust v mastertrust, and many more factors.

Ball: There is no blanket approach here. Each employer must decide this for themselves, based on their views around resourcing/costs and their ultimate purpose in offering a pension arrangement that goes beyond the minimum auto-enrolment requirements.

With more schemes now looking at the retirement end of the pension savings journey and considering what happens to members’ pots when they stop saving, we are starting to see an overlap between what are described as ‘products’ and ‘services’ offered by providers such as insurance companies and administrators.

This blurring of the boundary could make bundled products attractive, although ‘control’ is also an important issue to watch out for, particularly in terms of trustee responsibility for DC governance over the scheme as a whole.

Rajah: Neither solution is better or worse, and efficiencies and economies of scale can be found through both routes. However, the selection of a bundled or unbundled service depends on a number of scheme-specific factors. A key factor is the scheme’s governance budget – how much time do the company and trustees have to govern the scheme and liaise with the individual service providers?

In addition, asset size and number of members can affect the decision – under a bundled arrangement, the administration cost typically is bundled into a fixed annual management charge.

There is no such thing as a ‘one-size-fits-all’ capability. There is great flexibility in remaining unbundled, although this could come at a financial cost

Simon Chinnery, LGIM

Finally, if the scheme has very specific investment or administration requirements, an unbundled approach is more likely to be able to provide the desired features.

Myers: The answer to that question really depends on what you’re trying to achieve. Being unbundled gives you the ability to select the best-of-breed provider for each area of your scheme.

Consequently, it gives you greater control over the proposition you deliver to your members, so it is an option we see paternalistic companies and large/high-governance schemes preferring. However, this comes at a cost, both to the company and in terms of governance.

On the other hand, being bundled has the advantage of using one provider for all aspects of the scheme, which can lead to a more seamless member experience. This was beneficial for many post freedom and choice, when bundled schemes provided links to post-retirement solutions much quicker than their unbundled counterparts, although it has led to the providers directing members to their own post-retirement products rather than a whole-of-market solution.

Chinnery: There is no such thing as a ‘one-size-fits-all’ capability. There is great flexibility in remaining unbundled, although this could come at a financial cost.

We have, however, seen a growing trend from unbundled to bundled and mastertrust. This is for a variety of reasons, including the growing governance, administration and communications burdens, along with cost saving.

Cheseldine: How long is a piece of string? It used to be that the main criterion was size – the bigger the scheme, the more likely that unbundled was best.

However, much now also depends on the employer’s and trustees’ risk appetite together with both willingness and capacity to ensure good governance.

Some employers are prepared to pay the costs, not just monetary, of running unbundled schemes, because that is intrinsic to how they want their entire human resources and reward strategy to be perceived by employees. There are many soft benefits to retaining control in an unbundled environment, but you need to be happy to put the effort in.

Click here to read part one on how to adapt default investments to a changing world