New defined contribution (DC) default arrangements will require regulatory approval to launch as part of the government’s attempts to address fragmentation in the sector.
As part of the government’s “megafunds” plans, set out in the Pensions Investment Review’s final report, it has set out a “transition pathway” to help DC providers reach its target of at least £25bn in default arrangements by 2030.
While it has not set any limits on how many default funds DC providers can operate - despite an initial proposal to do so earlier in the review process - the government will “legislate to prevent new default arrangements from being created and operated, except in certain circumstances with regulatory approval”.
“We want a competitive market of fewer, larger, well-run schemes with the capability and scale to invest for the longer term which can benefit savers and their communities.”
Torsten Bell, pensions minister
Conditions for launching a new default arrangement will be set out in secondary legislation after further consultation, the government said, but would likely include meeting the needs of a protected group or ethical requirement, or to help manage conflicts of interest.
It has also stated that it expects all providers with multiple default funds to “proactively consider consolidation into their main default arrangement”.
“We are not requiring providers to consolidate every other arrangement that sits outside their large ‘megafund’ default arrangements or setting a fixed number, as we recognise that there could be circumstances where it will be in savers’ best interests to remain in their existing default arrangement,” the government explained in its response to the ‘Unlocking the UK pensions market for growth’ consultation, also published today (29 May).
This document sets out a multi-year approach from government and regulators to encourage consolidation of DC default arrangements, beginning in 2028 when the Value for Money framework is expected to be operational and further measures to enable mergers and bulk transfers are in place.
In 2029, the government will conduct a ministerial review to assess the impact of its megafunds plan and investigate why smaller default arrangements continue to operate.
From 2030, policymakers expect the new environment to be established with regular Value for Money assessments and the introduction of performance benchmarks.
DC pension scheme mergers: who’s exempt and who’s not?
Chancellor Rachel Reeves coined the term “megafunds” in her Mansion House speech in November, where she first set out the government’s ambitious plans to consolidate DC schemes.
The government now wants DC master trusts to target £25bn in assets under management by 2030, with a variable “transition pathway” to help smaller master trusts reach this level by 2035.
The £25bn figure applies to what the government has termed a provider’s “main scale default arrangement”. There are exemptions being put in place for hybrid schemes linked to defined benefit funds, and to industry-wide pension schemes such as Railpen and the Universities Superannuation Scheme.
Also exempt from the minimum size rule will be default funds designed for those with particular religious beliefs, meaning Sharia-compliant funds will not be required to merge or scale up.
Meanwhile, in an effort to encourage innovation, the government will also make collective DC pension schemes exempt from minimum size rules.
In his introduction to the consultation response, pensions minister Torsten Bell said: “We want a competitive market of fewer, larger, well-run schemes with the capability and scale to invest for the longer term which can benefit savers and their communities.
“Alongside that, we need to see a more cultural shift – from an excessively narrow focus on cost onto what matters most for savers: returns, and the eventual size of their pension pots.
“The proposals in our consultation are ambitious, and I am mindful that they represent a significant change to the current system. I have listened carefully to the responses to the consultation and that is why I am setting out a pragmatic approach to implementation.”
Concentration risk and ‘long and arduous’ merger processes
Industry experts were broadly supportive of the government’s plans, but warned that merging default arrangements would take a significant amount of time and resources.
“[Mergers] can be long and arduous processes and risk issues cropping up for people when looking to access their funds.”
Jon Greer, Quilter
Kathryn Fleming, head of DC consulting at Hymans Robertson, said: “We fully support the drive for scale and the benefits that setting a minimum size of assets under management, at £25bn, can bring.
“However, the implementation of such an approach will take time, which the government recognises, and we remain concerned about the potential for this to reduce innovation at a time when it is needed most.”
Jon Greer, head of retirement policy at wealth management firm Quilter, added: “Regardless of what industry you are in, such migrations, especially where schemes are winding up, can be long and arduous processes and risk issues cropping up for people when looking to access their funds.
“Furthermore, the master trust market… has diverging levels of service standards according to a recent report from LCP. As a result, this path to consolidation is likely to put pressure on existing players and may be bumpy.”
