Pressure builds on small DC schemes to consolidate

We have already seen a sharp increase in transfers of smaller schemes to master trusts during the pandemic. There has also been consolidation of the master trust market over the past few years, and this trend looks set to continue. 

In a recent consultation response, ‘Improving outcomes for members of DC pension schemes’, the government views accelerating the consolidation of the DC market into fewer larger schemes as a priority.

Unless improvements can be made rapidly and cost-effectively, the government will expect those schemes that do not demonstrate value for members to be wound up and consolidated

Fewer, larger, schemes would ensure all savers receive the best value from well-governed schemes that can achieve economies of scale, according to the Department for Work and Pensions.

The government says this will also deliver greater opportunities for members to access a more diverse range of investment products and strategies to benefit members and the broader UK economy.

Small schemes struggle to keep up

Under the proposals, trustees of schemes with less than £100m in DC assets will be required to undertake a “more holistic” annual value for members assessment and report on it.

The report should look at costs and charges in comparison with at least three other “large” schemes, one of which should be willing to accept a transfer in of the scheme’s members, net investment returns, and measures of administration and governance.

Unless improvements can be made rapidly and cost-effectively, the government will expect those schemes that do not demonstrate value for members to be wound up and consolidated. 

The DWP has said it is committed to legislating to mandate consolidation if it is not driven “at sufficient pace” by the new requirements.  

If these requirements are introduced, they will place an even greater governance burden on trustees of smaller DC schemes, which in itself could act as a further incentive to wind up and encourage consolidation.

The Pensions Regulator is also a keen exponent of DC consolidation for badly run schemes, as evidenced in its consultation on the future of trusteeship and governance last year. It has powers to wind up a scheme where this is in members’ interest and could step in if needed.

Separately, the government has launched an industry working group to assess and make recommendations on ways to consolidate small deferred pension pots in order to improve member outcomes — potentially providing schemes with yet a further reason to consolidate.

The emergence of DC super trusts?

The master trust market has also been consolidating. Triggered by the new master trust authorisation regime, it now looks likely that the market could shrink further if it becomes financially unsustainable for some of the remaining trusts to continue, particularly in light of the Covid-19 pandemic. The result could potentially be a handful of DC “super trusts” in years to come.

In its recent 15-year corporate strategy discussion document, TPR recognises its moving focus to DC, and foresees that it will be regulating fewer larger schemes, which “will become systemically important to UK financial stability”.

Master trusts are not necessarily the panacea for all DC schemes. While the benefits of economies of scale are clear and the master trust authorisation regime requires strong standards of governance, there are also potential downsides. 

There is less focus on the needs of the particular members of each scheme within the master trust. And the larger the scheme, the larger the potential risks if something goes wrong in terms of systemic administration risks or data protection breaches.

Small schemes, where the employer and trustees are engaged with the governance of the scheme and have adequate resources to commit to this or the employer subsidises the costs, could still provide a better option for members than moving to a master trust. These schemes will probably be able to show they provide value for members under the new assessment.

There is also the question of whether master trusts will be willing — and able — to accept transfers from all small schemes. Particularly for closed schemes, they may not be profitable for providers and the master trust may not be able to accept a transfer with no ongoing participating employer.

There are also some tricky legal and tax hurdles to overcome for hybrid schemes with defined benefit and DC sections wishing to transfer their DC section to a master trust.

Transferring DC assets into a master trust can be a complex process and should be planned in detail by employers and trustees of schemes contemplating this. Likewise, master trust sponsors and trustees will need to think about areas that will require scaling up to accommodate further rapid growth and further consolidation within the industry.

Emma Martin is associate director at pensions law firm Sackers