The Department for Work and Pensions wants to speed up consolidation among schemes with less than £5bn in assets. Although the initiative was broadly welcomed, experts have warned that rushing its implementation could worsen member outcomes.
On Monday, the DWP published a joint response to two of its consultations – ‘Improving outcomes for members of DC schemes’ and ‘Incorporating performance fees within the charge cap’ – alongside a call for evidence to consider what are the current barriers at consolidation in this space, which is occurring at a slower pace than needed, it said.
In its response, the government confirmed that small schemes with total assets of £100m or less will be required to carry out extra “value-for-money” checks and report the outcome of this assessment to the Pensions Regulator.
As reported by Pensions Expert when the proposals were first put, where trustees conclude that their scheme does not provide good value for members, immediate improvement will be looked for. Should this prove impossible, consolidation may be required.
With Guy Opperman now setting his sights on schemes with funds up to £5bn, all trustees will be receiving a clear message that size really does matter
Kate Smith, Aegon
In his foreword to the response, pensions minister Guy Opperman wrote: “I am determined to do more to ensure the trustees of smaller schemes act in the best interests of their members. I am therefore bringing forward measures that will ensure we tackle persistent underperformance and poor governance by accelerating the pace with which the market is consolidating.
“This will bring the benefits of scale to all scheme members, including a greater capacity to take advantage of illiquid and other alternative investment classes.”
The market saw a 12 per cent fall in the number of schemes last year alone, but consolidation is happening more slowly at “the smaller end of the market”, hence its focus on that area, the government’s response noted.
It stated that in 2019, 60 per cent of schemes with fewer than 100 members did not meet any of the government’s five key governance requirements, while costs and charges are typically higher in smaller schemes than in larger ones.
It also specified that only in “exceptional circumstances” would trustees who have failed to demonstrate value for money during the assessment be expected to pursue improvements rather than consolidation.
Although restricting itself to mention of schemes with less than £100m in assets, experts noted that the DWP’s related response to incorporating performance fees within the charge cap, in which the government aimed to increase access to illiquid investments for DC schemes, could be seen as encouraging consolidation of schemes of up to £5bn in assets.
Opperman wrote: “While the focus of these regulations is on schemes with assets of less than £100m, the principle of ensuring value to members applies to all schemes.
“The call for evidence published alongside this document begins the next conversation on what best value looks like for the millions of pension savers in medium and large schemes that are not in scope of the new value-for-members assessment.”
In its response, the Pensions and Lifetime Savings Association noted: “We believe that it is not pragmatic for funds with less than £500m to consider illiquid investments at all.
“The work which the government is leading to drive scheme consolidation will in turn create larger funds, and those larger funds will make it possible for DC schemes to invest in illiquids, but only for a small proportion of scheme assets.”
Kate Smith, head of pensions at Aegon, said: “With Guy Opperman now setting his sights on schemes with funds of up to £5bn, all trustees will be receiving a clear message that size really does matter.”
Don’t be hasty
The DWP’s proposals have not as yet been given a specific timeframe for implementation, but experts warned that rushing the process could have deleterious effects on member outcomes.
Callum Stewart, senior DC consultant at Hymans Robertson, told Pensions Expert that the government needs to consider the risks when it comes to setting a timeframe, and keep member outcomes in mind.
“There is a risk that members incur higher-than-anticipated transition costs because of price swings driven by the size of assets involved,” he said.
“These schemes may be providing strong governance and good value for members, so the impetus to move is not there.”
Continuing the drive to improve governance standards at master trusts would make “the appeal of consolidation and improving member outcomes as clear as possible,” Stewart continued, suggesting that a timeframe “of at least five years would be reasonable, both to drive standards in this way, and provide enough time to smooth the various risks and costs associated with transitioning assets”.
“This time should be used wisely to identify innovative ways to support the transition of larger schemes while minimising transition costs. This means we can expect to improve member outcomes, without incurring excessive costs and risks to get there,” he said.
However, he acknowledged that any specified timescale would carry risks.
“The current landscape for DC provider selection permits greater competition through transition and charges being negotiated – there is a potential that a specified timescale might remove (or at least limit) competition and choice, and overload those currently responsible for provision of employee benefits to comply within a particular period,” Stewart said.
The unsolved problem of ‘value leakage’
Though the government’s response mentions the Australian consolidation market several times, there is no recognition that that market is “driven by member choice”, said Mark Futcher, partner and head of DC at Barnett Waddingham.
“Employees do not have that choice in the UK at the moment,” he said.
“The Australian system also has significant issues in the ‘at-retirement’ phase, which they have not tackled. Members making inappropriate choices at retirement is an area of massive value leakage – let’s tackle this before things get too big.”
Value leakage at retirement has many causes, Futcher told Pensions Expert. For instance, transferring to a retail product such as a self-invested personal pension “is often done on a cash transfer basis, which means there is out of market risk and the member bears the full transaction costs involved, too”.
“Charges are often much higher with an individual retail product, with a 1 per cent annual management charge not uncommon,” he continued.
Smaller schemes to prove value for members or face consolidation
Defined contribution schemes with assets below £100m will have to prove their value for members, or face being advised to wind up or consolidate, according to new rules proposed by the Department for Work and Pensions.
“If we compare this with a typical workplace DC charge of around 0.35 per cent, then the increased charges over the period on which the member may draw income may equate to around two years’ worth of extra income.”
Finally, choosing the wrong option at the point of retirement can have a significant effect. It is “still the case that selecting the wrong annuity, for example, could waste 25 per cent of the fund – to put that another way, the member could waste 10 years’ worth of contributions”, Futcher said.
“A modern workplace DC arrangement can help mitigate – sometimes in their entirety – these issues for members, albeit it generally requires the support of the sponsoring employer and trustees.”
