DWP consultation on addressing the challenge of deferred small pots

Background

The Department for Work and Pensions (“the DWP”) has issued a call for evidence on “Addressing the challenge of deferred small pots”.

In this response

• Responses to specific questions and related comments

Responses to specific questions and related comments

We welcome the opportunity to respond to this call for evidence. In addition to answering specific questions which are pertinent to our practice, or which we believe could give rise to difficulties in practice for our clients, we have provided some initial general comments.

General comments

We welcome and support the aim of addressing the rapid growth of deferred small pots, and reducing the negative impact this has on affected members and the wider pensions industry. We have the following general comments about the proposals under consideration:

• A market-wide solution will need to allow for the extensive variety of size and type of pension scheme in the UK (including trust-based schemes, contract-based schemes, occupational pension schemes, personal pension schemes). Schemes are subject to different sets of legislation, regulation, and scheme-specific rules. In our view this is not sufficiently addressed in the call for evidence, and should be a key consideration in the next stages of the policy development.
• The legal and practical restrictions on transfers pose a significant hurdle to automatic consolidation. We expect changes to existing legislation will be required to enable transfers to be made sufficiently quickly and cost-effectively to achieve the policy aims.
• Any solution to the problem of deferred small pots should be appropriately designed to ensure it has a net positive impact on affected members and their retirement outcomes. An important part of the solution will be the communications members receive, so that members are appropriately informed about the proposed consolidation and their alternative options with clear and consistent messaging.

Specific questions

Question 1: Do you agree that these are the appropriate key criteria to inform development of a market-wide small pots consolidation solution? Are there additional/different criteria to apply?

The key criteria appear sensible. To ensure the proposals achieve the policy aims across the market, the application of the criteria should take into account the wide variety of schemes currently in the market. We expect the analysis will look different for small single-employer occupational schemes compared to large master trusts, for example.

The practical aspects and cost of administering pension transfers will be an essential consideration under criteria iii (“supports a competitive, sustainable and more efficient workplace pensions market”).

Question 2: How do you think we can increase member-initiated consolidation and what are the opportunities, risks, and limitations of member-initiated consolidation?

We strongly support the aim of improving member engagement with pensions, but any policies seeking to increase member-initiated transfers must ensure members are sufficiently protected against the risks of scams or poor outcomes, and that members have enough information and understanding to make informed choices.

Progress to improve member engagement more generally could build on existing initiatives. This could involve, for example, extending simpler annual benefit statement rules to a wider category of schemes, services and campaigns to improve member understanding of the benefits of consolidating small pots (eg provided by the Money and Pensions Service), and improving access to and ease of pension transfers which could perhaps build on the pensions dashboards infrastructure.

Member-initiated consolidation is unlikely to resolve the issue of small pots alone, even where member engagement is improved, and a solution which does not require member engagement would also be needed.

Question 3: We would be keen to understand from respondents, how far do you believe market innovations can go in reducing the growth of deferred small pots?

We expect there is potential for further market innovations to help reduce the growth of deferred small pots. However, this potential is limited by restrictions on transfers in legislation and scheme rules, commercial considerations (eg the cost of consolidation compared to the size of the pot) and practical limitations (eg platform capability). In our view, legislative changes, including a Government-backed solution, are required to achieve a significant reduction of deferred small pots on a market-wide basis.

Question 4: Do you consider one of the values below to be the most appropriate starting limit for eligibility for automatic consolidation, and why – or is there an alternative value?

1. £1,000
2. £2,500
3. £5,000
4. £10,000

This is not a legal question, but we suggest any threshold should be subject to regular review and should be capable of revision in response to market changes.

The eligibility criteria should also take into account any valuable scheme-specific benefits which could be lost on a transfer, such as an underpin or guarantee, as well as protected pension ages.

Question 10: Do you think there should be a minimum pot size limit for pots to be eligible for automatic consolidation? If so, what do you think this limit should be, and what should happen to pots below that limit?

Any automatic consolidation solution should at least preserve the existing de minimis protection against erosion by flat fees. The de minimis threshold could be increased for combined pots. We note that members with several pots below the de minimis may not benefit from consolidation if it would expose their (currently protected) benefits to flat fees where they would otherwise have been protected.

We acknowledge the concerns with allowing refunds. However, we suggest that this may be an appropriate solution in certain circumstances, such as where the refund is of an amount that would have a negligible impact on the member’s retirement outcome (even if consolidated with other very small pots), the cost of consolidation is significantly greater than the value of the pot, and the member can be located to provide bank details.

Question 11: Do you agree that setting a prescribed period for a pot to be classified as deferred is the most appropriate solution – and what period of time would be appropriate, and why? If not, what would be a more suitable approach?

No, there will be different reasons why contributions might temporarily stop, and it would be very difficult to set an appropriate period of time. Inactivity could be the trigger for a member communication or reminder, but we do not consider this would be an appropriate trigger for automatic consolidation.

The best alternative approach appears to us to depend on the consolidation solution used and the type of pension scheme. For example, ceasing employment may be the most appropriate trigger for consolidation for occupational and workplace pension schemes, as we expect employers may already have systems in place to notify trustees / pension providers of a member ceasing employment. Where a member has multiple concurrent jobs, ceasing employment may not be the most appropriate trigger for consolidation on a pot follows member basis, unless an appropriate consolidator could be identified (eg the pension provider associated with the member’s highest earning current job).

Question 13: What are the key benefits / risks of a multiple default consolidator and single default consolidator approach, including impacts on the wider pension market, and employers?

There could be significant practical hurdles to a multiple default consolidator approach which should be fully considered. Our concerns include:

• the method used to allocate pots to a particular provider if there is no existing consolidator pot for that member
• the method used to identify a member’s multiple small pots and ensure they are consolidated into the same vehicle, and
• the ability for the authorisation regime to ensure consistent standards.

We agree that the single default consolidator approach would have the benefit of simplicity, but this would come with a loss of competition.

Using the member’s first automatic enrolment scheme as a consolidator for future small pots may not be possible in all cases, as schemes may restrict, or have discretion over whether to accept, transfers-in. Such schemes may have ceased to be in existence if they themselves have consolidated and wound up.

Question 15: What would be the most appropriate approach to giving members choice in terms of choosing their consolidator, and what approach should be taken if the member did not make an active choice?

This may depend on the definition of “deferred” and the pots in scope (see the response to Question 11). If leaving employment is the trigger for consolidation, members could be given information by their former and new employers in leaver and joiner statements, letting the member know where their pot would be consolidated unless the member opts out or chooses a different vehicle by a certain deadline.

Question 17: What are the key benefits / risks of a pot follows member approach, including impacts on the wider pension market and employers?

We agree with the potential benefits of a pot follows member approach, but, as for our answer to Question 13, the practical difficulties are not fully addressed. It is not clear how pot follows member would work for members with multiple jobs or former employees who become self-employed, or how the practical and legal hurdles to effecting transfers and matching old pots to the correct new pot would be overcome. For example, it is not clear how, without active member involvement, old providers could be expected to find, and transfer to, the member’s new provider, and what the data protection implications would be.

A pot follows member solution could involve member-initiated consolidation, which would help address some of the practical issues. Members may be more likely to engage with their pension when changing jobs, particularly if they receive appropriate, timely communications from their old and new employers. However, as mentioned in our answer to Question 2 above, a solution based solely on active member involvement is unlikely to fully resolve the issue of small pots.

Question 18: Of the two solutions set out above what is your preferred approach, and why?

Both solutions would require careful consideration of the practical implications and legislative changes to work on a market-wide basis. The solutions appear to lend themselves to different types of small pots, and perhaps could be used concurrently, alongside member exchange. For example, very small pots and/or pots which have been inactive for a significant amount of time may be best suited to a default consolidator approach.

The pot follows member approach may be more suited to “new” small pots, where it may be easier to trace members and new employers, but potentially with the default consolidator being used where there is no member engagement.

We expect there would be difficulties in a pot follows member approach to managing pots which have been deferred for a longer time, due to the likelihood of member records being out of date and members potentially having multiple deferred pots in scope.

Question 20: Should there be an initial focus on managing the flow of new pots or removal of the existing stock, and where does the balance of impact lie for each of the solutions presented?

Focusing first on managing the flow of new pots could have the advantage of allowing the solution to be tested before scaling up and being applied to existing stock.

Question 23: Do you agree that same scheme consolidation has a key role to play in the wider consolidation of deferred small pots, and can act as a foundational measure to larger market-wide solutions? If not, why?

Yes, same scheme consolidation appears to us to be a sensible first step before implementing a larger solution. Careful consideration should be given to how to address, and administer, any differences in charging structures, investment options and default funds that apply to different pots within the same scheme, particularly where consolidation is without member consent. There may be scheme rule or platform limitations to overcome to enable this for all schemes, in addition to the legislative hurdles referenced in the call for evidence.