Ending the proliferation of deferred small pots
On 11 July 2023, the DWP issued a consultation on a proposal to resolve the issue of deferred small pots (“the consultation”).
This follows a call for evidence on addressing the challenge of deferred small pots issued in January 2023 (“the call for evidence”) to which we also responded. A copy of our response to the call for evidence is available here.
In this response
We are very supportive of attempts to resolve the issue of deferred small pots. This consultation addresses the issue within the trust-based market, and our comments are given in that context. It is important that the issue is also addressed within the contract-based market, and we are pleased that the consultation refers to the DWP working with the FCA to ensure alignment with the contract-based market where needed.
The trust-based market encompasses a wide range of schemes, and the ultimate design of the consolidator solution should reflect this. To reduce the risk of member detriment, the framework should be designed as far as possible so that members do not lose valuable scheme-specific benefits, such as underpin benefits, a “switch-back” option for the member to transfer the pot to fund a pension commencement lump sum in a hybrid scheme, employer-funded administration costs or tax protections. Where such benefits cannot be replicated or maintained in consolidator schemes, we suggest those pots are excluded from the scope of the consolidation.
As the DWP will appreciate, careful thought should be given to how the process will work from the transferring scheme’s perspective. Will legislation introduce a power for schemes to transfer small pots to a consolidator which will override scheme rules? In our view, this is necessary to ensure all occupational schemes will be able to transfer-out small pots to a consolidator. The framework should be designed to be as streamlined as possible from the transferring scheme’s perspective to reduce the burden on schemes and minimise costs.
Question 1: Do you agree with this proposal, or do you believe a central registry would be more effective approach to support the consolidation of deferred small pots? If so, how would you design a central registry?
We agree that there appear to be advantages to using a clearing house as a central point to store and manage data. A particular advantage is that it could remove some of the burden from transferring schemes around selecting the correct default consolidator and communicating with members. We are supportive of the aims of making the process as simple and automated as possible to help reduce costs for schemes and members.
Whether a clearing house or central registry is used, thought will need to be given to ensuring appropriate data protection and cyber security measures are in place to reduce the risk of breaches and scams, and to promote confidence in the system. Trustees of schemes which make a transfer acting on information given by the clearing house or central registry should be protected from future liability in relation to the transferred pot (eg by a statutory discharge such as that provided under section 99(1) of the Pension Schemes Act 1993 in respect of certain transfers).
Our expectation is that members could have more confidence in communicating with a government-branded/backed clearing house, and be more likely to engage with those communications. Members could be more concerned about pension scams if they are contacted by a consolidator scheme directly.
It is not clear from the consultation document who would be responsible for funding and administering a clearing house. To achieve the policy aims and help ensure a net benefit to members, the clearing and transfer process should be as simple and cost-efficient as possible.
Question 2: Which of the options we have set out do you think is the best approach to allocate a member a default consolidator in cases where a member does not make an active decision? Are there alternatives?
We agree there appear to be benefits to using a clearing house to make the allocation, depending on the chosen method. A clearing house would be better placed to access and store data, and could reduce the burden on transferring schemes.
Under option A, there may be practical issues and complexities associated with obtaining value data. Will schemes be required to provide value data to a clearing house, and if so at what point(s) in time? Who will assess the market share of the default consolidators and at what point(s) in time? Option B also requires some value data, to enable pot values to be compared in cases where a member has pots with multiple consolidator schemes, but appears to us less complex than option A.
We wonder whether option B could be used alongside a simple allocation system where a member does not have an existing pot with a consolidator scheme. We recognise the desire not to distort the market through allocation of small pots. However, the consultation suggests that a large portion of small pots could be allocated using option B. The alternative allocation system would deal with the remaining portion only, reducing the potential market impact. In our view, the costs and practicalities of administering the allocation system should also be prioritised.
Question 3: Do you agree that there is a need for an authorisation regime for a scheme to act as a consolidator? If so, what essential conditions do you think should form part of the authorisation criteria?
It is important that minimum standards apply to promote good member outcomes across all the consolidator schemes. Members should not be disadvantaged by their pot transferring to one consolidator over another. We wonder whether this can be achieved through the existing master trust authorisation regime, and the forthcoming new value for members framework, without imposing onerous new requirements. New requirements could make becoming a consolidator less attractive, and the cost of compliance will ultimately be borne by members.
However, please see our response to Question 6 in relation to protections around member charges and investment strategies.
Question 5: Do you agree with this proposal not to mandate schemes to undertake same scheme consolidation at this current time?
In our response to the call for evidence, we highlighted some of the practical barriers to same scheme consolidation (such as differences in charging structures and default funds), in addition to the legislative hurdles referenced in the call for evidence. Because of these barriers, as the DWP recognises in the consultation, many schemes are currently unable to consolidate multiple pots held by the same member within their scheme. Whether or not it is mandated, it would be helpful if legislation were introduced to enable same scheme consolidation.
If same scheme consolidation is a prerequisite for authorisation as a consolidator, which is suggested at paragraph 127 of the consultation, many schemes will be blocked from acting as consolidators without legislation to address this issue.
Question 6: As a whole, do you agree with the framework set out above for a default consolidator approach? Are there any areas that you think have not been considered, that need to form part of this framework?
In addition to our general comments and responses to the questions above, we have the following comments about the framework:
- protections around charges should be built in to reduce the risk of members being disadvantaged by consolidation. For example, consolidated pots should retain protection from erosion by flat fees, as we suggested in our response to the call for evidence. As mentioned in the general comments above, it may be appropriate to exclude pots in schemes where the employer pays administration charges from the scope of consolidation
- protections should also be built in around investment options. We expect that a very large proportion of small pots will be invested in the default fund. Consolidators should take into account the particular characteristics of small pots and how they are likely to be used when setting and reviewing the default fund investments
- if small pots become eligible for consolidation 12 months after the last contribution, there is a risk of catching members who are on family leave or sick leave. Extending the period to 18 or 24 months would help reduce this risk
- we agree that the interaction with the forthcoming new value for money framework is important (as noted at section 2.3 of that consultation outcome) and should be thought through carefully. For example, it may be helpful for consolidators to assess the value of small pots separately to other benefits, to avoid small pots distorting the overall assessment
- careful thought should also be given to the process from the transferring scheme’s perspective. We suggest the framework should remove, or at least minimise, any decisions / discretions which need to be exercised by trustees of the transferring schemes, since these would add additional cost and time to the transfer process and could be onerous for transferring trustees. Legislation should be introduced to provide an overriding power to enable the transfer and a statutory discharge (as mentioned at Question 1), and
- as mentioned in our general comments above, pots with valuable scheme-specific benefits which cannot be replicated in the consolidator scheme should not be transferred.