Future of the DC pension market: the case for greater consolidation
In September 2020, in the consultation Improving outcomes for members of defined contribution schemes, the government set out that while consolidation is, to some degree, already happening, the rate at which this is occurring is slower than is needed. This consultation has been launched to understand the barriers to further consolidation of the occupational trust-based DC market in the UK.
In this response
We welcome the opportunity to respond to this consultation.
Our understanding is that the Government is pursuing greater consolidation both to ensure individuals are in well-run schemes, and to enable schemes to achieve the necessary scale for more innovative investment strategies.
In a recent conference, the DWP representative commented that a significant number of small schemes do not comply with legislation. It seems highly unlikely therefore that they will comply with the new value for members assessment and, as a result, identify that they should transfer members to a larger scheme and wind-up. That means the changes being made will not fully achieve the Government’s objective to assist those schemes which need help to exit the market. In our view, it is only the small schemes which have sufficient resources to take advice that will look to wind up and consolidate.
For those without resource, we believe the Government needs to take a different approach. TPR may need to provide them with strong guidance coupled with a good communication strategy on the need to assess their position. TPR may also need to work with master trusts, providers and other industry bodies to help explain the transfer process, and give a greater steer on how to wind-up pension schemes with DC benefits. We note winding-up guidance is already available, but in its current form some pension scheme trustees will struggle to get themselves through the process without the support of advisers.
We comment further below on the need to address the barriers to consolidation which we know, from working with our own clients and other advisers in the industry, are preventing some transfers from taking place.
We have not sought to answer every question in the consultation but have limited our responses to those areas which are pertinent to our practice.
Q1. Do you agree that the government is right to aim for fewer, larger schemes going forward? Are there any risks?
We appreciate the arguments for scale and note the strong evidence that very small schemes suffer from poor governance, which in turn correlates to poor member outcomes. But, as was acknowledged by the DWP in a recent conference, there is no evidence that schemes between £100m and £5bn in assets are badly run or have poor outcomes. There are some very well run schemes within that range, particularly but not exclusively at the upper end of the proposed asset range, which provide good value for members and good outcomes at retirement. Members of schemes where the employer currently pays for the administration (and investment costs) and/or where the employer and trustee are very engaged with the scheme, will likely suffer detriment as a result of consolidating into a master trust where costs are not covered by the employer and there is less ability/willingness to tailor the offering to the specific demographic of those members.
Having fewer, larger schemes in the market could result in waning competition which, in turn, could lead to less innovation (across the industry as a whole, not just in terms of investment) and less choice for employers over pension provision. This would not benefit members. In addition, a very contracted market poses a greater risk to the pensions system should one of the players fail. While the authorisation and supervision regime for master trusts is intended to prevent a disorderly market exit, such risks cannot always be mitigated to the point that they are removed entirely. Larger schemes are not immune to problems or mistakes which, due to their size and scale, could have more wide-reaching impact compared to smaller and medium-sized schemes. Either of those scenarios could result in decreased engagement and poorer member outcomes.
We are also concerned that, were the market to contract too quickly, this could have a significant negative impact on upcoming pensions projects such as the dashboard and management of small pots. Transfers between schemes can affect administration and member records/data, which are central to the success of those projects.
The upper end of the proposed asset range (£5bn) seems very high, given that it would currently include a number of master trusts which have recently been through the authorisation process and some of the largest occupational DC schemes in the market.
Q2. What impact will the new value for members assessment have on consolidation of schemes under £100 million? If you were a scheme that did not pass the value for members assessment, would you look to “wind up” or “look to improve” and how would you go about this? Beyond the value for money assessment, could government, regulators and industry accelerate the pace of consolidation for schemes under £100 million ?
In our view, DC schemes below £100m could seek to trigger wind-up before the first new value assessment falls due so that they are exempt from the requirement. The resources and costs needed to complete this assessment will be a concern for many schemes, particularly when the outcome is uncertain at the outset of such a project. Many occupational DC schemes’ expenses tend to be “employer funded”, and we expect this would be seen as an additional financial burden on the cost of running a pension scheme at a time when businesses are still engaged with dealing with pandemic related challenges. Some schemes may therefore take the view that they will end up in wind-up sooner rather than later, and it may be cheaper to cut their losses earlier in the process and move straight to wind-up to avoid the time and cost of completing the new value for members assessment.
Increasing regulatory burden on the smaller end of the market will therefore, inevitably, accelerate consolidation. However, there will still be schemes which are either unwilling or unable to consolidate; who will either ignore the new value for members assessment or be unaware of it. In other words, we are not convinced that the proposed approach will capture all of those schemes that the Government is most concerned about. To help address this, the Government could consider providing small schemes with their own standalone bulk transfer route (perhaps via TPR guidance as opposed to new legislation) so that those who cannot afford to take advice can still successfully consolidate. Ultimately, if that does not succeed, the Government may need to undertake more direct intervention and consider some form of compulsion as a further step.
As for whether schemes which fail the assessment would choose to improve or consolidate, the former is unlikely. Again, such schemes lack resource and would be likely to take the easier option, assuming of course they can find a larger scheme which will accept a transfer in of their members. This will be another challenge as some master trusts are not interested in the smaller end of the market for commercial reasons. Again, this is a matter the Government will need to address to enable small schemes to wind-up and consolidate.
Q4. Assuming a scheme wishes to consolidate, how significant are the barriers identified above? Are there others? How do barriers vary for medium-larger schemes? How can the government, regulators and industry remove these barriers?
The barriers identified in our responses above for smaller schemes are significant. For medium-larger schemes, the barriers of not being aware of the requirements/not having resource to go through the process and/or seek advice, and the likelihood of a master trust not being willing to accept a bulk transfer are less significant, but others remain.
We were involved with the creation of a paper on barriers to DC consolidation which was sent to the DWP by the DC Governance Group. The paper represents our views on the technical legal and tax barriers to consolidation and how these may be removed, so we will avoid repeating those here.
In addition, there are trustee duties that will affect the decision whether to transfer members to another scheme without member consent. Trustees have to answer two key questions:
- can we make the transfer? (Do we have the power to do so under the scheme’s trust deed and rules?)
- should we make the transfer? (Is it in members’ best interests?)
Where DC assets are held within a DC section of a hybrid scheme, under the scheme rules and/or existing legislation, it may not be possible for trustees to make the transfer for example. Where members have guarantees or tax protections that would be lost on transfer, in most cases a transfer will fail at the second hurdle.
Compulsory winding up and consolidation (which overrides any existing legal hurdles) may be the only viable option for schemes who wish to consolidate but are unable to wind-up / transfer to a master trust currently for any of the reasons explained above.
An additional barrier that it will be difficult for the government to address is cultural. Many paternalistic employers still want to offer their own occupational pension scheme to their employees and to remain engaged with it. Some smaller well-run schemes have complex benefit structures which are bespoke to the type of workforce and embedded in the “offering” of employment terms and conditions. To an extent, master trusts are trying to address this by providing employers with bespoke arrangements, but these bespoke arrangements will not be sustainable in the longer term (particularly in a market where a handful of providers could become dominant, as mentioned above).
Q5. How can we mitigate any risks associated with scheme consolidation?
The government needs to ensure that master trusts are incentivised to innovate, which is more likely to happen if focus switches from charges to value; a narrative already being changed by the new value assessment but which could be advocated further. This should ensure there isn’t a race to the bottom on fees, to the detriment of the offering as a whole.
Q7. How important is scheme consolidation in driving better member outcomes?
Scale is just one factor. While evidence indicates larger schemes tend to be better governed than smaller schemes, as noted above, there are many well-run smaller schemes. Both can produce good member outcomes. The key is the value being provided to members. Clearly investment performance is one of the most significant factors in this but, as demonstrated by the new value assessment, it is also important to consider other matters such as member communications, the scheme’s administration systems and processes etc. However, we would agree that larger schemes tend to be better resourced and therefore better able to offer good overall provision.
Another significant factor in driving better member outcomes is providing members with better support through guidance and advice when making decisions on their decumulation options and also ensuring there is innovation in the decumulation options on offer within the market. It only goes so far if a member is in a low cost, well run, well performing large scheme during the accumulation phase but then makes a poor decision at retirement and runs out of money later in life. We are aware the government is looking at this separately but this should be factored into the discussion on consolidation.