30 January 2023 was a bumper day for defined contribution (“DC”) pensions, with the DWP publishing no fewer than four separate documents under the over-arching theme of improving Value for Money (“VFM”) for savers. Taken as a whole, the package of measures has the stated aim of ensuring that DC pensions are “fairer, more predictable, and better run”. The consultation closes on 27 March 2023 with the FCA expected to carry out a further consultation on proposed changes to FCA rules in due course, taking account of responses to this consultation.
In this article we take a closer look at the proposals and what they might mean in practice for DC schemes and their members - the DWP’s clear view seems to be that VFM translates to smaller schemes in particular being driven towards consolidation and / or winding up.
Context
According to the Office for National Statistics, the number of DC savers in the UK now outnumbers the number of defined benefit (“DB”) savers – at the end of 2019 there were 22.4m members of DC schemes, compared to 18.3m members of DB and hybrid schemes. It is this growth in DC pension provision, driven in no small part by the advent of auto-enrolment, which has inevitably led to increased focus on how DC schemes are managed and run, not least because unlike a DB scheme, where risks are shared between member and employer, in a DC arrangement the member bears all of the risk and there is no guarantee of return.
It’s clear that the task of running a DC pension scheme is becoming ever more onerous. Layer upon layer of new governance requirements have been introduced in recent years and yet the 2021 survey of trust based DC schemes by the Pensions Regulator (“TPR”) revealed that many smaller schemes in particular are not aware of the rules that apply to them. In particular, 67% of schemes with less than £100m of assets were not aware of the new legal requirement on them to carry out a more prescriptive ‘value for members’ assessment, introduced on 1 October 2021.
It’s against this background that the four 30 January 2023 documents were launched and we consider each in more detail below.
VFM
The “big ticket” item of the four, this joint consultation from the DWP, the FCA and TPR focuses on changes that could be made to maximise VFM for DC savers. The emphasis is on using consistent key metrics across the industry so as to improve transparency and drive improvements, since it will be easier for both savers and employers to compare the overall value and performance offered by schemes.
Trustees of smaller occupational DC schemes will already be familiar with the “value for members” requirements which came into force in October 2021. Broadly, occupational DC schemes with assets of less than £100m which have been operating for 3 years are required to report against key metrics in relation to their scheme’s governance and administration, and to compare their scheme’s costs, charges and investment returns against three other larger schemes on an annual basis in their Chair’s statement.
The proposal in the VFM consultation essentially builds on these existing value for members requirements. The remit is much broader – all occupational DC schemes (auto-enrolment and legacy, trust and contract based) are within scope, though micro-schemes (including small self-administered schemes and executive pension plans) are excluded. The consultation also envisages a “phase 2” where the VFM framework will be extended to cover non workplace pensions and DC pensions in decumulation.
In the consultation document, “VFM” is defined as meaning that “pension savers’ contributions are well invested in the best interests of savers, and savings are not eroded by high costs and charges in the context of the market today”. Three key elements of VFM are identified, schemes will be required to report against each; these are “investment performance”, “costs and charges” and “quality of service”.
On a practical level, the PLSA has already flagged that, whilst using consistent metrics across the industry to enable consumers to easily compare schemes is desirable, delivering this is not straightforward across a pensions landscape where schemes have different membership profiles and governance structures. When reading the consultation document it’s clear that there is still a lot of work and thinking to be done when it comes to what the individual metrics will be and how they will be delivered. There are particular complexities for multi-employer schemes and schemes with bundled investment and administration services.
There are further intricacies to consider in relation to how the information reported is collated, when and where it is published (centrally or by individual schemes) and how it is assessed – should there be industry wide benchmarks, for example, or a comparison against other schemes (to be selected according to specified criteria, as in the current value for members assessment)?
The consultation runs until 27 March 2023 but already the message to underperforming schemes is stark – improve, consolidate or exit the market. We can therefore fully expect the proposals, if implemented, to drive further consolidation in the DC market and the consultation makes no apology for this - the stated policy intention is to “support the further consolidation of pension schemes, where this is in the best interests of savers”. We note that the consultation document highlights that consideration is being given to whether TPR should have new powers to enforce wind up and consolidation “where a scheme is consistently not offering value for its members”.
Collective Defined Contribution (CDC) schemes
Perhaps an inevitable corollary to the VFM consultation, with its drive towards consolidation, this second 30 January 2023 consultation document explores options for expanding the remit of CDC schemes.
In 2022, single and connected employer CDC schemes were introduced for the first time. To recap, CDC design enables employer and employee contributions to be paid to a pooled fund with the associated economies of scale, rather than each individual having their own pot separately invested. In addition, the pooled nature means that the fund is less vulnerable to investment and longevity risk. So, although largely untested at this early stage, on the face of it the CDC model would appear to sit well within the VFM framework.
The current consultation looks at options including introducing multi-employer “whole life” CDC schemes (i.e. accumulation and decumulation phases), and enabling “decumulation-only” CDC schemes. This would make CDC saving available to a much wider cohort.
There is some exploration of how these alternatives might work in practice in a trust-based environment, with oversight by TPR. It is envisaged that new multi-employer or decumulation only CDC schemes would continue to require TPR authorisation, to ensure that they are well designed and well run. On the VFM theme, it is no surprise that the proposals include an indication that the “whole-life” CDC schemes should be subject to the 0.75% CDC charge cap.
Small pots
In another limb to the VFM framework, this DWP call for evidence looks at the growing issue of the large number of small pots of DC savings belonging to deferred members, and invites comment on potential solutions for consolidating member savings.
The growth in the number of deferred small pots is attributed to the success of automatic enrolment – it’s great that more people are saving for retirement but this has resulted in individuals, particularly those who move jobs frequently, accumulating multiple small pots over their working life. Small pots are bad for both members and schemes because they’re inefficient – the costs of administering them are often disproportionate and indeed, members can lose track of small pension pots altogether.
The DWP is therefore seeking a large scale automated consolidation solution to the small pots problem. Building on the work done by the Small Pots Cross-Industry Coordination Group, it wants to hear from the pensions industry on two broad alternatives:
- default consolidator scheme
- pot follows member
Further responses are invited on issues such as how to encourage member led consolidation, and at what level should the maximum (and minimum) pot size be set for automatic consolidation.
Facilitating investments in illiquid assets
Finally, the DWP has published a response to its consultation on broadening the investment opportunities of DC schemes, together with final draft regulations and statutory guidance. The policy aim here is to “boost returns” by opening up the opportunities for schemes to invest in illiquid assets, hence being a continuation of the VFM theme.
As part of this exercise, cost barriers to investing in higher growth assets (such as infrastructure and private equity) will be removed by exempting some performance fees from the DC charges cap (i.e. the 0.75% cap which applies to the default fund for DC auto-enrolment schemes and qualifying collective money purchase schemes) that would otherwise apply.
The consultation response indicates that this proposal received broad support from respondents, and draft regulations have been published, indicating that the exclusion of “well designed” performance fees from the charges cap will come into force with effect on and from 6 April 2023. Regulation 2 of the draft regulations “proposes to repeal the previous description of ‘performance fee’ contained in Regulation 2(1) of the Charges and Governance Regulations and replace this instead with a tight conditions-based definition of what can be considered a well-designed, “specified performance-based fee” structure that trustees or managers of DC and CMP schemes that are covered by the charge cap must follow if they want to exclude these performance-based fees from their charge cap calculations.”
The draft regulations are supported by draft statutory guidance, which includes guidance for trustees on what they need to consider in reaching agreement with a fund manager if they wish to invest in such a way and to take up the option to exclude certain performance based fees from the charges cap exclusion.
The regulations also provide for new obligations for trustees to disclose details about investments, including asset allocation and policies in relation to illiquid investments – this obligation will come into force for the first scheme year which ends after 1 October 2023.
Conclusion – Four strands but one unifying theme
There is a clear central policy concern in relation to some smaller schemes not offering good value for their members which this package of measures seeks to address. Alternatives for those schemes which may be driven towards consolidating are also being explored, in the form of broader options for CDC saving. In addition, the measures look to target some of the known areas of concern relating to efficiency, in particular consolidating small stranded pots, which can only be a positive for members and schemes alike.
The VFM measures being consulted on will expose underperforming schemes, thereby delivering the stated aim of driving further consolidation in the UK DC market. Whether this will be the end of the story remains to be seen. The Government has long looked to Australia as a beacon of best practice in relation to DC consolidation. Their regulator, the Australian Prudential Regulation Authority (“APRA”), has introduced a superannuation heatmap which uses a graduating colour scheme to provide clear data on schemes’ performance across the areas of investment returns, fees and costs and sustainability of member outcomes. Where a fund is rated negatively on the heatmap after two years, the APRA stops automatic enrolment contributions being paid into it, thereby driving further merger and consolidation in the market amongst existing superfunds. With the value of DC assets under management expected to overtake DB assets in the next 15 years, we should expect a greater focus on DC in future.
This article was written by Louise Pettit.