Q2: Do you think that the amending regulations achieve the policy aims of encouraging smaller schemes to consolidate into larger schemes when they do not present optimal value for members?
Value for members should be a universal industry standard
We note the following statement in this consultation, which suggests that value for members should be an objective standard applied to all DC pension schemes:
34. Achieving value for members is important for all occupational pension schemes, regardless of their size or duration.
It is likely that there are many schemes with assets great than £100m that do not provide optimal VFM. The proposal in this consultation – to only apply the VFM standard to schemes less than £100m – is inconsistent with the objective of establishing industry-wide standards for VFM.
We suggest the Regulator consider applying the principle of relative value for members to all single employer schemes. This would equally achieve the policy aim of encouraging schemes to consolidate, regardless of scheme size.
Q3: Do you believe that the statutory guidance increases clarity about the minimum expectations on assessing and reporting on value for members for specified schemes? Are there any areas where further clarity might be required? Which schemes should be in the VFM comparison set?Compliance costs are significant
Identifying three schemes for comparison is an onerous task that requires extensive benchmarking and analysis. If the trustees must believe, on reasonable grounds, that one of the three comparison schemes would be prepared to accept a transfer of members of the specified scheme if the specified scheme is wound up, then a detailed search must be undertaken and terms at least tentatively secured in order to conduct a valid comparison.
Master trusts do not offer standard terms – they are negotiated separately with each employer, who in turn will seek a different mix of employer- and employee-borne costs. Perhaps master trusts should be required as part of their authorisation to offer standard terms or a ‘rate card’ for small schemes under £100m, in order to facilitate this analysis.
We suggest that it is appropriate for Regulators to consider the costs of compliance and whether those costs are reasonable, as part of effective and proportionate regulation. The methodology outlined in Appendix E is extensive, potentially adding tens of thousands of pounds to a small scheme’s cost base. The existing guidance on relative VFM in the Regulator’s DC Code (above) appears to be reasonable but perhaps not as widely performed or included within the Chair’s statement as it could be.
Other practical considerations
Asset values can at times vary due to market conditions – such as in March -June 2020 – so a hard £100m limit could be arbitrary. Perhaps this could be a 2-year average rather than a point-in-time value at year-end.
There are some small schemes with unique characteristics that may not be able to find a suitable master trust or GPP to which they can transfer. It is suggested that the Regulator consider an exemption be available for unique schemes that are unable to consolidate once they have argued their case. For example, for schemes unable to find a suitable master trust or scheme to accept them, due to the unique nature of their scheme and/or members, an exemption could be permitted and re-applied for regularly eg three-yearly.
Another category worth considering are hybrid DB/DC schemes, where there can often be technical obstacles to consolidation. For example, trust deeds and rules that may not easily allow the DC section to be outsourced without impacting all members. Many hybrid schemes allow the DC portion to be repatriated to the DB section for the purpose of maximising taxfree cash on retirement, whereas transferring to a master trust may mean the loss of this substantial member benefit.
Similarly, there are a host of protected benefits within existing legacy schemes that need to be preserved by trustees in members’ interests and mean that schemes are unable to consolidate easily, regardless of the outcome of relative value analysis. For these schemes, the cost burden of extensive relative value for members analysis appears unhelpful.
Balancing consolidation policy with retirement income adequacy objectives
Consolidation has the potential to lead to lower costs and better compliance amongst smaller schemes, but it must also be balanced with objectives of retirement income adequacy. There are some risks to adequacy in a consolidation policy if it leads to a lower level of commitment
and support from employer sponsors – especially on the issues of funding and contribution levels:
Funding of scheme costs by employers could fall
Many employers fund the governance and administration costs of running their schemes, with members meeting the investment costs. This also applies to deferred pots. Today’s single employer scheme is typically made up of over half deferred pots from former employees and employers also fund the governance and administration costs of those deferred members.
At the point where employers and trustees transfer their schemes into multi-employer schemes, such as master trusts and GPPs, the employer has an opportunity to review its funding policy – especially for deferred members. On transfer, the full costs of running the scheme (governance, administration, and investment) may be shifted to members as the employer’s commitment to the scheme reduces. This could result in members bearing more or all the scheme’s costs compared to the previous single employer trust. To summarise, consolidation may in fact lead to higher costs for members if employer funding falls away.
Private sector contribution levels fall to auto-enrolment as the norm
Another potential outcome of industry consolidation may be that pensions lose their role in distinguishing the benefit packages of employers and simply become commoditised. With a commoditised private pension sector supplied by a handful of master trusts/life insurance companies, there is no role for the pension in a competitive employee proposition. Why, then, would an employer offer their employees contributions above the auto-enrolment minimum?
If all pensions start looking the same and contributions are standardised, employees become indifferent to the employer on the basis of its pensions benefits. The dominance of master trusts in Australia has had this effect on pensions, which are now standardised across employers who rarely offer contribution levels above auto-enrolment levels (except in the public sector). Consolidation needs to be approached in a considered manner, and perhaps paired with an increase in minimum auto-enrolment contributions, so that adequacy in UK pensions overall does not deteriorate further in international rankings.
+44 (0) 20 3786 6251 (Georgina Milton)
+44 07788 491 582 (Ian Terry)