There are many benefits to consolidation. But before we make more changes to our pension system, we need to re-think how to create a better and fairer system for all savers.
Change is happening fast in the UK’s defined contribution (DC) pensions market. Consolidation is well under way and is already reshaping the sector. This is being driven by a range of forces, from government policy to increased governance and trusteeship requirements, that have significantly ramped up the risk and cost of running single employer trust-based schemes.
The trust-based DC market has consolidated by nearly 40% in just a decade to a total of 27,700 schemes as of December 2021, according to The Pensions Regulator’s (TPR) 2022 DC Trust Report. The number of schemes with 12 or more members have declined by 63% since 2012, including by 12% last year alone.
Master trusts are benefitting the most from consolidation. They have increased assets by almost 50% to £78.8bn over the course of 2021, according to the watchdog’s report.
This trend is not limited to the trust-based pension sector; some sponsors of group personal pensions are also moving to, or considering, master trusts in the pursuit of better value for money.
However this causes a dilemma. Providers of master trusts are of course welcome to more assets flowing in their direction, and it doesn’t matter from where. But employers do need to consider what in fact creates best value for money for employees; moving to a lower charged vehicle is one part of the puzzle. Increasing contributions is by far the biggest driver (at least in the early years) to creating the best outcome. Could we have better models for charging structures, one that is mutually beneficial for providers and employees; e.g. progressively lower AMCs for higher contribution levels?
Sweet spot for schemes
While I sympathise with trustees’ and employers’ concerns about regulatory and governance challenges and higher costs, it breaks my heart when well-run, trust-based schemes are wound up and moved to a master trust.
There are many good reasons for schemes to stay as they are. The trust-based framework offers trustees and sponsors the ability to tailor pension benefits most pertinent to the scheme’s members. But, at the same time, master trust providers can potentially offer better value for money or improved member outcomes, as these providers have the scale to make huge investments in their propositions and the ability to quickly innovate.
It may be worth trustees and employers considering their options in this sweet spot in time, where intense competition for assets means master trusts are offering great deals to attract schemes.
It is not uncommon to see base annual management charges as low as 0.2-0.3%, with some providers also willing to stump up hefty transition fees, which can run into hundreds of thousands of pounds. In some cases, providers are even willing to cover any direct transfer penalties; e.g. from moving away from a with-profits fund.
It is therefore an opportune time for trust-based schemes to assess whether they are getting the best deal in the market and consider, on an objective and factual basis, what the master trusts are offering.
We also think it is worth reviewing contract-based pensions to check if they are providing value for money for their members – and look at how these arrangements compare to master trusts.
To do this, trustees and companies need to have a purely objective view of the market and understand the potential implications of making the move. They should spend a lot of time choosing the best provider and seek independent advice to understand the widely different master trust propositions. These assessments also need to consider the scale of any undertaking to wind up a trust-based pension scheme. Sponsors and trustees should not underestimate the cost of scheme wind ups.
The consequences of consolidation – is big really best?
Last summer, the Department for Work and Pensions issued a call for evidence on how to drive more consolidation in the DC pensions market, and what barriers are holding this back. It argued that consolidation would improve members’ retirement outcomes through better governance and greater investment in illiquid assets.
At Barnett Waddingham, we are thinking about the longer-term impact of more consolidation and the potential consequences for member outcomes. Is bigger always better? And is there a risk of going too fast, too soon?
Australia’s pensions system is often cited by politicians and experts as a great example of what consolidation could look like in the UK. Its pension system has undergone massive consolidation over the past two decades – following a series of major policy changes such as greater governance requirements – and the number of pension funds is set to fall further in the coming years.
One benefit of consolidation is the increased ability to invest in a wider range of assets, particularly illiquid ones such as infrastructure or ESG specific assets that can deliver long-term sustainable returns for members.
Speaking at our DC Pensions Conference in November 2021, Nick Sherry, former Australian Minister for Superannuation, explained the key drivers behind consolidation in his country and lessons for the UK as it goes down the same route.
Sherry said investing more in infrastructure, which requires a lot of scale and expertise and can be expensive, can be achieved much more easily in a consolidated market.
One of the most cited reasons for the lack of UK DC pension fund investment in infrastructure is that the market is heavily fixated on daily pricing, which is challenging to provide for illiquid infrastructure.
However, Sherry did not think that should be a barrier to investing in this asset class as Australian superfunds manage to provide daily pricing despite their huge allocations to infrastructure.
Indeed, he says it is more a question of scale. The top 15 mega-funds dominating Australia’s sector have each amassed assets of around AU$100-200bn (£56-112bn). Greater scale has resulted in superfunds increasing their average allocation to infrastructure to 20%, and most also have developed specialist ESG investment units and overlays.
Back in the early days of consolidation, Australian superfunds collaborated to invest in big infrastructure projects. Nowadays, they often team up with other big pension funds and institutional investors around the globe to invest in even bigger and better opportunities.
The UK’s pension funds fail to do this despite our pension system being the third largest in the world, and bigger than Australia’s, according to The Thinking Ahead Group’s Global Pension Assets Survey.
To make it easier for schemes to invest in illiquid assets, the DWP proposed removing performance fees from the 0.75% charge cap in a consultation that ended in January.
The UK government is a big supporter of pension funds investing in infrastructure, and particularly sees the growth in masters trusts as an opportunity to help meet the costs of improving domestic infrastructure. The “largely untapped pool of capital” from DC pension funds is mentioned in the government’s Build Back Better initiative, its plans to support post-pandemic growth through investment in infrastructure and the transition to net-zero.
However, it will be essential for any proposed infrastructure investments to generate a decent economic return for pension fund members and therefore improve their retirement outcomes.
In our DC webinar, Sherry said investing in such projects should not compromise trustees’ fiduciary duty to members and cautioned against governments dictating to pension funds that they must invest in a particular infrastructure project.
We also need to be conscious of further consolidation within the UK’s master trust market and the impact that could have on competition among providers. In 2021, the number of master trusts dropped from 38 to 36 while membership increased by about 10% to 20.7 million, according to TPR’s DC Trust report.
More activity is on the horizon, as partnerships are being set up between larger and smaller providers. There is also the possibility of international pension providers or big retail banks entering the UK master trust market.
Sherry warned that consolidation may result in too few pension providers and could erode competition and innovation – which could ultimately lead to poorer retirement outcomes for savers. Therefore, it is crucial to have enough pension providers to facilitate competitive tension and thirst for innovation in the UK market.
What should our system look like?
Consolidation clearly offers many opportunities, but it is unlikely to be the silver bullet for the entrenched problems of the UK pension system. There are issues that Australia has not been able to solve through consolidation, particularly at the post-retirement stage.
Before we make further big changes to the UK pension system, we need to think about the wider issues and how to solve them.
The younger generation, which will be solely retiring on DC benefits, cannot take it for granted that the DC pension system is fit for purpose to meets their needs. They can see flaws in the system already, particularly around lifestyle investment strategies that do not take enough upfront risk.
Younger people are also focusing on diversity & inclusion from gender, racial and sexual orientation perspectives, and expect their money to be invested in ESG/sustainable funds. They believe it is crucial to invest in assets to help create a better world for all, such as clean energy and social infrastructure, while generating long-term sustainable returns to grow their retirement pots.
The system is also technologically outdated, which is why member engagement is still incredibly low. The answer to this is making platforms and apps more user-friendly and adding better functionality; just as we have seen in online banking.
Master trusts have a huge opportunity to provide the right products and solutions to ensure the best possible retirement outcomes for savers.
Above all, young people want a pension system that is fair and equal, more inclusive, has no barriers, and provides good outcomes for all.
A fairer system for everyone
Creating a fairer pensions system for all is at the heart of our 2021 research Bridging the Gender Pensions Gap. We found, on average, women are saving less than men and have less in their pension pots at retirement, with differences ranging from 25% to 45%. This is largely down to women taking career breaks when having children and the imbalance of women working in lower-paid jobs.
Our report also found trans and non-binary people are also likely impacted by social marginalisation and discrimination when seeking and keeping employment, although there is insufficient data for firm conclusions. To meaningfully develop a system that works for everyone, we believe data needs to be collected and reported – then we can understand progress and the impact of policy changes.
Our call to arms to policymakers is this: we shouldn’t think that consolidation is a cure to all our pension ills. We need to readdress the inherent shortcomings in our DC system that hasn’t fundamentally changed since the 1900s and make it work much better for everyone.
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