The drive to DC consolidation

Pressure on small schemes to consolidate

In a recent consultation response, “Improving outcomes for members of DC pension schemes”, the Government views accelerating the consolidation of the DC market into fewer larger schemes as a priority.

Under the proposals, trustees of schemes with less than £100 million in DC assets will be required to undertake a “more holistic” annual value for members assessment and report on it, looking at:

• costs and charges – based on comparison with at least three other “large” schemes, one of which should be willing to accept a transfer in of the scheme’s members
• net investment returns
• measures of administration and governance

Unless improvements can be made rapidly and cost effectively, the Government will expect those schemes which do not demonstrate value for members to be wound up and consolidated.   The Pensions Regulator is also a keen exponent of DC consolidation for badly run schemes.  It has powers to wind up a scheme where this is necessary in order to protect members’ interests and could step in if needed.

If these requirements are introduced, they will place an even greater governance burden on trustees of smaller DC schemes, which in itself could act as a further incentive to wind up and encourage consolidation.  And if these proposals don’t drive consolidation “at sufficient pace”, the Government has said it is committed to legislating to mandate consolidation.

The move to master trusts

In practical terms, this means more DC schemes moving to master trusts.

We have already seen a sharp increase in transfers of smaller schemes to master trusts during the COVID-19 pandemic and this trend looks set to continue, with larger DC schemes also now looking at this option.

There has also been consolidation within the master trust market itself in recent years.  Triggered by the new master trust authorisation regime, the market could shrink further if it becomes financially unsustainable for some of the remaining master trusts to continue to operate in the current economic climate.

The potential result is a handful of DC “super trusts” in years to come.

Is it the end of small schemes?

In short, not necessarily.

Master trusts are not necessarily the solution for all DC schemes. Whilst the benefits of economies of scale are clear and the master trust authorisation regime requires strong standards of governance, there are also potential downsides.  There is less focus on the needs of the particular members of each scheme within the master trust.  And the larger the scheme the larger the potential risks if something goes wrong in terms of systemic administration risks or data protection breaches.

Small schemes where the employer and trustees are engaged with the governance of the scheme and have adequate resources to commit to this or the employer subsidises the costs, could still provide a better option for members than moving to a master trust.  These schemes will likely be able to show they provide value for members under the new assessment and will not be required to consolidate.

There is also the question of whether master trusts will be willing (or able) to accept transfers from all small schemes.  Closed DC schemes, or schemes with lots of small deferred pots, are unlikely to be profitable for providers, for example.

Action: plan ahead

Transferring DC assets into a master trust can be a complex process and should be planned in detail by employers and trustees of schemes contemplating this.  In particular, there are some tricky legal and tax hurdles to overcome for hybrid schemes with DB and DC sections and for DC schemes which have any kind of guarantees wishing to transfer their DC section to a master trust. There may be other options which should be considered in these cases.

Likewise, master trust sponsors and trustees will need to think about areas which will require scaling up to accommodate further rapid growth and further consolidation within the industry.

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