Unlocking the UK pensions market for growth: consultation on reforms to the DC pension market to build scale and put savers first

Background

On 14 November 2024, the DWP issued a consultation on reforms to the DC pension market to build scale and put savers first.

In this response

• General comments
• Responses to specific consultation questions

We welcome the opportunity to respond to this consultation. In addition to answering specific consultation questions which are pertinent to our practice, or which we believe could give rise to difficulties in practice for our clients, we have provided some general comments.

General comments

Both the previous and current Governments have stressed the importance of achieving scale within the pensions industry.  This has been mentioned in connection with various policy initiatives in recent years.  It is not therefore surprising to us that the Government is, in this consultation, focusing on consolidation to achieve scale.  However, our observation is that the reasons for wanting consolidation have evolved as the Government’s thinking has developed in this area.

To enable the Government to work effectively with industry in the pursuit of achieving its desired objectives, we think that it is vital that the Government is clear why it is seeking a drive for scale in DC pension funds at this time.  The DC consultation documentation states the purpose of the DC reforms is to solve fragmentation in the DC market, whereas it is clear from statements made by the Chancellor and elsewhere that the Government’s primary reason for wanting scale in DC pension funds right now is to allow/require the DC market to invest in “UK productive finance”.  These are two distinct objectives, which in our view, are best achieved in different ways so it is really important for the Government to clearly define what it wants from the DC pensions industry.

We agree with the Government that there could be circumstances where large, well-run schemes, could and should offer opportunities for innovative investment choices, including UK productive finance assets.  In this context, we have four key comments to make, of a general nature, about the drive towards scale:

1. It is not clear from the detailed proposals (as outlined in the consultation document) whether the Government’s objective is to consolidate at “investment fund” level (and how that is defined) or whether its intention is to reduce the number of pension schemes that operate to a small number of trust based “master trusts”. We understand from events attended by Emma Reynolds (the then Pensions Minister) and discussions with key players in the industry since the consultation was published that the Government’s objective is to create investment funds (as opposed to pension schemes) which are large enough to invest in UK productive finance rather than, at this stage, to eliminate the contract-based market and instead operate a trust-based pension market with a limited number of master trust schemes.  It is important that the Government is clear on what it means by consolidation because the views provided in this consultation response could be quite different depending upon what is intended.  For example, we believe that it is likely to be much quicker to achieve consolidation at an “investment” level rather than a “scheme” level, bearing in mind some of the issues we have set out below.  If consolidation is sought only of investments, rather than the pension “wrappers” around them, that may also help to mitigate some of the less desirable aspects of consolidation, such as lack of consumer choice, restrictions to innovation and market domination. We would encourage the Government to also consider an approach where each pension provider, over time, is expected to offer at least one investment fund “at scale” to enable investments in, for example, UK productive finance but, where the provider is able to offer such a fund, it can also offer other smaller fund choices alongside.  If the government’s intention is to enable investment in productive finance, this should achieve that objective but, from the industry’s perspective, it also allows providers to grow other innovative funds alongside this structure, thereby supporting further development in the DC market/new market entrants.
2. In our view, the proposed pace of consolidation is optimistic and would be better staged over a longer period, particularly given the other changes that are happening between now and 2030 (introduction of pensions dashboards, digital transformation, inheritance tax changes, change to normal minimum pension age, small pots consolidation, new trustee decumulation obligations and the output of the advice/guidance boundary review, to name a few). Consolidating at scale requires a level of systemisation and automation that is not present in all cases, and an overly hasty drive to a consolidated market will place a heavy burden on administration services teams which are already under strain.  The result of introducing changes too quickly could be large numbers of “disorderly” exits which are managed badly despite everyone’s best efforts, and that could have an adverse impact on trust in pension savings and member outcomes.  In other words, if consolidation happens too quickly, and without a publicly shared roadmap for doing so, the result could cut across other Government objectives at a time when savings adequacy is under threat.
3. Scale on its own will not guarantee that trustees and providers will choose to invest in the way that the Government would like. There need to be clear reasons that support investment decision-making, particularly in trust-based pension schemes, where trustees have legal duties to their members.  On a practical level, it may be helpful for trustees to have (a) access to new guidance, case studies and examples of where investment in different asset classes has resulted in better member outcomes, to encourage more engagement in different types of investment design and (b) support in finding new investment opportunities.  In addition, it may be preferable to create more opportunities for all schemes to invest in this asset class, and time may be better spent removing any immediate barriers to them doing so.
4. From discussions both internally at Sackers and within the industry, there are a number of terms in the consultation document which need to be clearly defined by the Government. To work towards a common goal, the industry and the Government need to have a common understanding on the terminology, which does not currently exist.  Key terms on which absolute clarity is needed include “UK Productive Finance”, “Fund”, “Default”, “approve”.  This is explored further in our response.

Responses to specific consultation questions

Chapter 2 – Achieving scale in the Defined Contribution market

Question 1: Do you think providers should be restricted to a limited number of default funds, and if not why? Please consider any equality considerations, conditions and to what extent saver choice could be impacted?

General comments

We have no issue in principle with limiting the number of default funds, provided that this does not stifle innovation in the market or customer choice. We also need to make sure that the level at which the definition of “default” is set is workable in practice – eg at aggregated strategy level rather individual fund level.

Default arrangement verses default funds

Whilst the consultation acknowledges that the terms “default arrangements” and “default funds” are used interchangeably (paragraph 31), we would highlight that there is currently no legal meaning of a “default fund”. A “default arrangement” is defined in legislation. This often comprises one or more “white labelled” funds, or a whole white labelled strategy made up of layer upon layer of “funds”, or (perhaps more appropriately) “pooled investment products” which will differ depending on the age of a member.

The consultation does acknowledge that “before specifying a maximum number of defaults and a minimum size of AUM rule” the DWP must consider whether to apply the rule at “default arrangement/scheme level” or a “default fund level” (paragraph 34), with the suggestion that if the latter option is chosen it would be at the “entry” level default fund. This is not a legally defined term or a term that is commonly used in the market, but we assume what is meant here is at white labelled fund/blended fund level. It is also unclear what the reference to “scheme” means here. Is it to a section of a master trust or to the master trust as a whole? It is therefore not currently clear from the consultation the level at which the Government proposals would apply, ie at which level do they wish assets to be aggregated. We think it is critical as a first step that further consideration is given to clarify this.

Issue of inadvertent/technical defaults

The consultation does not address the issue of inadvertent/technical default arrangements which fall within the current legal definition of “default arrangement”. These are commonly created when strategic decisions are taken to move members without their consent, for example where a fund is closed. Further consideration will therefore be needed on how these proposals impact such arrangements.

Their inclusion in the proposals would be challenging, since inadvertent defaults are by their nature highly unlikely to ever get to a £50 billion threshold. As the issue of inadvertent/technical default arrangements already causes significant administrative and investment governance challenges in practice, we would welcome changes to the legislation to exclude these from the definition of “default arrangements” and/or their exclusion from these policy proposals.

Impact on bespoke defaults

Many master trusts currently create bespoke defaults for individual employers based on the specific membership profile of that employer’s workforce. These are typically priced differently and have different asset allocations to the standard defaults. The current proposals would likely require such arrangements to be closed and consolidated (since they are very unlikely to meet the £50 billion threshold). Whilst this may be the Government’s intention, there could well be adverse impacts on employer engagement with pensions as part of the remuneration package. Also, employers often subsidise the cost in return for a more bespoke offering so if this offering were lost it could reduce both overall value for members and employers’ appetite for using master trusts for their pension provision.

Membership demographics

Default arrangements/funds are by their nature not funds which savers have chosen themselves. However, there may be valid reasons for schemes to want different default funds in place for different parts of the membership eg depending on their age/length of time to retirement, pot size, choices being made at retirement. We would caution against removing the ability to select different investment options for different categories of members within the same scheme, but this can be made to work if the definition of default is set at a strategic/aggregated level. This is particularly important if the FCA advice/guidance boundary review (and, by extension the proposed new decumulation duty to provide a default retirement option) is likely to focus on different customer segments receiving targeted support based on their common characteristics.

Question 3: What do you think is the appropriate minimum size of AUM at default fund level within MTs/GPPs for these schemes to achieve better outcomes for members and maximise investment opportunities in productive assets?

We cannot answer this question without clarification of the asset level at which a minimum size of AUM is intended to apply (see General comment (1) above). However, we would say that whatever the Government’s minimum AUM target is, it should be phased in over time. This approach would be less disruptive to the market and to other policy objectives.

Question 5: Do you think there should be targets for (i) achieving a reduction in default fund numbers down to a single fund and, (ii) setting incremental minimum AUM?

Given the complexities we have outlined we consider the target date of 2030 to be very ambitious. Whatever the target date, we think that a clear framework and staged approach to the timescales would be helpful, akin to the approach taken for dashboards and automatic enrolment. If requirements come in too quickly there is a major risk of disorderly exits from the market which could exhaust administrative resources and cut across other policy objectives (ie small pots consolidation, VfM, dashboards etc).

Another issue is the impact on new market entrants which are beneficial for both innovation and competition. As you recognise, new entrants would be unable to meet the threshold requirements immediately so, to mitigate against this stifling of innovation and competition, there would need to be a clear “glide path” for them to achieve scale.

Question 7: Given the above examples, what exclusions, if any, from a required minimum size of AUM at default fund level and/or the maximum number of default funds requirement should government consider?

Type of scheme

We consider there to be a rationale for excluding not for profit, non-commercial master trusts from the scope of any proposals on minimum AUM. These are trust based schemes, such as the Superannuation Arrangements of the University of London (SAUL), who typically exist to serve a discrete community and have decided to introduce a DC benefit element alongside defined benefit pensions. However, while employers in such schemes may have a shared interest in benefit provision, they are not formally connected so are technically caught by the DC master trust regulatory regime.

Analysis carried out by DWP in 2023[1] on the market segments of master trusts has already recognised that schemes such as SAUL (a not for profit, non-commercial master trust) are different from other master trusts in the sense that, unlike commercial master trusts, they are not actively seeking to increase scale to gain a higher market share. There was also a recognition that this type of scheme might instead be thought of as an extension of the single employer trust market, albeit subject to higher levels of regulatory oversight.

Applying any minimum AUM rules to non-commercial master trusts risks disrupting what will have been developed as a bespoke DC benefit design for the relevant memberships, often integrated with defined benefit provision.

Type of default

We would also suggest inadvertent/accidental defaults are excluded from the proposals for the same reasons explained above.

Limiting the number of “funds” would also be difficult for schemes which operate Target Date Funds, as by their nature there are multiple funds targeting a variety of different ages. Again, to mitigate this, the definition of “default fund” could be articulated at a strategic, aggregated level to enable these funds to continue.

Question 8: With regards to the proposals in this chapter, we anticipate the need for mechanisms to encourage innovation and competition, and for safeguards to protect against systemic risk. Are there any other key risks that we need to consider? How do we mitigate against them?

The proposals, as drafted, could potentially make the fiduciary duties of single employer/own trust trustees (eg the need to invest in the best financial interests of members) more difficult to apply by reducing the number of investment funds available to them to invest in.

The proposals will need to be carefully drafted to avoid the risk of lack of diversification of investment so that the potential for systemic risk in the market is appropriately managed.

There is also the impact of the new VfM framework to consider which, with default arrangements being rated red, amber or green over a predominantly backwards looking period of one, three or five years, could result in a drive towards lower cost default funds. This doesn’t sit well alongside an initiative to invest in UK productive assets which, typically, are longer term investments with higher fees and lower returns over a shorter period. Essentially, there is a potential tension between the Government’s current two main policy objectives for DC arrangements.

In addition, in our view, there is an adjacent risk that with currently just a small number of managers focusing on UK infrastructure and private equities, those managers may not be able to access enough opportunities to fill up their allocation if default fund size is to increase. Large scale pooling of investments could also have unintended wider consequences on the market, including an increase in liquidity risk.

Q10: We would welcome views on what further interventions or regulatory changes might be necessary or beneficial to accelerate this process?

A number of legal and tax hurdles prevent schemes from consolidating, including the existence of hybrid benefits, benefits with underpins or guarantees and members who have tax protections, in particular protected tax-free cash. These are expected to cause problems for schemes facing the new VfM assessments too. There is a real risk that some schemes will be “trapped” between a situation of non-compliance with regulatory requirements (failing to meet the VfM test and/or the minimum AUM/number of defaults requirements), and failure to meet trust law duties (failing to protect existing entitlements).

Chapter 3 – Contractual override without consent for contract-based arrangements

Question 12: Under what circumstances should providers be able to transfer savers to a new arrangement without their consent?

As a general point, we fully support the policy intention to enable contractual overrides for contract-based pension arrangements, subject to appropriate protections. In our view, there is a clear need for these proposals and clear benefits, but the detail needs to be worked through. It should also be noted that in the current market there are sometimes wider issues at play that could influence whether a transfer can be made, even when it would be in the members’ interests. We would welcome anything which removes these barriers, as long as it’s clear why the transfer is in the members’ interests.

It may be appropriate for transfers under the contractual override not to all be treated in the same way. For example, it should be easier to transfer a legacy arrangement which is clearly not value for money and where there are no GARs etc, compared to a transfer of an arrangement where the benefit is more marginal.

Question 13: Do you think that an independent expert, such as an IGC, should be responsible for undertaking the assessment of whether a transfer is appropriate?

In practice, IGCs have been set up as non-executive strategic oversight committees which operate as a “check and balance” on the provider’s key activities when it comes to value for money. The proposals, as currently articulated, potentially mean that IGCs would need to get more in the weeds of whether or not transfers are appropriate. This would likely involve detailed segmentation of member demographics and a technical understanding of how the transfers operate and would change the role of the IGC from that of a body which provides strategic oversight to an operational decision-making body.

We would support a role which sits more squarely within the IGC’s current role, oversight, ie reviewing the provider’s detailed assessments. We think it is preferable for the IGCs to take on this more limited role in the process, acting simply as a “check and balance” on the provider’s decision to make a transfer, rather than for the IGC to act as the primary decision maker.

This alternative approach would also sit more neatly within the consumer duty requirements which are applicable to providers and would avoid a situation where the role of the IGC could cut across these requirements.

Question 14: What, if any, changes may be needed to the way an IGC’s role, or their responsibilities/powers for them to assess and approve contractual overrides and bulk transfers?

When discussing this with the industry, it became clear very quickly that there are different understandings of exactly what is meant by “assess” and “approve” for these purposes. We think the Government will specify exactly what it means here.

If “approve” is taken to mean an executive, binding decision, the proposal would bring an IGC’s role closer to that of trustees. However, trustees and IGCs have different roles from a legal perspective. Trustees are the legal owners of pension scheme assets, with the power to move those assets, and must look after those assets in the interests of the scheme’s beneficiaries (the members and, potentially, the scheme sponsor). In contrast, IGCs are not asset owners and do not have such duties or powers to approve a movement in assets.

We think that if “approval” is taken to mean a check and balance review and oversight of a provider’s decision to transfer, as articulated in Question 13, then we think this would sit more neatly within the IGC’s current role. It would, however, add considerably to the IGC’s workload, which will need to be factored in, with appropriate resource.

Question 15: What, if any, role should the employer have in the transfer process?

In the case of a legacy arrangement, we do not think the employer should have a role in the transfer process. Where there are active arrangements with ongoing contributions from the employer, then the employer should have a role.

Question 16: For active schemes, would a transfer require a new contract between the employer and provider?

Yes, in the case of current “live” contracts for active members, it will depend on the terms of the contract, but we expect that in most cases, a new contract would be required. We have found that when advising on transfers from one arrangement to another within the same provider, there are a number of other issues to consider, including but not limited to meeting automatic enrolment and re-enrolment requirements, barriers arising from the requirements in respect of Part VII transfers, investment and platform provider contracts. This is an area which needs to be carefully thought through.

Question 17: What procedural safeguards would be needed to ensure that a new pension arrangement is suitable and in the best interests of members? What other parties should be involved and/or responsible for deciding the new arrangement?

First and foremost, the transfer needs to be in members’ interests (ie in line with COBS requirements around VfM and the FCA principles for business). There is very little/no mention of the interests of members in the consultation.

Any transfer would also, as a minimum, need to satisfy the consumer duty requirements. In practice, we think that this means that some assessment of whether the new arrangement provides value for members, taking into account the cost of the transfer, will need to be carried out and a framework may need to be put in place to this end.

Consideration would need to be given to the extent to which a provider/IGC would need to consider a transfer to another provider or whether it could just focus on other pension arrangements within its own portfolio, for example through undertaking external comparisons or benchmarking.

Question 18: Do you foresee any issues with regards to transferring savers from contract-based arrangements to either other contract-based arrangements or trust-based arrangements? If so, what issues?

We have advised a number of providers on transfers without consent from one contractual arrangement to another. Transfers from contractual arrangements to trust arrangements are less common but we are starting to see more of these considered. In short, whilst these transfers are quite often possible, they are invariably complex and typically require the provider to accept risk in aspects of the transfer. We would be happy to discuss this with the Government in more detail separately should this be helpful.

In terms of more general comments, the Government may want to bear in mind that individual savers could be satisfied with their current arrangement (particularly if it is not a workplace scheme) and not consider the new arrangement to be appropriate for them. For example, it may have fewer/different investment options or different fees. Although this is unlikely to be an issue where the transfer has been prompted by the original arrangement being deemed not VfM, there may be some members who wish to remain in the original scheme. Thought will be needed as to how to communicate a mandatory transfer to such members.

It is also worth mentioning that providers may have certain contractual arrangements that other schemes are not willing to accept. For example, schemes are unlikely to be willing to replicate a GAR (assuming schemes with guarantees would be in scope of the override). In addition, if the market has been very active, then some schemes may be at capacity and not able to accept a transfer.

Chapter 4 – Costs versus Value: The role of employers and advisers

For this chapter, we have provided some general comments.

Whilst we agree that employers should have to review their pension arrangements on an ongoing basis, we do not think this should take the form of a value test, given trustees and IGCs are already required to carry out a separate VfM assessment. Rather, we consider that employers should consider on a regular basis eg every 3-5 years, whether the arrangement remains appropriate for their workforce.

Regarding the advice some employers receive on pension arrangement selection, there are certain advisers/benefit consultants who benchmark master trusts and other arrangements and in doing so can have an impact on the market. There may be less of a role for these consultants once the VfM framework is in place, however, there will still be a need for VfM data interpretation. One solution might be for TPR to have its own benchmarking service.

We would also add that, in our experience, we do not see these advisers placing excessive weight on cost savings (as is suggested in paragraph 108), this focus tends to come from the employers. Costs are usually just one aspect of any benchmarking review, and matters such as investment performance, customer experience and administration service levels are always considered in the transfers we have seen take place.

[1] Evolving the regulatory approach to master trusts