Pension simplification will bring tears at bed-time.

Shouldn’t climate change be giving us sleepless nights?

The illustration is from “Greta and the giants” , an alarming children’s book designed to entertain and inform  from Zoe Tucker (author) and Zoe Persico (illustrator).

I say “alarming” because climate change should be giving me tears before bed-time. I am not the one to pay the price if my generation doesn’t take decisive action now.  It should be me – not the grandchildren who should be alarmed!

I am totally behind the Government’s intention to simplify the private pension framework to ensure we do all we can to mitigate climate risk and improve member outcomes

But how to simplify…

What decisive action can be taken to accelerate the pace of change in our fractured and complex DC pension framework?

The Government faces difficult choices; does it read the equivalent of “Greta and the Giants” to us and hope that those in charge start managing climate risks a little better? Or does it take sterner measures , taking decisions out of our hands and forcing change?

The problem is that the majority of the 42,000 remaining occupational DC schemes are already asleep and need waking up. The same can be said for many participating employers of insured DC schemes.

A prod or a nudge?

So the plan is for fiduciaries to prod plan sponsors (employers) into reviewing current plans and consider whether there may be better alternatives out there. The FCA’s CP 20/9 consultation explicitly mentions two large master trusts (Nest and People’s Pension) as alternatives to employers in failing GPPs , GSIPPs, and Group Stakeholder Pensions.

Maybe this is a prod too far, as this is going down like a lead balloon with the insurers behind contract based plans and not much better with their IGCs and GAAs.

We have yet to see a similar backlash from smaller occupational schemes to the DWP’s proposals in last September’s consultation on improving member outcomes, which argued that DC schemes with less than £100m in assets should consider consolidating to larger schemes (by implication large master trusts) unless they could prove special value to their members.

I am not sure that most DC schemes are taking the DWP’s intent seriously. That sounds like a mistake as Government seems lined up for change.

Whether it be the FCA, tPR or DWP of the Treasury cracking the whip, the message seems to be the same. Workplace pensions are expected to be playing a part in improving the environmental , social and governance practice of those managing UK and global assets. This can best be achieved by consolidating pension provision into a handful of master trusts and groups of personal pensions.

Coercion or compulsion?

The philosophic difference between the Treasury’s agenda to date (freedom and choice) and the DWP’s (nudge) has led to quite different results.

Left to our own devices, we seem to choose reckless conservatism. Cash ISA accounts vastly outnumber stocks and shares accounts.

But the excess returns from invested ISAs over cash ISAs means that there is now more money in Stocks and Shares ISAs, despite their being fewer in number

Left to our own devices, we will adopt reckless caution and  rather than invest for the future but insure our current cash-flows with money in the bank (or the ISA equivalent). I fear the ISA story is repeating itself in the transfer of invested funds to cash at retirement. This certainly seems to be the evidence from the FCA’s Retirement Income Market Data.

The evidence from the laissez-faire policy of freedom of choice is that it does not lead to long-term investment but to short-termism through a dash to cash.

By contrast, a coercive nudge to the default in workplace pensions means that over 90% of workplace pension contributions find themselves invested in stocks and shares and of the remaining 10%, a tiny amount finds its way into cash.

The message is clear, people will accept Government coercion , so long as there’s an opt-out and so long as there is sufficient trust in the system (much the same can be said of vaccinations).

But compulsion is a different matter. Attempts to compel people to save into one fund, or trustees to wind up their trusts or employers to switch workplace pension provider, are unlikely to work in a pension system that values self-determination.

The Government appear determined not to dictate an investment strategy around climate change, not to compel people to save through auto-enrolment and not to force closure of failing DC schemes.

So how does Government simplify pensions without tears at bedtime  compulsion?

The answer appears to be through a variant of “comply or explain”. The TCFD disclosures which large schemes will have to make from later this year, require trustees to adopt targets, if only to ensure they get the right information to know their carbon footprint.

The disclosure on Value for Members, consulted on by the DWP and FCA (with the help of tPR) will similarly not require anything but disclosure of the current state of affairs. But if smaller DC pension schemes cannot explain why they aren’t keeping up with larger ones, they will be expected to wind up and transfer assets to their bigger brethren.

This is a very nuanced game and I’m not sure it will work , unless – that is = the rules are explicit and the comparisons are obvious.

The DWP is  looking at ways to compare one scheme with another using a system of “net returns” which will show which schemes are delivering most value by netting off costs against performance.

But this puts the cards in the hands of the fund managers and consultants specializing in performance measurement and performance attribution. We know that what members get by way of the annual percentage increase in their pot does not always align with what fact-sheets tell them they should be getting, what goes into an internal rate of return is more than the pure performance of the fund.

So the nuancing of net returns will be in the hands of those who have every reason in maintaining the status quo. Small schemes are the lifeblood of many asset managers , consultants and indeed professional trustees. There is no reason why they should vote for their own extinction and if they hold the cards on performance, do not expect many DC schemes to be consolidating on the basis of “self-assessment”.

The urgent need for standardisation

The examples of where Government has been able to improve governance of pensions are few but are instructive. Government can standardize behaviour to a point where market bias is eliminated and decisions are taken on fact not opinion. A good example of this was the construction of cost and charges templates  within the Institutional Disclosures Working Group. These templates have standardized the reporting of costs and charges and are driving down the slippage of performance in fund management because people are aware of what good does and doesn’t look like.

The same has to happen on the reporting of “net performance” and other aspects of the value for money formulation. We cannot go on with a thousand flowers blooming but to no effect, we need to have a simple way of explaining what value people are getting for their money. If we can standardize the definition of value for money, we can standardise how it is measured and if we can get to a standard measure we can get schemes to compare themselves to others and – if they cannot compete – consolidate by winding up.

It is within the Government’s power to create a common definition of value for money and a common way of measuring whether it can be achieved. We believe that reporting should be evidenced based – deriving from experienced returns measured using member data. This is simpler, cheaper to achieve and cuts out all attempts at jiggery pokery through sophistication such as “risk adjusted returns”.

There will be tears at bedtime – for simplification to happen.

To simplify VFM in this way will mean that many of the subtleties with the current value for money framework (adopted individually be each board of  trustees, IGCs and GAAs) will be lost. It will mean that many trustees will find their schemes aren’t economically viable and some insurers may consolidate their workplace pensions with one of the few insurers still active in the market, meaning less IGCs and GAAs than the diminished number today.

My colleague Con Keating tells me that to get full economies of scale from a financial services operator, you need between £30 billion and £40 billion under management. There are very few workplace pensions that have achieved £10bn in assets. The bar that is currently set at £100m in the DWP’s consultation will need to rise considerably over time if full value for members is to be realised.

But that will mean a lot of schemes closing and a lot of tears at bedtime. Are those who parent pensions, those who are taking decisions on the simplification of the current pension framework, prepared for the tantrums?

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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