Sunak’s 2021 budget amounts to a kick in the backside to workplace pensions that could do for workplace pensions what the pension freedoms did to annuities. By workplace pensions, I mean the savings schemes funded through payroll and joined by auto-enrolment. I’ve embedded the Chancellor’s own summary of his budget at the end of this blog, I have no doubt of his intent and the energy behind it. His 11 at 11 does not mention pensions but the investment proposals in it are dependent on the unlocking of the trillion pounds we have saved so far , through payroll.
A game-changer for pensions?
First let me explain why I see this budget as such a game-changer for workplace pensions and why it may prove as important to pensions as 2014.
Before pension freedoms , the way we spent our pension was prescribed. Most people had to buy an annuity and only the independently wealthy could drawdown.
Before this budget, most workplace pensions were restricted in their investment strategy to a narrow range of investments, managed with little discretion against an index. The Treasury wants that to change and though Government will be consulting on change (unlike the freedoms) a change is going to come.
In September of last year, the DWP floated the ideas now being promoted by the Treasury. I have written about the DWP’s consultation “Improving Member Outcomes” at length. There is nothing in Sunak’s statement on pension investment in the budget that is not in the September consultation, but this time the message is from all Government and delivered on a bigger stage.
What is the DWP saying?
In summary, the paper proposes that workplace pensions invest for better member outcomes in a variety of assets that can variously be described as “patient capital”, “impact”, “social purpose” and “illiquid”. These assets do not fit within the framework of the current charge cap, so the charge cap will be re-written so that they do. They will be invested in more for their value than for the cost of the investment.
This re-write is gong to be very controversial, though the existing cap has never pretended to take into account the full cost of investment, accepting there have always been hidden charges that it does not cap. But the scale of potential charges that could be born by members to access these new investments could be much greater and while the cap itself will not change, its inclusivity will further reduce.
But the DWP does not consider that an elastication of the charge cap is enough. To invest in these new assets will take more skill, better governance and more funds than can be found in small DC schemes. The DWP’s solution is not to improve small DC schemes but to encourage them to wind up.
The market is continuing to consolidate, with a 12% fall in scheme numbers in the past year. Employer switching is expected to continue at a rate of between 5 and 10% each year. However, schemes at the smaller end of the market are consolidating more slowly, and it is these schemes that are the focus of our proposals.
Of around 3000 DC schemes on the Pensions Regulator’s (TPR) register, approximately 2150 have 100 members or less. Of these, approximately 850 have between 12 and 100 members and 1300 have less than 12 members.
The DWP is forthright in its assessment of what must happen
It is proposed that these regulations will come into force on 5 October 2021.
If the trustees of a smaller scheme consider that the scheme is not delivering good overall value following its value for members assessment, Government expects trustees to wind up the scheme and consolidate.
In circumstances where trustees are realistically confident that required improvements can be made, and/or where the wind up and exit costs may exceed the costs of making such improvements, and/or where there are valuable guarantees that would be lost on consolidation, the scheme may seek to improve. If the trustees fail in this attempt to improve they will be expected to wind up the scheme and consolidate the members into a scheme that offers better value.
Trustees must report their proposed approach to TPR. TPR has the power to issue an order to wind up the scheme, to remove trustees in certain circumstances, or to appoint new trustees to properly manage the scheme’s assets.
The fiduciary justification for consolidation is that it improves member outcomes by creating economies of scale which improve governance and bring down charges but the primary driver is that it allows large schemes to access the new investment opportunities envisage in the budget
Where do you set the bar for consolidation?
In its 2019 consultation, the bar for consolidation was set at £10m, in the 2020 consolidation it was set at £100m. It is generally considered that the bar for consolidation could rise higher leaving all but a very small number of own occupational workplace pensions with the vast majority of large employers participating in master trusts. This trend is already well underway with employers like Tesco and Vodafone no longer operating their own trusts but participating in multi-employer schemes.
It is quite possible that the bar could rise higher to £1,000m or higher.
But for consolidation to happen, there needs to be the approval from small scheme trustees, to hand over the keys , resign their responsibilities and wind up the trusts. This will be done with a heavy heart as many trustees are wedded to their schemes and the schemes themselves support a wide eco-system of intermediaries who have nothing to gain from consolidation.
Unless there is clear evidence that a small scheme is damaging member interests, the DWP is unlikely to see the kind of consolidation it (and the Treasury) is looking for. However the overt support for the consultation in the budget is likely to strengthen the DWP’s resolve and lead to a much harder line on the use of TPR’s powers to wind up schemes and remove trustees.
So watch out for a tough new consultation coming from the DWP in the weeks to come that will be “cap-busting” and firmer guidance on small schemes to carry out value for money self-assessment. As for action, it is hard to see how the DWP can put it more plainly than they did in September
It is not acceptable for savers to be enrolled in arrangements that do not deliver value in terms of costs, investment returns or secure and resilient governance. Government would expect trustees acting in the best interests of their members to take appropriate action to wind up and consolidate without TPR needing to exercise its powers.
The menace of consolidation is not consigned to small schemes. The FCA’s Value for Money consultation CP20/9 makes it clear that where IGCs come across failing employer schemes within the GPP’s they have oversite for, they should also intervene – showing alternatives that are more in the interests in members. Where there is no scope for improvement within the current GPP, the FCA are suggesting alternatives , specifically mentioning People’s Pension and Nest.
Whether the instrument for change is the Regulator, the Trustees or the employer, the driver for change is clearly Government and what is new about this is that the Treasury and the DWP seem to be acting in concert and with shared ambition. This has not always been the case in the past.
What does the budget means for workplace pension schemes?
In the short-term it will mean a lot of value for money assessments and benchmarking. It may means more standardization of VFM and a strengthening and simplification of the common definition as part of this.
It will mean a lot of work on data where small schemes decide to pack-up. Many small schemes have worries about their data and those concerns will crystallize at wind-up.
It will undoubtedly mean some difference of opinion between tPR and trustees on the ongoing viability of schemes and some enforcement by tPR using their powers.
In the medium term it will mean remaining workplace pensions becoming more ambitious in their investment strategies and passing on the costs of those strategies to members (justified by potential added value).
Not all schemes will be able to deliver value through investment and there will be further consolidation. It is possible that within a decade the number of multi-employer schemes left could be counted on the fingers of both hands, there might be even less single employer schemes. Some of the best single employer schemes may even convert to multi-employer if they see the commercial opportunities to deploy their skills wider
In the longer term this select group of occupational workplace pensions will continue to compete with contract based workplace plans and may seek commercial advantage in their ability to pool funds and provide scheme pensions using CDC legislation and regulations.
This is a major opportunity for master trusts which – if they take it – will mean they are managing money to and through retirement and not giving back value to annuities or drawdown within insured arrangements.
In this scenario, the binary choice will be between wealth management , typically advised and pension management, overseen by trustees.
Though the number of occupational schemes will be massively reduced, this does not mean their importance will be reduced. But their value – both to members and to society at large, may have substantially improved.
This is the video put out by the Chancellor to the Conservative faithful.