Tough decisions ahead

As flagged on this blog , the Government is turning the heat on workplace pensions to deliver. The raft of papers produced by the DWP culminate in  new regulations ,

The Occupational Pension Schemes (Administration, Investment, Charges and Governance) (Amendment) Regulations 2021

There is detail on the final Costs and Charges Statutory Guidance dealing with the way the charge cap will be loosened to allow for performance fees. This is the explanation for some minor changes in the guidance

And this leads to the Statutory Guidance on costs and charges itself

and guidance on the completion of the  Value for Members Assessment and Net Returns Reporting

They also include a further paper on the direction of travel with a new call for evidence on further market consolidation.

I will deal with the new consultation and its increase in scope in a separate blog. Here are my reactions to the detail of the new regulations and what they will mean in practice for small and medium size occupational DC schemes.

What does this mean in practice?

What it means is that all employers who run their own workplace pension , rather than participate in a master trust or GPP are going to have to consider why they are doing so. The regulations are being put in place by the DWP but they compliance will be monitored and enforced by the Pensions Regulator. Though the FCA is not directly involved, the comparisons  that smaller occupational schemes will need to make include GPPs overseen by the IGCs and the FCA. So in practice, these changes effect all parts of the workplace pension ecosystem and the shockwaves will be felt by  DB schemes for whom consolidation is also on the Government’s agenda.

The questions sponsoring employers will need to ask fall into two buckets

Bucket one- value; is the scheme offering the employer value for the costs it is incurring maintaining a trust and continuing to justify its existence relative to the scheme’s performance net of charges?

Bucket two- money; is the money the scheme is now costing justified in terms of the opportunity cost either of reinvesting in the business, distributing more to shareholders or paying more into employee’s pension pots?

The cost of providing the management information on which these decisions need be taken will be substantial. Each year, the trustees of smaller schemes will need to provide an exhaustive comparison of costs and charges and net performance , compared to three alternative schemes, one of which must be prepared to consolidate the scheme it is compared to.

Additionally, the paper talks of communicating this to members, introducing a new means of comparison involving the publication of the actual  internal rates of return members receive.

A tough and conflicted decision

Occupational pension schemes provide a living for many investment advisers, fund managers, lawyers, accountants, communication specialists and benefit consultants.

It is not in the interests of this retinue that the scheme closes and it is worrying that the trustees will be using existing advisers to complete the value assessments. We have seen how hard it has been for IGCs and GAAs to declare a GPP to be offering poor value for money and it is unlikely that any trustee will relish being told by those doing the assessment for them that the trust is failing.  Never the less, this is how it will be unless Trustees choose an independent assessment.

I remain unhappy that the principal means of comparison will be around net performance, which the DWP justify as “there needing to be consistency of approach”. In practice, net performance figures will be hard to compare and easy to manipulate to give the answer that trustees want to hear.

“Net performance ; –

1. Will not be the performance of the scheme even on a net basis

2. Will not be an aggregate or money weighted performance of the individual member pots

3. Will not reflect scheme or member dilution / spread / stamp  on  individual and bulk switches – especially lifestyle.

But it will include with spurious accuracy , transaction costs within funds.

Furthermore, the complexity of the various tables that will need to be completed will mean that comparisons will be far from clear. Some performance will show the scheme in a good light, some in a bad and as there is no instruction as to how to weight one cohort of savers against another, trustees will end up with too many numbers and none of them meaningful. The result will be fudges with a view that the comparisons were inconclusive.

Much the same will occur in the governance assessments where the trustees will be asked to mark their own homework.

In short, the new value for money assessments will be tough in the wrong way, they will be tough to measure and tougher to draw conclusions from. Most worryingly, they may not even be accurate and may lead to good schemes closing and poor schemes staying open.

I have told the DWP this in our consultation response and remain opposed to the system of net performance, especially where the advisers charged with doing the assessment have skin in the game with the result.

Enough moaning!

Despite my moaning, we have to live with the assessments. They are supposed to show that small schemes create less value than big schemes. Our work looking at the experienced performance of members (through IRRs) shows that there is a range of performance from very good to awful, amongst smaller schemes, while larger schemes tend to show performance in a narrower band

The PLSA have rightly referred to these value for money assessments as “nudges”.  They force employers to look at their scheme each year from a commercial perspective and I suspect that the much more compelling argument for the employer will be the reactions of staff and unions to any announcements that the scheme is under review.

The meaningful trade offs that will be considered in the boardroom will not be over the niceties of governance, data quality and net performance but over the opportunity costs of not participating in someone else’s scheme. If employees and unions are not coming out in arms over the prospect of a scheme closure , then the obvious cost savings from not running a scheme of one’s own will sway the argument.

Barriers to closure

However there are many barriers to closure that threaten consolidation and the DWP are calling for evidence of what they might be.

I have mentioned the reluctance of scheme advisers to recommend closure of a scheme from which they derive a living. It should be remembered that many multi-employer schemes are run by advisers but consultancies are siloed and revenue targets are personalised, even where there is a chance that the adviser scheme will be chosen to replace an occupational scheme, it is probably not going to benefit the existing adviser on a personal basis.

Secondly , there are issues over data which can best be described as embarrassing. The data we have analyzed is variable in quality

Many schemes we have analysed have high levels of suspect data and trustees may feel exposed, transferring records until they are properly cleaned. That process can be expensive and lengthy and can draw out any scheme wind up for years.

A third barrier to closure is the cost of wind-up. This is a legal matter and it varies with regards to the complexity of the scheme rules and legacy decisions taken to preserve various rights members may have had in the past. These vary from with-profits entitlements and guaranteed annuity rates to defined benefit underpins. These complexities are usually found in hybrid schemes where the DC section was often set up to protect the DB scheme from being wound up. The cost of wind up is usually the cost of meeting the needs of competing claims on other funds which might be lost without due care.

A final barrier is the natural reaction of members to loss. If a scheme is taken away and no proper argument can be given for this happening, members are likely to object. The argument that the new scheme will likely improve member outcomes can only be heard if it can be demonstrated and (as I point out above), the comparison tables on net performance and the analysis of data and governance are unlikely to convince members of the need to change.

The arguments need to be made in a persuasive way , using simplified metrics delivered from an independent source.  I would strongly argue that the cost savings created by scheme closure are shared with staff as an incentive to accept and embrace change.

Verdict

I am pro the direction of travel and keen that consolidation happens. I like the Government’s position and am pleased that they are pressing on. I am not so keen on the detail but am encouraged that the DWP are talking about member friendly means of explaining the benchmarking of schemes.

We will need to see a new and different approach from small employers to workplace pensions and we will also need to see a new approach corporate advisers.

In this highly disruptive phase of change, it is crucial that we are guided by the data.