DC investment administration – ripe for disruption.

Nico Aspinall, the doyen of DC CIOs has written the first of what I hope will be several “briefing notes” that he introduces as follows.

In my first briefing note I discuss why DC schemes need to remove their life platform and get with the custody solution.

Life company platforms are now the opaque, overly simplified, inflexible solution to problems many DC schemes have grown out of. It’s time to stop tinkering around the edges on this problem and move forwards constructively.

I estimate there are of order 30-40 schemes, maybe half of the assets in DC trusts, who should be actively working out what they can move to and benefit from the custody platform business.

At the same time too much is loaded onto the client in terms of managing the platform and it’s scary to think about the responsibility that comes with the power custody offer . Custody banks need to simplify what they ask of clients.

If you’re a Master Trust trapped by ownership in the insurance world: you have my sympathy. I think you’re going to watch the DC world becoming more sophisticated around you, slowly, but surely. Will value for members mean you have to make the change, or close?

You can read the full note here.

Let’s try to challenge these arguments and see where it gets us.

Aspinall argues that there are 30-40 DC schemes where members would get more value from the life company being rolled out of it and assets held either directly or in funds by the scheme’s custodian.

If life companies are offering an unnecessary layer of intermediation, why has nothing changed in the past thirty years? Change is driven either by competition, ease of use or regulation

Competition;  frankly , the buyers of workplace DC services, principally employers via their trustees but also employers from providers , are dependent on consultants. Employers are not good buyers as they do not have the skillset or the motivation to get the best deal from the workplace pension.

And they get no pressure from the people who they are buying services on behalf , because their staff are in no position to judge good from bad. They have no measure of value for money. It is as the OFT said in 2014.

With a weak “buy-side”, consultants have focussed on the “must haves” – typically compliance with auto-enrolment regulations, followed by the “nice to haves” – an engaging pension scheme that provides members with a quality service (and a minimum of complaints. The investment return that members actually receive is relegated to the bottom of buying and governance factors ‘ “the benefits occur a long time in the future“.

Against which argument , employers are waking up to the fact that the “future is now”. People are claiming on the pension pots and we know that for savers “outcomes matter”. Nonetheless, with no effective benchmark of what a good outcome looks like, it is still the case that outcomes are in practice a low priority issue and competition will not drive a shift to lower intermediation and better outcomes.

Ease of use; custodians operate at scale and demand that their users are technically competent to interact directly with them. Nico Aspinall touches on this problem when he says

Custody banks need to simplify what they ask of clients.

It is all too easy for trustees to outsource investment administration to life companies , rather than face the risk of maladministration from third party or in-house administration teams. Indeed the hegemony of life platforms arose out of the errors made by record keepers who were used to the relatively lax standards of DB investment , being called upon to administer DC schemes. Daily pricing, lifestyling and the risks associated with being out of the market, or worse being in the wrong market, are unacceptable to trustees.

Life companies offer and will continue to offer a value proposition that de-risks DC investment administration. The cost of this is passed on to members through higher fees and therefore reduced outcomes. But in the absence of competition at the member level, this has gone uncontested.

Why haven’t the custodians improved their direct to trustee offerings? Why do multi-billion pound  DC schemes use a sub-optimal investment administration system. The answer is that life company platforms are easy to use and custodial platforms aren’t.

There are big conflicts here, custodian banks act for life companies, there is very little  in it for them, to be gained from disintermediating their clients (and a lot to be lost).

Regulation; there is an assumption that big is beautiful and it’s driving the DC consolidation argument. The DWP and TPR would be pleased were there only 30-40 DC schemes in the UK. They are not pleased that there are 100 times that number.

But Government does not get involved in the granularity of “value for members”. It insists on net performance tables as a means of benchmarking VFM between schemes but these performance tables do not take into account the impact of investment administration as they simply measure fund performance net of fund costs.

The losses incurred by using a life platform are not transparent but they are real.  They can be measured by comparing the achieved internal rates of return against the predicted rates of return using net performance tables. Again and again, achieved returns are lower than predicted returns and most of the reason for that is the friction created by investment administration.

Nico Aspinall’s arguments go much further than this friction, they focus on the difficulties of holding alternative or ~”private market”  asset on a life platform relative to a custodial platform. The regulatory response to this problem has been the Long-term-asset-fund (LTAF) which is now being touted as an investable within life wrappers.

This is not what LTAFs were invented for, they were designed to be held directly by DC schemes on custodial platforms but this has not happened because regulators have not understood that life platforms rule the roost.

So regulation has the right intent but in practice is foiled by life platforms that prevail because no one is too worried about their impact on outcomes and because even regulators value the quiet life of sub-optimal but compliant administration over best practice.

Best practice must prevail

Aspinall says it is time for DC to grow up and he is right. But in order for it to grow up we will need a more competitive market with consultants demanding higher standards and better outcomes. Right now the debate is stuck on price as quoted price is what employers are buying on. We need our good consultants to move the market on.

We need custodians to listen to the demands of consultants for better standards. Nico Aspinall should not be a lone voice in this, he needs the major actuarial firms to take a lead as they have exclusive access to the 30-40 schemes capable of moving to a custodial platform today. We could do with research from the teams at Hymans , LCP, BW , Isio and the other independent consultants (e.g. who do not run master trusts sitting on life platforms). That research needs to focus on the cost of life platform administration and the opportunity cost of not directly investing directly into private markets.

Finally, we need the DWP ,tPR and FCA, in their work on Value for Money, to explain why they see value being driven out of consolidation and why they see it as important that the bar on DC scheme size needing to consolidate, is raised.

I agree with Nico Aspinall that we do not need more than 30-40 DC schemes to optimise value for members.  Focussing on removing life companies from these super schemes is a good idea.

Focussing on what really matters for members is a secure and improved retirement income≠


About henry tapper

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