Small defined contribution pension schemes face big regulatory changes

Small­er occu­pa­tion­al defined con­tri­bu­tion (DC) schemes must now under­go a new and enhanced val­ue for mem­bers (VFM) assess­ment. While the new sys­tem aims to secure the best pos­si­ble deal for pen­sion savers, it could have impli­ca­tions for advis­er costs, fund admin­is­tra­tion and more. 

In Octo­ber the UK gov­ern­ment and The Pen­sions Reg­u­la­tor (TPR) intro­duced the new VFM assess­ment for DC schemes with less than £100m. These funds must com­pare their costs, charges and invest­ment returns against three oth­er schemes. They also have to con­duct a self-assess­ment of their gov­er­nance and admin­is­tra­tion in line with sev­en key met­rics.

The schemes must then report the out­come of the assess­ment in their annu­al chair’s state­ment and pro­vide the find­ings to TPR in a scheme return. If the trustees can’t demon­strate that their scheme offers VFM, they will be expect­ed to wind it up and trans­fer their mem­bers into an alter­na­tive scheme.

Auto-enrolment success

The move has been part­ly prompt­ed by the suc­cess of auto-enrol­ment, with more of us than ever sav­ing into DC schemes. TPR does not want any­one to “be left lan­guish­ing in poor­ly gov­erned schemes which do not offer the same val­ue as larg­er schemes,” as its exec­u­tive direc­tor for reg­u­la­to­ry pol­i­cy, analy­sis and advice, David Fairs, puts it.  

It’s thought the gov­ern­ment believes larg­er schemes have the resources avail­able to ensure good gov­er­nance. They can also nego­ti­ate low­er charges thanks to economies of scale. 

“Small­er schemes are per­ceived by the gov­ern­ment as hav­ing more lim­it­ed invest­ment oppor­tu­ni­ties, where­as a large mas­ter trust with assets in the bil­lions may be able to take advan­tage of sig­nif­i­cant infra­struc­ture invest­ment oppor­tu­ni­ties,” says Suzanne Bur­rell, pen­sions part­ner at Shoo­smiths, a law firm. These might include trans­port projects and efforts in the sus­tain­able ener­gy space.

The mas­ter trust autho­ri­sa­tion regime also set a high bar for every pen­sion scheme in the UK with require­ments includ­ing proof of finan­cial sta­bil­i­ty and a test to check that those run­ning the scheme are fit and prop­er to do so. With every mas­ter trust now demon­strat­ing that it pro­vides VFM for its mem­bers, this was the nat­ur­al next step for the DWP and TRP.

“I’ve seen a num­ber of our clients move their defined con­tri­bu­tion schemes into mas­ter trusts in recent years and this has been eas­i­er to accom­plish fol­low­ing the intro­duc­tion of the autho­rised mas­ter trust regime,” says Bur­rell. “It’s like­ly that the new val­ue for mon­ey assess­ment results in a fur­ther wave of con­sol­i­da­tion of DC sav­ings.”

Some employ­ers, she observes, may have tak­en a delib­er­ate deci­sion to retain a DC scheme in-house so that that they don’t have to unrav­el some of the ben­e­fits that they pro­vide. These might include a “with-prof­its” pol­i­cy, which is aimed at smooth­ing out the peaks and troughs in the val­ue of mem­bers’ invest­ments caused by mar­ket volatil­i­ty.    

The ben­e­fits might also be pro­vid­ed as part of a hybrid arrange­ment in a scheme which cov­ers both DC and DB ben­e­fits. Although hybrid schemes are not exempt from the VFM, some believe the DWP might look at them if their assets exceed £100m but the DC ele­ment is less than £100m.

Costing time and money

What­ev­er the ben­e­fits to savers and the country’s infra­struc­ture, estab­lish­ing the new regime could take a sig­nif­i­cant amount of man­age­ment time by admin­is­tra­tors and dri­ve up advis­er costs, in the short term at least. As a result, some schemes might opt to look for con­sol­i­da­tion oppor­tu­ni­ties to man­age these addi­tion­al costs and admin­is­tra­tive require­ments, even if they can tick the VFM box. 

Where schemes can’t sat­is­fy the VFM require­ment there will be even more work to do. How­ev­er, that could pro­vide com­pa­nies with the time and space to rethink their pen­sion fund strat­e­gy and ensure that what­ev­er new scheme they intro­duce meets not just their rewards objec­tives but their cor­po­rate cul­ture. Could their scheme help play a role in their cor­po­rate social respon­si­bil­i­ty (CSR) or envi­ron­men­tal, social and gov­er­nance (ESG) goals, for instance?

The require­ments could boost mas­ter trusts. “This is the biggest oppor­tu­ni­ty to grow their client and asset base since the intro­duc­tion of auto­mat­ic enrol­ment,” says Mark Pem­berthy, prin­ci­pal and ben­e­fits con­sult­ing leader at Buck, a pen­sions, HR and employ­ee ben­e­fits con­sul­tan­cy. “The major mas­ter trusts are all posi­tion­ing them­selves to be the merg­er scheme of choice and the next few years will define the shape of the DC mar­ket for years to come. Sim­i­lar­ly, asset man­agers con­tin­ue to work hard to win invest­ment man­dates from the mas­ter trusts in order to par­tic­i­pate in the rapid­ly grow­ing DC pen­sion mar­ket.”

The move by the DWP and TPR could accel­er­ate the growth of mas­ter trusts, which added £30bn in assets in 2020, large­ly thanks to con­tri­bu­tions from auto-enrolled mem­bers, accord­ing to research by fin­tech firm Broad­ridge. They will enjoy a growth rate of 24% a year to amass £461bn in assets by 2029, by which time they’ll account for 75% of total trust-based assets.

Expanding scope

How­ev­er, many won­der if the VFM assess­ment require­ment will now be extend­ed to larg­er schemes. Last sum­mer the DWP gath­ered evi­dence on the bar­ri­ers and oppor­tu­ni­ties for greater con­sol­i­da­tion of schemes with between £100m and £5bn of assets under man­age­ment. It will pub­lish a sum­ma­ry of the evi­dence received and an indi­ca­tion of its next steps in the com­ing months.

David Snow­don, DC direc­tor at mas­ter trust provider SEI, believes that the mar­ket for mas­ter trust ser­vices will become increas­ing­ly buoy­ant. “Com­pa­nies think­ing of mak­ing the move in 2022/23 should be mind­ful of poten­tial capac­i­ty issues as many oth­ers seek to join a mas­ter trust,” he warns. 

While they should pro­vide val­ue for mem­bers, that doesn’t mean all mas­ter trusts are the same, Snow­don adds. “It’s impor­tant to find the right fit for your scheme mem­bers, with providers out there vary­ing between frills or no frills, off the shelf or tai­lored, mass mar­ket and bespoke,” he says. “And with a con­sol­i­dat­ing, con­tract­ing mas­ter trust mar­ket, employ­ers should make sure they choose one that’s here to stay.”

Some experts believe these changes will accel­er­ate the con­sol­i­da­tion in DC schemes, a devel­op­ment the gov­ern­ment has encour­aged. The next few years are set to see an increas­ing­ly com­pet­i­tive mar­ket as small­er schemes decide which mas­ter trust to join. This VFM ini­tia­tive will have inter­est­ing ram­i­fi­ca­tions for the entire pen­sions indus­try.