How new regulation is boosting trust in workplace pensions

Work­place pen­sions is a mar­ket in flux. For more than two decades, employ­ers have been replac­ing final salary or defined ben­e­fit (DB) pen­sions with defined con­tri­bu­tions (DC) arrange­ments.

The rea­son is sim­ple. Employ­ers are no longer pre­pared to shoul­der the risk of DB scheme lia­bil­i­ties and have passed the invest­ment risk on to the often-unsus­pect­ing employ­ee mem­ber.

In 2012, the gov­ern­ment launched the auto enrol­ment (AE) project to dri­ve up the num­bers of employ­ees sav­ing into pen­sions, reduc­ing pen­sion­er pover­ty and the bur­den they might place on the state. On face val­ue, it’s been a resound­ing suc­cess. Since Octo­ber 2012, more than 10.5 mil­lion indi­vid­u­als have been enrolled in work­place pen­sions who pre­vi­ous­ly were inel­i­gi­ble or had sim­ply opt­ed out. How­ev­er, the amounts saved into work­place pen­sions are small – and falling over time, accord­ing to data from The Pen­sions Reg­u­la­tor (TPR). 

Peo­ple haven’t got the tools to under­stand that because they haven’t had any finan­cial edu­ca­tion

So after almost a decade, the gov­ern­ment is increas­ing the pres­sure on employ­ers to not sim­ply offer pen­sions, but to improve those offer­ings to employ­ees. New require­ments in the Pen­sion Schemes Act 2021 for DC schemes include beef­ing up enforce­ment, increas­ing dis­clo­sure and report­ing require­ments and direct­ing schemes to pre­pare for the pen­sions dash­board project, which is cur­rent­ly in progress but has suf­fered numer­ous delays.

Better protected

Helen Ball, a part­ner at spe­cial­ist pen­sions law firm Sack­ers, says AE was the cat­a­lyst for improv­ing pro­tec­tion of the aver­age DC scheme mem­ber. Pre­vi­ous­ly, there was lit­tle law specif­i­cal­ly gov­ern­ing DC; once AE was imple­ment­ed, a code of prac­tice was pro­duced, quick­ly fol­lowed by reg­u­la­tions.

“It def­i­nite­ly has improved and tight­ened up deci­sion-mak­ing,” says Ball. “A sim­ple exam­ple is that many DC schemes would not have reviewed their invest­ment strat­e­gy often, or even at all. There is now a legal require­ment to review the default invest­ment strat­e­gy every three years.” 

TPR’s insis­tence on greater board diver­si­ty for DC trustee boards and the lengths it went to autho­rise mas­ter trusts in 2017 have also dri­ven up stan­dards, says Ball. How­ev­er, she asks whether that real­ly tar­gets the schemes that con­cern the reg­u­la­tor the most: non-com­pli­ant schemes that are often small­er in size. TPR has also acknowl­edged that small schemes are not nec­es­sar­i­ly bad schemes.

While the aver­age mem­ber is now bet­ter pro­tect­ed, that doesn’t improve their under­stand­ing of the qual­i­ty of their scheme. It also doesn’t pre­pare them for the retire­ment they might expect.

An uncertain future

Accord­ing to con­sul­tan­cy group Aon’s DC Pen­sion and Finan­cial Well­be­ing Employ­ee Research 2021, employ­ees are con­cerned about sav­ing for the future. A quar­ter believe they will nev­er be able to retire and at least half think they will have to work past the age of 68. Almost nine in every 10 (87%) expect a short­fall in their retire­ment income. 

Some say they’re pre­pared to save more in the future or economise in retire­ment, but 11% accept that they do not know how they will address this. 

Despite these fears, almost three quar­ters (71%) have no idea how much they need to save before they can retire, with the num­ber high­er among women (76%). 

Per­haps of great­est con­cern should be that 63% of those with the least time to save – respon­dents above the age of 55 – have not set a goal for retire­ment.

Almost two thirds of employ­ees (63%) feel they aren’t sav­ing enough to meet their long-term needs, while a third say they can prob­a­bly afford to save more. Few­er than a third say they can’t afford to save more for the future and a quar­ter (25%) say that oth­er finan­cial goals are more impor­tant now. How­ev­er, more than a third (34%) say there’s noth­ing stop­ping them from sav­ing more now.

“Peo­ple haven’t got the tools to under­stand that because they haven’t had any finan­cial edu­ca­tion,” adds Ball. “That’s real­ly why schemes are being com­pelled to demon­strate val­ue for mem­bers.”

Putting the member first 

The Aon data shows that one in sev­en employ­ers are look­ing to save mon­ey in the way they run their DC plans. There has cer­tain­ly been a move away from run­ning small schemes. TPR data shows that while the vast major­i­ty of schemes are micro schemes with few­er than 12 mem­bers, the num­ber of small schemes has been falling year on year.

While there may have been good rea­sons for run­ning a stand­alone DC scheme in the past, the need to demon­strate val­ue for mon­ey to mem­bers is forc­ing schemes to look for an alter­na­tive. Even some large schemes of more than £1bn in assets have realised that some­one else may be able to do a bet­ter job of man­ag­ing the pen­sion than they will in the future. 

The reg­u­la­tor is keen to have a sim­pler mar­ket to over­see with few­er mov­ing parts, though this does not man­date con­sol­i­da­tion with a third-par­ty spe­cial­ist such as an insur­er or mas­ter trust. Employ­ers who choose the path of con­sol­i­da­tion have a respon­si­bil­i­ty to con­sid­er the best val­ue, says Alis­tair McQueen, head of retire­ment and sav­ing at the insur­er, Avi­va.

“We must always remem­ber that when we – employ­ers, trustees, or reg­u­la­tors – talk of con­sol­i­da­tion, we are in fact talk­ing about oth­er peo­ple’s mon­ey,” says McQueen. 

“The val­ue an indi­vid­ual has in their cur­rent pen­sion arrange­ment can only be judged by that indi­vid­ual them­selves.”

The Aon research shows that few have an informed opin­ion of their scheme, but McQueen is con­fi­dent that most employ­ers are con­scious of their duty of care to their employ­ees’ finan­cial futures.

“Any good employ­er will act in the best inter­est of their employ­ees. The fastest grow­ing sec­tion of this mar­ket is mas­ter trust, but the employ­er and trustees must decide whether that is the right thing to do.”

Bigger, better, stronger

For employ­ers select­ing a busi­ness to run their work­place scheme, it’s vital to con­sid­er whether the cho­sen com­pa­ny is com­mit­ted to the long term. “There will be fur­ther con­sol­i­da­tion with­in the mas­ter trust mar­ket,” says Andrew Chesel­dine, a pro­fes­sion­al trustee and chair of the trustee board at mas­ter trust Smart Pen­sion.

While there are almost 40 to choose from, at least 10 of these are hybrids with spe­cif­ic func­tions or mar­kets, while oth­ers have yet to achieve crit­i­cal mass. 

“A num­ber of mas­ter trusts are look­ing to grow or leave the mar­ket because they’re not cost effec­tive at their cur­rent size,” he says.

Since their autho­ri­sa­tion, mas­ter trusts are finan­cial­ly stronger. Like insur­ance com­pa­nies – which have their own mas­ter trusts – they are required to keep reserves. 

“While there may be some dis­ad­van­tages, such as not hav­ing the same tai­lored ser­vice when mov­ing to a mas­ter trust, by and large, mem­bers will be in a stronger scheme and may gain some com­fort from it hav­ing a brand they are famil­iar with,” says Robin Dargie, senior con­sul­tant at Quan­tum Advi­so­ry.

This doesn’t mean schemes will become any cheap­er to run, says Chesel­dine. While there is a charge cap set at 75 basis points (0.75%), an aver­age mas­ter trust will already be offer­ing 50 (0.5%). How­ev­er, it may dri­ve down fees for stand­alone DC schemes.

“Employ­ers will see a ben­e­fit because quite often they’re sub­si­dis­ing DC. The mem­bers will see an improve­ment in secu­ri­ty, because they’ll be part of a much big­ger, bet­ter-reg­u­lat­ed scheme,” he adds.

Small pots

AE has caused anoth­er prob­lem that won’t be resolved by con­sol­i­da­tion of small­er DC schemes. 

Many indi­vid­u­als have small pots from being enrolled for short term or pre­vi­ous jobs.

These pots are often unclaimed by employ­ees, because they have lost track or were unaware they ever exist­ed. The val­ue of these pots is under­mined by ongo­ing charges and con­sumers would be bet­ter off if they were put to work in a sin­gle pen­sion vehi­cle.

There are cur­rent­ly 3 mil­lion such pots worth less than £100 and 9 mil­lion under £2,000, says Chesel­dine, who is on a work­ing par­ty look­ing for a way to con­sol­i­date them. 

“At the cur­rent rate, there will be 20 mil­lion small pots in exis­tence by 2025,” says Chesel­dine. “While this is quite a sep­a­rate issue from dri­ving up stan­dards through con­sol­i­da­tion, it does­n’t mean that we shouldn’t think about it, as both mat­ters could have a con­sid­er­able impact on incomes in retire­ment.”

A brave new DC world

The pen­sion busi­ness isn’t known as a hotbed of inno­va­tion. Rev­o­lu­tion, when it comes, tends to hap­pen at a glacial pace. Col­lec­tive defined con­tri­bu­tion (CDC) is no dif­fer­ent. 

The Pen­sion Scheme Act 2021 final­ly pro­vides leg­is­la­tion to allow the for­ma­tion of CDC schemes. Like DB schemes, employ­ers pay a fixed rate of con­tri­bu­tions into the scheme and mem­bers are paid pen­sions. How­ev­er, the dif­fer­ence is that increas­es on those pen­sions will vary accord­ing to afford­abil­i­ty. This way, an employ­er can share the risk of pro­vid­ing such a ben­e­fit with the mem­bers. 

The attrac­tion for employ­ers is fixed costs, so their pen­sion bud­gets won’t vary. 

Mem­bers may expect a pen­sion pay­ment on aver­age 70% high­er than they might achieve from buy­ing an annu­ity with a DC pot, and 40% high­er than pro­vid­ed under a typ­i­cal DB scheme, accord­ing to research by con­sul­tants Willis­Tow­er­sWat­son.

The val­ue an indi­vid­ual has in their cur­rent pen­sion arrange­ment can only be judged by that indi­vid­ual them­selves

Volatil­i­ty – the curse of DC invest­ments, par­tic­u­lar­ly for those close to retire­ment – is smoothed out so that pen­sion lev­els are rel­a­tive­ly sta­ble. CDC may also mean there’s less chance of mem­bers out­liv­ing their assets, as is the dan­ger with an income draw­down solu­tion.

Trade unions are rather more pos­i­tive about the poten­tial for CDC than tra­di­tion­al DC. In fact, the Roy­al Mail and Com­mu­ni­ca­tions Work­ers Union have been lob­by­ing hard for a change in leg­is­la­tion so a CDC scheme for up to 140,000 mem­bers might be cre­at­ed.

Aviva’s McQueen can see why Roy­al Mail finds CDC an attrac­tive alter­na­tive. As a large employ­er, it has a high­ly unionised work­force, while it cur­rent­ly has a DB pen­sion arrange­ment. Such fac­tors make CDCs attrac­tive to such a unique, estab­lished employ­er. 

“We will watch with inter­est to see how it takes advan­tage of it,” McQueen adds. 

CDC has its crit­ics, too. For­mer pen­sions min­is­ter Baroness Ros Alt­mann of Tot­ten­ham is “very ner­vous” about the intro­duc­tion of CDC. One of her con­cerns is the poten­tial impact of the abil­i­ty to trans­fer out of the scheme on the scheme itself. 

“There is no pro­vi­sion for risk mar­gin here,” says Alt­mann. “If you trans­fer out, the expec­ta­tion seems to be that you get the full cur­rent val­ue. While you are per­fect­ly enti­tled under the cur­rent legal sys­tem to do this, I think there should be a hair­cut to the trans­fer val­ue.”

Alt­mann sees the poten­tial unfair­ness, which could lead to dif­fer­ent gen­er­a­tions select­ing against each oth­er and max­imis­ing their cut. This could under­mine the point of a col­lec­tive vehi­cle.

“The risk to the indi­vid­u­als in the CDC scheme could be that it deliv­ers no pen­sion at all,” she adds. 

Cap­i­tal Cranfield’s Chesel­dine also strug­gles with bal­anc­ing fair­ness for all mem­bers with the abil­i­ty to trans­fer out of the scheme. But despite his reser­va­tions, he thinks CDC could be a use­ful tool in post-retire­ment ben­e­fits.

“It’s a good start and using an organ­i­sa­tion like Roy­al Mail will help to test the mod­el, because it is such a big organ­i­sa­tion,” says Chesel­dine. 

“How­ev­er, the prob­lem will come when peo­ple start try­ing to sell it to much small­er organ­i­sa­tions with less sta­ble work­forces.”

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