Why size really does matter in the world of pensions

Research into the effects of economies of scale in our industry show that big is really very beautiful when it comes to pensions.

This is why it’s vital that the Government consultation into improving member outcomes must include lessons from other countries, such as Australia, Canada and the Netherlands.

Lessons from Australia

Australia’s independent Productivity Commission, which advises the government there on policies to improve living standards, reported in 2018 that merging the smallest 50 schemes with the 10 largest would make the average member A$22,000 better off in retirement with the gains much larger for those coming from those smallest schemes.

The findings from ‘Down Under’ backed up findings in earlier reports from Canada and the Netherlands which found the greatest savings were to be made at the administrative layer. This is because the total costs at the administration layer don’t rise much as extra members are added. The size and cost of operating the board of trustees and advisers to the board, for example, are fairly similar regardless of the size of the scheme. Consequently, the cost per member drops as each additional person becomes a member. The independent international pension analysts CEM estimate that every tenfold increase in membership decreases administration costs by 63% per head on average.

All these studies also found that there were cost savings to be made at the investment layer too. They were smaller in magnitude than those at the administration layer but were still significant. The Dutch prudential regulator has found that a Dutch scheme that had 10 times the assets would, on average, lower investment costs by 7.67 basis points. Both Dutch and Canadian research has concluded that the gains are likely to be greatest where pension schemes are able to take some of the investment functions in-house.

A report in October 2012 by the Pension Investment Adviser to the Canadian Deputy Prime Minister and Minister of Finance argued that this lay at the heart of the recognised success of that country’s public sector pension funds; providers that we now regularly come across as owners of UK infrastructure. The Canadian report found that pension schemes needed to have assets under management of $50 billion to maximise their economies of scale at the investment layer.

Proposed changes in the UK market

Here in the UK, the Department of Work and Pensions (DWP) is now proposing to follow in Australian footsteps and require the trustees of sub-scale pension schemes to assess whether they offer value for money and whether they ought to consolidate into a larger scheme. This statutory requirement would apply to schemes that have been in operation for more than 3 years with less than £100 million in assets. The assessment of value for money would relate to net returns and to the other aspects of good governance which The Pensions Regulator (TPR) holds as being key parts of the customer experience.

There’s nothing to suggest that the economics of pensions in the UK are different from other parts of the world. The evidence from self-reporting surveys of trustees conducted by TPR is that the trustees of small schemes are unable to cope with meeting many of their required duties. We also know from surveys conducted by the DWP that charges vary by size of scheme, with higher charges generally applying to smaller schemes.

While a very welcome step forward, it’s unclear why the UK government is proposing to restrict the application of the new duty to schemes with less than £100million in assets. It would seem self-evident that every scheme should have to demonstrate that it offers value for money and if it does not, it should consider exiting the market. The inference from the Australian Productivity Commission’s findings is that schemes with less than A$1 billion (£546m) are unlikely to offer value for money.

The DWP’s consultation response doesn’t contain any economic modelling specific to the UK. It’s to be hoped that the DWP will produce its research on the economies of scale as a necessary part of the cost-benefit analysis needed before a bill becomes law.

The global evidence about the benefits of bigger, well-run schemes is there for all to see. It would be helpful to see similar research published on UK schemes.

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Find out how employers can consolidate with The People’s Pension on our website.

The quiet inevitability of consolidation

In an industry full of buzz words, there’s one which crops up more often than most – consolidation.

In reality, pensions have been consolidating over the last decade, an evolution largely driven by The Pensions Regulator (TPR), Department for Work and Pensions (DWP) and the Financial Conduct Authority (FCA).

Originally their focus centred on the legal duties of defined contribution (DC) pension schemes and boosting retirement savings. Although this remains paramount, there’s also been a notable shift towards driving up the quality of workplace pensions for better outcomes for members. This, of course, should be the reason for being for all master trusts.

Master trust authorisation process complete

Last year we saw the end of the first phase of this culture shift towards better governance in pensions – master trust authorisation. When the authorisation process came to an end in the early autumn, 38 master trusts successfully gained authorisation, reduced from 93. That said, many master trusts decided not to apply in the first place.

Since that highly rigorous process ended last autumn, the question ‘what next’ has loomed large over the sector. In reality, the next steps we take aren’t a great secret as we all expect tighter regulations as the drive towards further market consolidation, led by TPR and the DWP, continues to unfold.

Why do regulators encourage consolidation?

The focus of the regulator will most likely be directed at challenging smaller single-employer DC trusts that lack resource and access to specialist support and are unable to meet the required standards of governance or proposition development.

Much of this change in the pensions landscape has been brought about by the advent of auto-enrolment, with larger DC pension schemes growing substantially in membership and assets under management, making them significantly bigger than many smaller DC pension schemes.

As a result, in the last decade there has been a clear drop in the number of small DC schemes registered. Statistics from TPR revealed that the number of pension schemes with 12 or more members has more than halved between 2009 and 2017, falling from 4,570 to 2,180.

Smaller schemes face significant challenges

How much further this figure continues to reduce remains to be seen. We know that the requirements of time, resource and cost can present major issues for some smaller DC pension schemes looking to meet the increasingly burdensome regulatory requirements. According to a TPR report last year, larger DC pension schemes were able to meet 84% of the regulator’s key governance requirements in contrast to both micro and small DC pension schemes, who only met 15% of them.

There are numerous conversations already taking place between trustees, sponsors and advisers of these smaller schemes and their counterparts at master trusts about if and how consolidation can be achieved in the best interests of members.

We must also remember that it isn’t just the smaller outfits that will consolidate. In the 1990s, there were 25 active group pension providers but now this is a much more streamlined 7.

Quietly evolving towards consolidation

In terms of pensions governance, we are certainly in a better place than we were 10 years ago, but there’s still a long way to go before we can honestly say there’s complete fairness in the market. There will be no Big Bang but a quiet, methodical evolution over the next decade.

After all, nobody expected consolidation to happen overnight.

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Find out more about what to consider on our webpage about consolidation of trust-based occupational pensions.

What to consider when transferring schemes

The UK occupational defined contribution (DC) market is one of the least consolidated in the developed world, but things are changing. Single-employer DC trusts are in the spotlight.

At the time of writing, there are 2,180 pension schemes in the UK. That’s considerably more than Australia, for example, with just 233, and Mexico, which has only 11 workplace pension schemes.

A growing trend for consolidation

The Pensions Regulator (TPR) and the Department for Work and Pensions (DWP) are encouraging consolidation in the UK DC landscape, promoting fewer, higher quality, better regulated schemes.

Single-employer DC trusts are being pushed along by a unique range of factors, including greater costs. Short service refunds were abolished just over 4 years ago. This prompted a rise in membership and a proliferation of small pots for many active DC pension schemes. However, for the larger number of smaller pensions schemes who offered this option, it can be costly and complicated to administer.

In the same year we saw the new 0.75% charge cap for default funds. Larger schemes, like The People’s Pension, have used their scale to make sure high-quality investment options remain available below this rate. Smaller schemes may have difficulty achieving this and, if they want active investment options, the charge cap poses significant challenges.

Regulators expect high standards of governance

Other pressures come from The Pensions Regulator. Its 2016 paper on 21st century trusteeship offered clarity on what they expected of pension scheme trustees. This includes:

  • their roles
  • board composition
  • risk management
  • and a host of other issues.

This renewed focus makes it abundantly clear that the expected standard of governance is high.

The regulator has also pointed out to trustees its high expectations of both transparency, not least in the chair’s annual statement, and good investment choices for members. DWP regulations also mean trustees must strengthen their approach to environmental, social and governance (ESG) issues in their investment options.

Trustee boards are now required to consider ESG. And this means time and money spent on adopting new policies and working with investment managers to offer new options. These are all material changes – requiring substantial amendments to working practices, policies, processes and the amount of time individual trustees spend on governing their schemes.

Trustees are feeling the pressure

Trustees that signed up to the role expecting a specific time commitment will be interested that the regulator is now asking whether quarterly meetings are enough – and whether the board should meet every month instead?

This increased burden on trustee boards is laid bare by data from the regulator. They have 5 key governance requirements – which range from independence to providing good value for members.

According to a May 2019 TPR report, just 23% of all pension schemes met 2 or more of these requirements. This is perhaps unsurprising, given that in the pensions market, the benefits of scale can be felt in governance, good value and the quality of investment options.

Master trusts: an option for consolidation

If the occupational DC pension market continues to consolidate it seems reasonable that trustee boards of single-employer DC schemes will look at master trusts as a possible consolidation option.

Master trusts operate under the same regulations and laws as single-employer DC trusts, unlike contract-based schemes, commonly referred to as group personal pensions. This means that the trustees have the same direct responsibility toward members’ best interests. Master trusts are just one of several available options, which is why we’ve created a ‘key considerations guide’, setting out what the journey could look like.

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Find out more about what to consider on our webpage about consolidation of trust-based occupational pensions.

Playing pensions catch-up with ‘Down Under’

Forget year-round sunshine and shrimps on the barbie. It’s the Australian pensions system that many in our industry have looked to with envy.

For the last 25 years, under the compulsory superannuation model, employers ‘Down Under’ have been forced to pay a significant contribution into a “super”, or retirement fund, for their workers. It now holds huge assets and is the largest defined contribution system in the world per capita.

In the UK, pensions savings have extended to millions more people in the last few years thanks to auto-enrolment, but as a nation we’re still a way behind Australia. As we move towards potential consolidation of master trusts as a result of The Pension Regulator’s (TPR) authorisation process and many single employer trusts are looking to move to a select group of larger master trusts, it’s worth asking what we can learn from Australia’s extra years of experience.

Watershed moment – big is beautiful

Master trust authorisation is at a critical point. Applications have been submitted to The Pensions Regulator and industry predictions suggest the result will be a small number of big players managing workplace pension schemes in the future.

The ultimate aim is for auto-enrolment to evolve into a more stable and effective system of retirement saving. So although we’re taking a different approach we’re heading in a similar “big is beautiful” direction to the multi-trillion dollar Australian pensions system where AUS $2 trillion of assets are managed by around 225 funds.

Play catch-up but don’t play with fire

We’re still a few steps behind so it’s a good opportunity to take stock. One thing is clear to me – we must learn useful lessons from Australia and avoid pitfalls. My colleague Gregg McClymont has previously analysed the issues and lessons around various scandals which hit the industry. Read his thoughts here.

I agree that the shocking headlines about greed and misconduct by banks and other commercial providers should serve as both a warning and an opportunity. At the heart of this is the question over proprietary/for-profit compared with not-for-profit – something I discussed with colleagues and financial advisers at a recent event we, The People’s Pension, organised.

To profit or not-for-profit?

In Australia, the numbers stack up in favour of not-for-profit funds which make up the top 10 performing pension funds across short and long time periods. Even before official enquiries were launched into banking and superannuation, people could see the long-term financial benefits of not-for-profit – or profit-for-member as they are often referred to in Australia.

The “profit-for-member” terminology resonates well for me, coming from an organisation which has a firm commitment to putting people ahead of profit. The People’s Pension has no shareholders to answer to so we can genuinely ensure that any profits are ploughed back into improving value and service for our customers. Our Charitable Trust also gives back to society and individuals as part of our mission. I’m proud of all this from a moral standpoint but I also believe it’s a good approach for the industry – and retirement planning – in the UK as a whole.

Where does this leave us?

At The People’s Pension we’re fortunate (as are our 4m members) as one of the largest master trust workplace pensions in the UK that we can provide stability and experience in the pensions landscape. We should build on the consolidation process of master trust authorisation and champion the value we can offer people through a long-term, “profit-for-member” approach to pensions.

Anyone focusing on chasing short-term returns or making bad decisions in the interests of sponsors rather than members should take heed of the Australian lessons. If we can all do that, then hopefully big really will be beautiful for British pensioners.