Why the UK pensions market could learn from Australia

This Australia Day, we take learnings from Down Under and look at how UK pensions could benefit from the advancement of the country’s superannuation system.

This is highly relevant to the UK because the Australian Superannuation system is roughly 10 years ahead of the UK in its DC journey and policymakers often, but not always, look to Australia for inspiration.

The Your Future, Your Super policy package follows on from a series of inquiries into the performance of the Superannuation system. These, especially the final report of the Productivity Commission, made serious criticisms of parts of the Super system and have forced a heavyweight response from the Australian government.

The performance element of Your Future, Your Super, implemented last year, subjects funds to a pass/fail test based on investment performance. The regulator (APRA) examines 7 years (changing to 8 from 2022) of a registerable superannuation entity’s (RSE) investment performance and compares it to a benchmark portfolio. The benchmark is put together using the RSE’s asset allocation and a series of benchmark indices for each asset class.

If the RSE’s performance is more than 0.50 per cent lower than the benchmark, then it fails the performance test. If the annual test is failed more than two years in a row, then the RSE is banned from accepting new business into the product. This strongly incentivises “failing” funds to merge.

Australia’s Superannuation was already consolidating rapidly ahead of this regime coming into effect. Some analysts expect further consolidation and a dramatic shrinking of the market to far fewer funds. We see that as likely but are cautious about estimating how may funds Australians may have to choose from.

Value for money is key

There are both positives and negatives from this for the UK. We think the main lesson for the UK is that if the regulator, in this instance TPR backed by the Department for Work and Pensions (DWP), wants to increase the pace of consolidation in workplace DC then binding value for money tests are one way to achieve this. The current approach UK to driving consolidation based on value for money is focused on DC smaller schemes and allows trustees of the schemes in scope much more discretion in compliance than the Australian version.

One potential outcome of the recent TPR/FCA consultation on value for money metrics would be the strengthening of this regime and its application to more schemes. The Australian audit applies to all regulated funds, not just smaller ones.

Too much focus on past performance can be a negative

We do, though, see negatives to the Australian approach. The approach focuses only on past performance. There are two problems with this. First, past performance is not a good guide to the future. Poor past performance tends to persist while good performance may not. This limits its use as a decision-making criterion, even for regulators and professionals. The real value in a pension scheme is driven by the decision making around a scheme’s default fund, which is impossible to capture quantitatively. But it is also the key thing you would want to understand if you were trying to judge which funds are more likely to show value for money over the long term.

Second, performance next to a reference portfolio creates quirks. A conservative fund might outperform its benchmark and pass the test. A more aggressive fund might outperform the conservative fund but underperform its benchmark and find itself, effectively, out of business.

We look forward to seeing how a tougher value for money regime plays out in Australia and whether a consolidated market really delivers the benefits promised.

Why an overhaul of annual statements is the first step towards better disclosure of information

More than three years on, the 2017 review of automatic enrolment is beginning to have an impact on the sector.

The Department for Work and Pensions (DWP) remains committed to the main proposals in the medium to long term: removing the lower qualifying earnings band and lowering the age threshold to 18 but we expect these in a future Pensions Bill. They seem to have been justifiably delayed by the fallout from the pandemic. However, the Government has chosen to force the pace on the main proposal from the review’s engagement strand, the simplified annual statement.

This simplified annual statement is a standardised annual statement. It covers two pages and is designed to show the information required by law to be in a statement in a way that enables comparison between different schemes.

End the use of jargon

Between the end of 2017 and autumn last year, the Pensions Minister Guy Opperman and the DWP tried to encourage the industry to adopt the simplified statement, with the former expressing his disapproval at ‘jargon-filled, confusing statements’.

While a few providers have adopted the new document, most have stuck with their original statement. More than a year ago, the DWP consulted on the way forward and published its response earlier this year, which served to underline how the department has lost patience and is now looking to mandate the statement, meaning that providers will be compelled to introduce it.

So how has it come to this? Providers have three main reasons for not adopting the statement. Firstly, statement overhaul is regarded as being too expensive. One of the major life houses completed a full revision of its statement recently at considerable cost. It’s hard to make a case for putting the statement up on bricks again so soon after completing a major revision of product documentation.

Secondly, some companies have expressed concern over the quality of the simplified statement. Innovation is increasingly a feature of our industry and there’s an increasing move towards online and video communication of core pensions information and there are some who believe that the way they do things now has advantages over the simplified statement.

The introduction of dashboards

Lastly, there are pensions dashboards, which are likely now to go live from 2023 and will allow people to see their pensions entitlements together on one online portal. With high levels of internet access now throughout the UK population, it seems probable that dashboards will replace both paper and electronic statements as the main way that people get information about their pensions.

Dashboards have the potential to completely reshape the way that people interact with their pensions and may render current approaches to communications with members redundant. An obvious question to ask would be ‘why do you need a paper or electronic statement if you can just look up the relevant information online with a few key strokes?’ with the follow up of ‘when did you last look at a paper bank statement?’ What really needs to be considered with the introduction of dashboards is a full review of all the information we, as an industry, share with pension savers, not just annual statements, and when that information is released. Instead of sending an individual annual statement, why not point them at a dashboard so they can see all of their pensions in one place?

We’re now waiting for the DWP to bring forward a new consultation paper on the simplified statement and this could in turn be followed by regulations which might mandate them.

This should prompt more debate, not only about the adoption of the statements, but also about the disclosure of pensions information more generally. Hopefully the new consultation could result in improved annual statements becoming a stepping stone to improving the way that the pensions industry communicates with retirement savers as we move into the dashboard age.

A first step towards fixing the small pots problem

The eagerly anticipated report of the Department for Work and Pensions (DWP) working group on small pots, which was published in December, sets out potential ways forward for resolving the problem. It will be tough to fix but the size of the problem is growing, meaning that it’ll be harder to solve the longer it’s left.

Small deferred pension pots have been considered a significant problem since the inception of automatic enrolment in 2012. It has always been the case that employees switching jobs would leave behind stranded pots. The phenomenon has multiplied under auto-enrolment because the policy brought in workers who shifted employment far more frequently and whose salaries were lower. The Pensions Policy Institute estimates that as a consequence of this combination of deferred pots and a mass workplace pension system, there’ll be 27 million dormant small pots in circulation by 2035.

Small pots are an issue for providers, particularly the master trusts which serve the auto-enrolment market, because they may never generate the fees required to cover the costs of their administration. Regulatory levies are currently also calculated by number of members rather than assets. This has the consequence that regulatory costs have fallen disproportionately on schemes with large numbers of deferred small pots. These are the schemes which have picked up the bulk of the millions of employees brought into pension saving by automatic enrolment.

Cross-subsidy

Higher financial burdens for schemes becomes a problem in turn for active members, since a cross-subsidy is required from the fees charged to them to cover the cost of administering the unprofitable pots. The problems for savers don’t end there. A trail of small pots makes it difficult for those employees with small pots to keep track of their pensions and to keep on top of what they need to save in order to generate a reasonable retirement income. Both members and providers have a strong interest in fixing the problem and both will benefit from removing unnecessary costs from the workplace pensions system.

Potential solutions

The working group’s report is a reasonable first step and gets a lot right – both the working group and DWP have done well in a short time to synthesize diverse views and come up with a way forward.

The first thing they got right is that there’s a need for an automatic solution to consolidate small pots held by different providers. The experience of Australia and small dormant super accounts is that the number of pots an individual has grows early in someone’s working life and they aren’t voluntarily consolidated until people approach retirement. Having a dashboard that facilitates voluntary consolidation, like Australia, hasn’t been enough to solve the problem.

The second thing they get right is the importance of administration reform. Again, the main lesson of the international experience is that transfers need to be cheaper, exchange of data needs to be rendered easier by an industry-wide standard and there’s a need for a rock-solid identity verification process so that automatic consolidation can be done securely.

The key insight here is that fixing known administration problems might enable quite a wide range of different options for consolidating small pots. Administrative reform creates a pitch on which more than one game might be played.

The second insight is that there are a lot of potential overlaps between the administration changes needed to power a consolidation solution and the components of the pensions’ dashboard. It seems likely that the data standard to be used by the dashboard might be used as the basis for a standard that might power a consolidation system.

There’s a lot more work to be done on consolidation models as well. The report recommends further work on pot follows member and on “consolidators”. The former would consolidate dormant pots to the active pot, while the latter would establish a single destination for all an individual’s deferred small pots. Both DWP and industry will need to look in more depth at how these consolidation options might work. Ideas that initially seem attractive can rapidly seem much less attractive as work progresses and technical difficulties emerge.

Member exchange

The report also recommends that the industry take forward work on “member exchange”, a variant of pot follows member. Member exchange is attractive as it might be possible to consolidate small pots using the bulk transfer regulations. This would obviate the need for further legislation and might enable master trusts to make faster progress on the problem.

Conclusion

The amount of work required now is, frankly, gargantuan. There needs to be a durable partnership between the pensions sector and the DWP in order to reconfigure a large part of how workplace pensions work.

Response to small pots report

On Thursday, December 17, the Department for Work and Pensions published the report from the industry’s small pots working group.

The publication of the report and its recommendations is an important step towards small pot consolidation within the automatic enrolment market. The Pensions Minister Guy Opperman MP has indicated he will study the report and recommendations in detail in 2021.

Tim Gosling, head of policy at The People’s Pension, who sat on the master trust expert panel that fed into the working group, said: “This report lays out a workable roadmap for dealing with the small pots problem. The scale of the challenge is significant: without action the problem will become much harder to manage and will destroy value for members. We welcome the Minister’s support for industry to lead on proof of concept trials, including support for the member exchange pilot.”

ENDS

The People’s Pension response to the DWP consultation

The People’s Pension response to the DWP’s Investment Innovation and Future Consolidation consultation

The People’s Pension response to the DWP’s Investment Innovation and Future Consolidation consultation

Responding to the DWP’s Investment Innovation and Future Consolidation consultation, Gregg McClymont, director of policy at The People’s Pension, said:

“Pension fund management is not a cottage industry. It demands economies of scale. Pension scheme members would be better served by fewer, much larger schemes, run in the interests of their members and able to leverage the economies that come with genuine scale.

“But there is also a need to think about the consolidation process and how trustees will choose a new scheme. It’s important that the consolidation process is genuinely competitive. The Competition and Markets Authority’s recent investigation into the fiduciary market suggests there is much work to be done to ensure competitive tenders”.

ENDS