UK Government proposals to shake up pensions industry

On 11 July, the Government published a raft of consultations and responses to earlier consultations setting out some fairly loose proposals which could fundamentally change some key aspects of the UK pensions industry.  The drive behind these reforms is not solely focussed on improving member benefits, as recent reforms have been, but also on how the £2.5 trillion of pension scheme assets can be used to help grow the UK economy.  This objective may well cause some tensions for trustees whose investment duties are to balance risk and reward and, in line with long established case law, act in the best financial interests of their members.

Many of the proposals are not fully formed and it is likely to take some time for the Government to finalise the details of what it wants to do.  Others require changes to primary legislation which means that the Government needs to find parliamentary time to devote to them.  This means that there is currently no clear timeline as to when most of the new proposals are likely to be developed further or become law. 

The proposals were spread across eight documents and covered a wide range of topics including: consolidation of deferred pots, decumulation in DC, value for members, DB superfunds and Collective Defined Contribution (CDC) schemes, use of assets and surplus in DB schemes and a further review of trustee skills.  This speedbrief gives an overview of each set of proposals.

DB consolidation and superfunds

In 2018 the Government consulted on setting up DB superfunds and it is now responding to that consultation.  The definition of ‘superfunds’ is evolving but broadly they are occupational pension schemes where the employer covenant is replaced with a capital buffer, and the overall structure contains a mechanism to enable financial returns to be paid to a third party. 

The response clarifies some of the details around the authorisation and supervision regime which would apply, as well as the amount of capital that superfunds will be required to have.  There are also more details around the level of funding that they will need to maintain.

For schemes to transfer to a superfund, they must not be able to afford buy-out now or in the future and the move to a superfund will have to increase the likelihood that members will achieve full benefits.  Superfunds are aimed at schemes that are about 70-90% funded, although simply being at this level of funding will not mean that a scheme is immediately able to transfer to a superfund.

Looking ahead, the respective benefits and risks associated with transferring members to a superfund or running a scheme on to pursue buy-out over a longer timeframe will be important considerations for DB trustee boards.

CDC schemes

CDC schemes potentially provide a better outcome for members compared to DC arrangements, because they do not allow member choice in investment and provide pensions directly from the scheme (although such pensions can go down if investments underperform).  The Government is proceeding with proposals to extend CDC schemes to allow them to be set up for non-associated employers (i.e. similar to commercial mastertrusts). 

The response to consultation identifies two different kinds of CDC schemes:

• Whole life schemes – these will provide both for the build-up and payment of pensions.  The response provides more detail around the authorisation and supervision regimes that will apply to such schemes and the conditions they will need to meet.  Draft legislation will be issued in the Autumn.
• Decumulation schemes – these can be used as an option to transfer member pots into at retirement.   There are a number of issues which still need to be finalised, in particular how they can achieve sufficient scale from the outset to work.  As a result they will not be included in the Autumn legislation and the Government will continue to consider the issues.

Value for members framework

The Pensions Regulator remains concerned that significant numbers of smaller DC schemes are not assessing whether they provide value for members.  The Government also wants to drive the consolidation of underperforming schemes into better performing ones. 

As a result, the Government, FCA and Pensions Regulator are proceeding with proposals to introduce a new value for members framework, which in time should replace the existing chair’s statement.  The obligations and requirements on trustees under the proposals are not to be under-estimated.

The majority of DC schemes will need to collect data on a number of specified metrics as at 31 December each year.  The metrics will relate to gross investment returns looking back 1, 3 and 5 years and 10 and 15 years if available.  Gross returns will be required for the past year and further back where possible.  Other information will also be required, such as the outcome of a standard member satisfaction survey.  This information will need to be made publicly available by 31 March each year.

Based on a comparison of the data published by other schemes, each scheme will need to publish the results of a value for members assessment by 31 October each year and specify whether the scheme: (a) is value for members, (b) not value for members or (c) could be value for members if specified changes were made.  It is anticipated that no member should be in a scheme that does not provide value for more than 2 years.

Retirement options in DC schemes

The Government is consulting on proposals which will introduce a statutory duty on trustees to consider the needs of their members when they want to access their pension pot. Trustees will be required to offer decumulation services which are appropriate for their members.  Members will have the option to either choose this default service or access external products. 

For many DC schemes, their primary focus has been on the accumulation phase.  However, with these proposals, whether retirement options are offered within the scheme itself, or through partnering with an external provider, there will be a greater focus and obligation on DC trustees to support members at the decumulation stage of their journey.

Every member should have access to a decumulation option even where they don’t want to make the complex decisions about how to take their benefits.  It is possible in the future that decumulation services will form part of the value for members framework referred to above. 

Deferred small pots

The Government has been considering the problems in relation to small deferred pots for some time.  The nature of the modern workforce is such that individuals move employment more often than was previously the case, they often then lose connection with the scheme which they may have been a member of for a short period of time, and schemes are left holding small pots which are disproportionately costly to administer.

The Government is now consulting on options to deal with pots of less than £1000 where no contributions have been made for at least a year.  Its preferred option is to have multiple default consolidators to which the small pots would be transferred.  This will require a transferring scheme to be able to identify where they should transfer a member’s benefits and the Government is suggesting that there should be a clearing house which could communicate between transferring and receiving schemes and with the member to match deferred pots effectively with a consolidator.  Schemes will need to be authorised to act as a default consolidator, including authorised master trusts.  This model is perceived as likely to lead to a more consolidated master trust market.

In conjunction with the dashboards project, this should help reduce cases where members lose the benefit of a series of small pots which, when aggregated, could make a difference; as well as supporting those schemes which may otherwise have little option but to administer very small member accounts for an exceptionally long period of time.

Options for DB Schemes

The Government has issued a call for evidence to gather information on how DB schemes could use their assets “more flexibly” (while maintaining appropriate security of the benefits promised and not undermining trustees’ fiduciary duties).

It looks at whether trustees might be under invested in “productive assets” and what might be done to change this.  Consideration is also being given as to whether enabling easier extraction of surplus by employers might encourage more risk to be taken in DB investment strategies, and how this could be done in practice. 

The call for evidence also considers whether a public sector consolidator vehicle (such as the PPF) could potentially support longer term investment horizons and investment in UK productive finance and help schemes where the insurance buy-out market is not within reach. 

Trustee skills, capability and culture

DWP and the Treasury have issued a joint call for evidence which aims to gather information around trustee capability and other barriers to trustees performing their duties in a way which results in the best outcomes for members.  There is concern that UK trustees are not investing in high-growth companies as much as their international counterparts and the Government hopes that by increasing trustee expertise, especially around investments, allocations to illiquid assets might increase.

The call for evidence seeks views on the capability of trustees, whether the current framework and guidance on fiduciary duties is sufficient to help trustees make decisions in the best long-term interest of members and if greater accreditation in some form is required.  It also asks whether and how advice provided to trustees affects decisions on investing in unlisted equities.  Clearly, long-established principles of trustee fiduciary duties as well as specific requirements which are already enshrined in the current Investment Regulations would need to be considered as part of any review on how trustees might assess their allocation to particular asset classes.

Local Government Pension Scheme investment

The LGPS is one of the world’s largest pension schemes and has assets of £364 billion.  The Government says that its scale gives it the potential to have a significant impact through its investments and lead the market in innovation and transparency and while long term stable returns to pay pensions for its members are the primary purpose of the investments, there is scope to deliver substantial benefits to the UK as a whole. 

The Government has launched a consultation, which is open until 2 October 2023, which amongst other things, seeks views on increasing LGPS funds’ investment into high growth companies via unlisted equity, including venture capital and growth equity and requiring funds to have a plan to invest up to 5% of assets to support levelling up in the UK.

What next?

Unless otherwise stated, the consultations and further calls for evidence close on 5 September and draft legislation on CDC schemes is due in the Autumn.  Beyond that there is no clear time scale for any of these proposed reforms.  Some may take several years or more to materialise.

There is nothing for trustees to do at the moment but they should definitely be on the alert for more developments, particularly in the context of trustee skills and expectations around capabilities.  The gist of the changes in relation to investment may also present difficult issues in relation to how they should balance risk and reward.

DC trustees need to watch out for developments in relation to the new value for members framework and consider how they will be able to obtain all of the required information.

The proposals in relation to DC schemes will be considered in more detail in our summer edition of DC Practical Notes.