DC reforms – a significant shift towards good member outcomes?

• United Kingdom

• Pensions

02-02-2023

This week, the government published a package of proposals to reform the DC landscape and close the pensions inequality gap between members with DB and DC pensions. The ultimate aim of the reforms is to create "fairer, more predictable, and better-run pensions”.

In our view, these reforms are the most material and significant package of DC developments since freedom and choice in 2015.  The suite of DC proposals include:

• Consultation on "Value for Money: A framework on metrics, standards, and disclosures"
• Call for Evidence on "Addressing the challenge of deferred small pots"
• Consultation on "Extending Opportunities for Collective Defined Contribution Pension Schemes"
• Response to consultation on "Broadening the investment opportunities of defined contribution pension schemes"
• Further report on "Understanding member engagement with workplace pensions"

Value for Money Framework

DWP, FCA and TPR are consulting on a new value for money (VFM) framework and VFM assessment process – the aim is to provide a consistent and uniform way of assessing VFM across all DC workplace (and in time, non-workplace) arrangements, which will facilitate better outcomes for savers and promote further consolidation.

We set out below our short summary of the top 10 points that governing bodies, providers and employers should be aware of. For a more detailed analysis, please see our separate article on the new VFM framework.

1. Shift from costs to value

This is reflected in the change from using the term “value for members” to using “value for money” and adopting a focus on measurable outcomes.

2. Two stage process - VFM framework and VFM assessment

The framework sets out requirements for governing bodies (trustees, IGCs and GAAs) to publicly disclose specified “VFM framework data” and then use this data (and data from other schemes) to carry out and publish a VFM assessment.

There will be a phased approach to the implementation of this new process starting with workplace defaults and extending to the wider non workplace market.

3. Consistent metrics, uniformity and transparency

All schemes will need to disclose the same information on investment returns, costs and charges and quality of service (known as “VFM framework data”).  Data will need to be published by 31 March in each year and may need to be in a prescribed format.  This degree of uniformity is intended to facilitate easy comparison between schemes.

4. Employer subsidies excluded from net returns

To enable like-for-like value comparisons between schemes, information on investment returns will need to exclude member-borne costs (including transaction costs and performance fees) and also any costs paid by the employer.

5. Investment and administration costs to be shown separately

Schemes will need to unbundle investment and administration costs. They will need to disclose: (i) investment returns net of all costs and charges; and (ii) investment returns net of investment charges only. They will also need to assess the quality of services by reference to administration (non-investment) costs (in order words the difference between (i) and (ii)). Schemes that use combination charging structures may also need to express charges as a single annual percentage.

6. Quality of service to be measured against quantifiable outputs

To address concerns that “quality” is a subjective concept, schemes will need to look at measurable outputs. For example, communications could be assessed by reference to whether they drive improved member outcomes, looking at things like the percentage of members who update/confirm options or expression of wish forms.  

7. VFM assessment results

All schemes will need to use the same step-by step methodology to carry out an assessment and will need to conclude that the scheme is either VFM (green rating); or it is not VFM (red rating); or that it could be VFM with some specified improvements (amber rating).  Where a scheme is not VFM, the regulators expect schemes to take action.

8. Regulatory enforcement powers

Regulators could be given powers to take action where schemes do not deliver VFM.  This suggests that there will be enhanced regulatory scrutiny, intervention and the potential for mandatory consolidation for schemes that are not found to provide VFM.

9. Reporting deadlines – same for all schemes

All schemes will need to publish their VFM framework data by 31 March each year. This will enable schemes to compare, benchmark and publish their assessments by 31 October in the same year.  This is a radical change to reporting which is usually by reference to scheme year ends and therefore different from scheme to scheme.

10. Reporting format

The Government is considering whether to require schemes to use reporting templates to ensure uniformity of disclosure.  There may also be a publicly accessible central depositary for VFM data to enable market comparisons and regulatory oversight, rather than just having schemes publish data on their own websites.

Deferred small pots

Without intervention, the government estimates that there will be 27 million deferred DC pots by 2035. Members may lose track of multiple pots over time or be disincentivised or disengaged by small pots that do not contribute in a meaningful way to their prospective retirement income. In addition, for some providers, the administration costs involved in managing millions of deferred small pots may outweigh the amount they receive through charges and threaten their financial stability.

In conjunction with the consultation on the VFM framework, the DWP published a call for evidence seeking views on the best solution for dealing with small pots. The call for evidence asks:

• What a small pot is. Financial thresholds between £1000 and £10,000 are being considered.
• Whether there should be a minimum threshold for consolidation of a small pot.
• When a small pot is deferred and whether there should be a defined period of inactivity. The call for evidence asks what time period would be appropriate.
• Whether small pots should be consolidated into a single consolidator or numerous commercial consolidators with different options for determining how a member should be allocated to one.  
• Whether “pot follows member” could also be used, although there would also be complexities where members have several jobs at once or move jobs frequently. 
• Whether any solution should initially focus on new small pots or the existing stock of small pots.
• If other solutions, such as consolidating member pots with a single provider, would help. 

However, the Government has not yet consulted on any firm proposals – this is a little disappointing given the amount of time that small pots consolidation has already been under consideration.

Collective defined contribution (CDC) schemes

In August 2022, legislation came into force allowing connected employers to establish CDC schemes and start operating them, subject to authorisation from the Pensions Regulator. The latest consultation is seeking views on proposals to expand CDC provision to multi-employer and commercial pension schemes, such as master trusts. 

The government also wants to develop its understanding of how CDC in decumulation would work in practice.

This is a long way from being a formal proposal to allow the CDC market to grow, but at least it is a step in the right direction. In our view, the Government should be focussing more closely on CDC in decumulation – it feels ancillary to “whole-life” solutions in the consultation – and in this Speedbrief, we set out where we believe the Government should focus its attention. 

Investment in illiquid assets

As part of its drive to encourage schemes to invest in illiquid assets, the Government has confirmed it is going ahead with a number of proposals that it previously consulted on, including:

• DC schemes will need to set out their policy on investing in illiquid assets in their default SIPs.  Schemes will have to provide information about illiquid assets or explain why they do not invest in them.  These requirements will apply when a default SIP is updated after 1 October 2023 with a long-stop date of 1 October 2024.
• For scheme years ending after 1 October 2023, DC schemes required to prepare a chair’s statement will need to include information about the percentage of assets allocated to eight specified asset classes.  This information will also need to be put on a publicly available website.  Statutory guidance sets out how trustees will need to approach this in different circumstances.
• Schemes will be able to exclude “specified performance fees” from the auto-enrolment charge cap. Specified performance fees are payable where investment performance exceeds a pre-agreed rate or the value of investments exceeds a pre-agreed amount. The statutory guidance says that trustees will need to consider whether the additional incentive provided by such fees will lead to additional value to members and explains in more detail what performance fees are and the component elements that trustees need to consider.  Existing provisions allowing the smoothing of performance fees over a 5 year period will cease to apply but schemes currently using them can continue to do so until 2028 at the latest. 
• From the first scheme year ending after 6 April 2023, the amount of any specified performance-based fees in relation to each default fund will need to be included in the chair’s statement and put on a publicly available website.
• Existing provisions allowing the smoothing of performance fees over a 5 year period will cease to apply but schemes currently using them can continue to do so until 2028 at the latest.

Regulations making these changes are due to come into force from 6 April 2023.