Industry organisations have welcomed the government’s package of defined contribution (DC) measures aimed at addressing pension inequalities, although experts have emphasised the need to get the details of the proposed reforms right.

The Department for Work and Pensions yesterday (30 January) announced a number of measures designed to close the pensions inequality gap and create "fairer, more predictable, and better-run pensions”.

The measures have been broadly welcomed by the pensions industry, with Pensions and Lifetime Savings Association (PLSA) director of policy and advocacy, Nigel Peaple, arguing that the reforms have the potential to enable savers to benefit from greater efficiency and value from the management of their pensions.

“Generating greater investment growth is also a vital tenet of savers achieving better outcomes through the DC regime, something which may be made available to even more people, thanks to the proposals on extending the collecting defined contribution (CDC) regime, and with greater allocations to certain suitable illiquid assets,” he continued.

“We look forward to engaging with government and regulators on these initiatives as we seek to develop and implement them in the most effective and appropriate way as part of a wider strategy to improve outcomes for the UK’s retirees.”

In particular, the government's package included plans to extend the scope of CDC, a call for evidence on small pots solutions, as well as a consultation on proposals for a new value for money (VFM) framework, and confirmation of new regulations around illiquid investments.

Addressing the small pots problem

The government's call for evidence on addressing the deferred small pots problem is focused around two potential automated consolidation, a default consolidator model, where each small deferred pot would be automatically transferred to a single scheme, and pot follows member, where deferred pots follow the worker and are added to their new active pot.

Industry experts have welcomed this focus, with Association of British Insurers (ABI) director of policy, long-term savings, health & protection, Yvonne Braun, arguing that "member-led consolidation, while important, will only go so far".

"We’re pleased the government recognises the need to introduce legislation to solve the small pots problem, which was a key recommendation from the ABI and PLSA Small Pots Coordination Group report last year," she continued.

"To materially reduce the millions of small pots, a whole of market automatic transfer model is likely to be required, and legislation will be crucial to compel providers to take part in the solution.”

Scottish Widows head of policy, Pete Glancy, also welcomed the efforts to address the small pots issue, arguing that "the current system offers a 20th-century solution to a 21st-century challenge, and leaves people struggling to keep track of their different pension pots".

He stated: “To devise a solution that involves the least amount of effort for employers, government must help tidy up the pension pots that have been – and will continue to be – left behind as workers move jobs.

"Digitising the DC ecosystem, for instance, would improve efficiencies, lower the cost of transfers, and incentivise the consolidation of savers’ small pots. This could also reduce costs for the pensions industry itself, leading to lower charges being passed onto savers.”

Adding to this, Hymans Robertson partner, Michael Ambery, said that the consultation "couldn’t be more timely or relevant".

"The erosion of small pots, the advent of the pensions dashboard and low member engagement will be woven together to ensure change from this consultation as part of a higher level action plan, further protecting members and small pensions pots from becoming worthless," he stated.

And some organisations have already made their vote on the proposals clear, as Standard Life workplace managing director, Gail Izat, backed the introduction of a ‘pot follows member’ approach whereby pensions under a certain size automatically transfer when people change jobs.

“If implemented efficiently this will have the advantages of not requiring any action from the member," he continued.

"It is also an easy concept for consumers to understand compared to other more complex approaches. In a charge cap environment concerns about the value for money offered by receiving schemes are greatly lessened.

"Alternatives such as a default small pot consolidation option, in which any small deferred pots would be transferred to a pre-determined consolidation destination look less practical as this runs the risk of distorting competition, and gives consolidators little incentive to invest in their proposition.”

However, AJ Bell head of retirement, Tom Selby, warned that while a system of auto-transfers for small pots could help tackle some of the problems currently faced by savers, it would also raise "a whole host of new challenges".

"What happens, for example, if someone is automatically moved from a low charging scheme to a high charging scheme? Or from a scheme where investment performance is good to one where performance is poor?" he queried.

“There are also policies with valuable guarantees attached which risk being lost on transfer, although these generally exist outside of the automatic enrolment landscape. Addressing these challenges will be critical if any system of auto-transfers for small pots is going to get off the ground.”

Creating new options

The DWP's package also included a consultation on extending CDC pension schemes to accommodate multi-employer schemes, as well as the potential of CDC as a decumulation only option.

These proposals, whilst previously hinted at, have been welcomed by industry experts, with Standard Life managing director, Claire Altman, highlighting the consultation as “an opportunity to explore the feasibility of whole-life multi-employer schemes based on current frameworks and the challenges that come with this”.

“It will also – importantly – explore the role of CDC in decumulation and whether there is significant appetite for CDC decumulation-only products,” she said.

“There will be important considerations for employers, particularly in relation to the complexity of CDC and managing employees’ expectation of guarantee. We look forward with interest to seeing the outcome of the consultation.”

The focus on decumulation-only CDC options was also highlighted by Hymans Robertson partner, Kathryn Fleming, who argued that while CDC in decumulation might not be the right solution for all DC savers, it could offer an “exciting prospect of a solution that bridges the gap between the complete flexibility and risk of drawdown and the certainty but irreversible option that is offered by annuities”.

“It is right that the conversation takes place now as the scale required to deliver these solutions is fast approaching,” she added.

The need to move quickly was also echoed by Aon partner and head of CDC, Chintan Gandhi, who urged the government to commit to ensuring the regulations are in place for both of the potential forms of CDC schemes to exist by the end of 2024.

Gandhi continued: "A key development is DWP allowing for CDC benefit designs where there is a uniform contribution rate across all employees (and so a varying accrual rate by age), matching how the vast majority of DC schemes operate.

“We agree with DWP that CDC pensions should at outset target a level of inflation-proofing. This is vital to balance savers’ desire for their pension income to broadly keep pace with the cost of living, while reducing the likelihood of cuts to members’ target pensions.

“However, there is a tightrope to walk because the DWP focuses on additional member protections – which is laudable – but risks making multi-employer CDC schemes too onerous to set up.

"This is particularly true for commercial schemes. We think that providers considering decumulation—only will be watching carefully to see where the balance lands so this round of regulation will be an acid test for UK CDC.”

Establishing a value for money framework

Alongside the plans for extended CDC schemes and small pot solutions, the DWP revealed its proposed value for money (VfM) framework, developed in partnership with The Pensions Regulator (TPR) and the Financial Conduct Authority (FCA).

The framework outlines how schemes will be expected to provide savers with better value from their investments and a quality level of service, and includes key metrics, standards and data disclosures for DC pension schemes.

Pensions Management Institute (PMI) director of policy and external affairs, Tim Middleton, highlighted the joint consultation from the DWP, FCA and TPR as demonstration of the “unity of purpose in seeking real value for pension savers”.

“It is important to note too that the consultation sees value not simply in terms of low management fees, but also considers the extent to which funds achieve their intended performance. The public should be encouraged by such a thorough approach,” he added.

Aegon head of pensions, Kate Smith, also welcomed the consultation, arguing that the proposed framework "has the potential to transform the pension market and provide better member outcomes where every pound saved counts".

"All pension schemes and Independent Governance Committees carry out value for money assessments and publish their findings, but they don’t do it in exactly the same way, or at the same time, which makes comparisons challenging," she explained.

"The VfM framework will change all of this, mandating a consistent, transparent approach published each October, eventually across all pension schemes, with the initial focus on workplace default funds used for auto-enrolment.

"It will lead to much greater data collection across the pensions industry and assessments using common metrics and templates to allow pension schemes to be compared, with benchmarking to follow."

However, Smith clarified that there is "still a lot of to work to do before the proposals become regulations and effective", including the development of benchmarks, how and where the VfM assessments are to be published and whether TPR will be given powers to force consistently poor value schemes to wind up.

At an event announcing the reforms, Pensions Minister, Laura Trott, previously emphasised the need to give the regulator the power to take action where needed, however, stating that "this is not just something that is theoretical".

Further clarification is also needed in other areas though, as Izat suggested that one area where clarity will be important is around the intended audience for value for money assessments.

He explained: “In the workplace market where trustees and scheme advisers typically select pension providers, they are well-placed to assess the merits of investment approaches on behalf of members who may not have the specific experience that trustees and advisers can bring to bear.

“There’s a further opportunity to ensure that the consultation complements the FCA’s forthcoming Consumer Duty which will place a significant emphasis on ‘fair value outcomes’ which looks to ensure there is a strong link between cost and benefits to the customer.

"We hope that a common understanding of both the audience and the Consumer Duty link can be developed as part of the consultation process.”

In addition to this, Izat argued that while the focus on recent papers has been on measuring investment performance, costs and charges and customers services, the latest consultation should ensure consideration is also be given to other factors customers value, such as the engagement activities and the functionality of online services like apps.

Hargreaves Lansdown senior pensions and retirement analyst, Helen Morrissey, also stressed the need to get the value for money framework "right", warning that VfM "is a notoriously hard concept to define".

She continued: "There’s a balance to be struck - make the framework too rigid and you veer into a box-ticking exercise that risks stifling innovation, while keeping it too broad means schemes may not be sufficiently held to account.

“There are challenges though – value for money is a notoriously hard concept to define. It’s a huge positive that the conversation recognises that cost is just one aspect of value for money - we need to look at outcomes too."

In addition to this, Morrissey stated that a focus on communications will be "vital", arguing that "it shouldn’t be enough for a provider to say they issue certain communications to be deemed as offering value".

A first step?

Despite the positive reaction to the DWP's DC measures, industry experts have suggested that broader changes are still needed, with a number of commentators emphasising the need to also implement the 2017 auto-enrolment reforms.

The PLSA's Peaple, for instance, argued that "a further key component of any DC pension is the level of contributions", welcoming the government's repeated commitment to introduce the reforms, although he also expressed hope that they set out a timetable for this "soon".

While the DWP recently rejected calls to outline a timeline for the implementation of the 2017 reforms, Trott yesterday (30 January) reiterated the government’s commitment to a mid-2020s timeline for the 2012 AE reforms at a PLSA event announcing the DC measures, the 2017 reforms as a “very important next step”.

Yet PensionBee director of public affairs, Becky O’Connor, argued that while the consultations from the government are welcome, they “seem to only be nibbling at the edges of these significant challenges”.

She continued: “There are several pension inequalities gaps: the gap between women and men; the gap between defined benefit and defined contribution outcomes; the gap between healthy life expectancies in different parts of the country; the gap between employees and the self-employed and the gap in pension wealth among different ethnicities, to name a few.

“There are other things the government does not appear to be looking at that could be of more benefit in closing the various pension inequality gaps, such as increasing minimum employer contributions and introducing auto-enrolment for 18- to 22-year-olds.

“With so much pressure on the state pension, there is an even greater need to boost private pension saving to create decent retirement outcomes worth working for, for the whole workforce.”

Legal & General (L&G) echoed this, arguing that while the measures are a "very welcome boost to the industry", there is still more to done.

In particular, the group urged the government to undertake a review to assess whether auto-enrolment (AE) has been effective in creating adequate and sustainable retirement incomes, as well as outline a clear timeline for implementing AE changes, and regulate personalised guidance to close the advice gap.

L&G head of product policy strategy, Colin Clarke, stated: “The issue isn’t that people are only saving ‘just enough’ to get by in later life.

"It’s the fact they aren't saving enough but don’t realise it, so are under a false impression about the state of their retirement. We all need to help savers understand their pension choices and improve engagement levels.

"These factors have always been important, but against the backdrop of rising living costs they are now critical to help boost pension adequacy in the UK."

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