With the UK government favouring the consolidator model over ’pot follows member’ model to put an end to small pension pots, the pensions industry is considering whether the proposed model is achievable or too complex.
On 10 July, chancellor of the exchequer Jeremy Hunt announced a package of proposed financial service reforms including nine relating to pensions.
This included an open consultation from the Department for Work and Pensions (DWP) on ending the proliferation of deferred small pots which proposes setting up a small number of authorised schemes to act as a consolidator of deferred pots under £1,000 after dropping the alternative ‘pot follows member’ model proposed in a previous call for evidence.
The proposed creation of a public sector consolidator could open up de-risking opportunities for smaller schemes, according to consultancy Broadstone.
It added that from a cost, governance and regulatory perspective, consolidation at the smaller end of the market could be advantageous as well as for schemes with challenging benefit structures or legacy issues.
Broadstone suggested that the expertise of the Pension Protection Fund (PPF) could be used to power a public consolidator which could also offer other solutions together with reducing the supply issue – however any public consolidator should be a wholly separate entity from the PPF, it added.
Higher levels of consolidation would naturally lead to fewer schemes which would each manage a larger asset base, which it believes in turn should result in better access to investment options, including productive finance as proposed by Hunt in his Mansion House speech, that might not be available to smaller schemes or cost effective for them to consider.
The People’s Partnership agreed that the consolidator option will help build the scale required to enable pension schemes to invest in less liquid assets.
However, it warned that there is a vast amount of work to do over the next six months to operationalise the framework.
Phil Brown, director of policy at People’s Partnership, said: “Our main reason for support of this proposed solution is that it will hold consolidator schemes to a higher regulatory standard, which will only improve outcomes for savers.”
He said that from an operational perspective, the core processes needed to make consolidators work are very similar to the processes needed to make ’pot follows member’ work.
He continued: “There is also an opportunity to learn from the dashboard project. While there’s a lot of detail to work through, the consolidator proposal looks achievable and no harder than anything else that was on the table.”
He added: “With the policy direction now set, it’s now up to the industry to make this work.”
According to Nick Meredith, products director at insurance and investment digital solution provider Equisoft, the only supporters of the consolidator model appear to be “those organisations who would look to be consolidators”.
He said: “We still feel ‘pot follows member’ delivers a much clearer solution for consumers while avoiding the complexity and cost of centrally procured government infrastructure.
“We also feel that some of the issues cited as to why ‘pot follows member’ was not the right choice, are not adequately resolved by the DWP’s proposed solution.”
According to Meredith, the default consolidator model relies on consumers being actively engaged and having “relatively sophisticated” understanding of the small pots process.
“We know from experience that this is unlikely, and the proposed communications as part of the mechanism are far more likely to lead to concern or confusion,” he noted.
Meredith also expressed reservations over the proposed value limits seeing as engagement from already “disengaged individuals” is unlikely to happen until meaningful pot sizes of £10k as per previous industry recommendations are achieved.
In addition, he stated that the proposed solution has an unfair risk and reward profile as it puts much of the operational effort on the ceding scheme while the consolidator gets the benefit from the ultimate transfer of assets and the resulting economies of scale.
However, according to Meredith, the biggest concern is the concept of a “central government clearing house or register”.
He said: “This is in complete contrast to the current dashboard project where creating a central register was specifically ruled out.
“Centralised government procured systems do not have a great track record and we also have concerns about the security of consumers data”
Nick Meredith, products director at Equisoft
“Centralised government procured systems do not have a great track record and we also have concerns about the security of consumers data and the potential for cyber-attack that creating a single, vulnerable target might lead to.”
He said that as it stands today the proposal is “too complex, risky, expensive and will take significant time to deliver”.
He continued: “In the meantime, the small pots problem continues to grow, and consumers are losing real value as their pensions wither away.”
Standard Life also expressed concerns over the consolidator model.
Gail Izat, managing director for workplace at Standard Life, said that the consolidator model could run the risk of distorting competition, as the process for selecting the consolidators is not yet clear.
She said: “If members are allocated to the first scheme they were automatically enrolled into, there is the risk of entrenching existing market positions.
“It also risks further complicating the pensions system for savers due to the potentially cumbersome nature of the process and complex terminology.”
The consolidator model requires the creation of a clearing house or central registry, the cost of which according to Izat will be substantial and could outweigh the potential benefits of the solution.
Izat added that the establishment of a central data point also raises concerns around the security risk of holding so much pensions data in one place.
Izat continued: “When designing the Pensions Dashboard, it was agreed that there would not be one point of data storage for this reason, and the principle stands here.
“If the government choose to follow through with the Default Consolidator option, then the process of selecting consolidators should be in the best interest of the saver.”
Consolidation of DB schemes
Mansion House reforms are also targeting defined benefit pension scheme consolidation.
If consolidation is aimed at smaller schemes, this also would benefit more schemes individually and would unlock more opportunities although with less of an impact overall, as the combined assets of the UK’s 4,000 schemes with less than 1,000 members and circa 1,800 even smaller schemes with less than 100 members would still be relatively small, according to Broadstone.
David Brooks, head of policy at Broadstone, said: “A public consolidator can be designed specifically to meet the needs of the government, so its purpose is evident.
“It could provide security to employers and members via a flexible investment strategy to encourage investment in ‘productive finance’ and with economies of scale to reduce cost.”
Brooks added that given congestion in the insurance market following the improvement in funding positions, it would also help “fill the gap” with smaller schemes currently struggling to attract the attention of insurers but with the ultimate backstop of buy-out over time.
Brooks continued: “As ever with these reforms we urge all parties to put the security of members at the forefront of policy change. A public consolidator will be subject to political pressures that means its purpose evolves over time and by its definition any form of gateway test will funnel schemes that are either higher risk or financially unattractive.”
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