A lot can happen in pensions in a week. The Chancellor’s 10 July 2023 Mansion House speech contained a package of proposed financial service reforms including no less than nine relating to pensions, all aimed at driving better outcomes for pension savers and delivering ‘greater economic growth’. The following day, HM Treasury published nine documents relating to the pension reforms – we summarise the key points from each of the reforms below.
If taken forward, the reforms could significantly change the pensions landscape, with consolidation not just of the defined contribution pensions (DC) sector but also the defined benefit (DB) pensions market and the Local Government Pension Scheme (the LGPS).
Consolidating DB and the superfund regime: consultation response
Over four years since its publication, the Government has now responded to its consultation on DB consolidation. Although the Pensions Regulator (TPR) set up an interim assessment and supervisory regime for DB superfunds in June 2020 (see our Insight), superfunds are not yet legislated for and just one superfund (Clara Pensions) has to date been assessed. The Government now has DB consolidation firmly on its agenda and has stepped up its efforts to progress the consolidator model.
What is a superfund?
Superfunds involve the transfer of a scheme’s assets and liabilities to a consolidator vehicle (regarded by the Government as an occupational pension scheme) under which the sponsoring employer’s liability is severed entirely or ‘substantially altered’. The employer’s liability is replaced with a capital buffer generally provided by investor capital and employer contributions. There is the possibility of returns being made to investors.
The idea is that through increased scheme funding, the capital buffer, economies of scale and better governance, the security of members’ benefits is improved. Employers benefit from liability management and the superfund can invest in a wider range of assets than those in which a DB scheme might typically invest.
Superfund legislation to be introduced
In summary, most of the 60 respondents supported the superfund proposals, and the Government will introduce primary legislation as soon as parliamentary time allows for superfunds and “other relevant models of consolidation.”
Which schemes are in scope to transfer to a superfund?
Superfunds are intended to be for schemes that cannot afford or access buyout, but which have sufficient funding to avoid the vehicle accepting too much risk. The response suggests that they will capture larger schemes with a 70% to 95% buyout funding level (with the 90% to 95% level being for those with either an uncertain or no employer covenant). Smaller schemes may come later when superfunds have become established. The response notes a possible cost being 90% of buyout or lower.
What will be the structure of a superfund?
It will be possible for superfunds to be either segregated or non-segregated. Although each approach has risks, the Government’s view is that restricting the structure could hinder take-on and it will be for the scheme to decide which structure is most appropriate.
How will superfunds be governed?
Although much of the detail will follow, the response provides several ‘broad principles’ on governance covering acceptable risk levels (risk of superfund entering the Pension Protection Fund (PPF) of 2% considered acceptable), controls on profit taking and intervention triggers (tiered through to wind-up) and the long-term objective (endgame to be specified but buyout not a requirement).
The Regulator will be responsible for assessing superfunds and their supervision and will have various powers to intervene in the operation of a superfund where necessary. Superfunds will have to provide appropriate monitoring and reporting information to the Regulator. There will be a Regulator code of practice on superfunds (as well as guidance).
Financial adequacy
This will perhaps be the most important element of the legislation. The regime needs to improve member security, cost less than buyout and be commercially attractive to providers and investors. Elements of the Solvency II framework will be used to reduce risk, but capitalisation will not need to be in line with Solvency II insurance requirements and it is proposed that superfunds will have ‘financial requirements set under a pensions regime’ – the response talks of technical provisions on a best estimate approach to cash-flow projection and a discount rate similar to a ‘low dependency investment strategy’.
DB superfunds have been waiting in the wings for quite some time now and have yet to fully emerge as an alternative to buyout for those schemes that cannot achieve this. It will be interesting to see in what way and how quickly they now develop especially taking into consideration the Government’s current initiative to accelerate implementation.
Options for DB schemes: call for evidence
The DB options call for evidence centres around how DB schemes can invest ‘more flexibly’, and more specifically, increase their investment in ‘productive finance’, an umbrella term for equity capital and finance for UK companies including start-ups, infrastructure and private equity and illiquid assets.
What is the purpose of the call for evidence?
The Government wants to give schemes more consolidation choices and more investment options so that surpluses can be increased while retaining member security and without impacting trustees’ fiduciary duties.
What questions are included?
The questions cover a wide range of issues including:
- whether DB schemes are underinvested in productive assets in comparison to international comparators;
- what can be done to incentivise investment in productive assets;
- various questions on the use of surplus and whether the legislation and tax position should be changed to incentivise investment to generate surplus, make access easier and refunds more attractive;
- options for consolidation including the ‘benefits and drawbacks’ of a public sector consolidator; and
- the potential role for the PPF as a consolidator – this stems from the December 2022 Department for Work and Pensions (DWP) review of the PPF which recommended that the DWP and PPF see whether it could become a consolidator or aggregated service provider for schemes that are ‘not attractive to commercial consolidators’ – little further detail is provided – at this stage, the Government is asking for evidence on the possibility of the PPF’s role being expanded including on the risks and benefits, the appropriateness of the PPF acting as a public consolidator, and its design.
This initiative dovetails into the DB superfund response, the overall premise being that DB consolidation will bring with it increased investment opportunities – having fewer, larger DB schemes would present a material change to this part of the pensions sector.
The call for evidence closes on 5 September 2023.
Trustee skills, capability and culture: call for evidence
What is the purpose of this call for evidence?
This call for evidence asks questions around the capability and skills of trustees, the role of advice and ‘barriers’ to the effectiveness of trustees which can affect saver outcomes. There is a particular focus on whether trustees have sufficient knowledge and skills to properly consider investment – not surprising given the Mansion House speech centred around economic growth.
The call for evidence is an indication that increased trustee professionalism is on the cards. We may see a TPR maintained trustee register and changes to the current trustee accreditation system. The Government also see trustees’ investment duties as potentially causing issues with its wider investment initiative but quite what the Government is thinking of doing to address these perceived barriers is unclear at this stage.
What are the Government’s concerns?
Evidence indicates that some trustees, particularly those of smaller schemes, do not have sufficient knowledge, understanding (KU) and skills. Reports have also shown that ‘limited investor capability’ is a barrier to pension providers utilising new forms and possibly better-performing investments. At present, UK schemes are not investing in high-growth businesses in the same way as international arrangements.
What evidence is requested?
Area 1: Trustee skills and capability
The first area looks at the legislative and regulatory KU expectations for trustees, if they are being satisfied and how capability can be improved.
It is noted that if trustees do not have sufficient KU, they should think about whether to consolidate into a bigger scheme that satisfies the requirements. The Government says evidence shows that generally schemes do not have sufficient KU to ‘engage effectively with alternative assets’. The Government believes that trustees who have better KU may invest more in higher-return assets which will in turn promote economic growth.
It is not clear how the Government thinks this will sit alongside trustees’ duties to manage risk and ensure investment decisions are in the best interests of their scheme’s beneficiaries. Wider economic growth is only relevant to trustees to the extent that is aligned with the security of benefits.
Registration and accreditation: The Government is considering whether TPR should maintain a register of trustees and ask questions about this. There are questions on whether the current accreditation framework is sufficient and whether each scheme should include a specific proportion of accredited trustees.
Professional trustees: There are current difficulties, e.g., supply constraints, in requiring every scheme to have a professional trustee. Nevertheless, in the long-term, the Government wants fewer schemes, with each having a professional trustee. In line with this vision, the Government is considering whether the professional trustee requirements need to be more stringent and, if so, how these standards should be set.
Area 2: The role of advice
Trustees are required to appoint various advisers, including in respect of investment and to obtain written advice in certain situations. Advice plays an important role in how trustees make decisions including on investments. The Government is looking at how advice, other adviser support and wider regulatory obligations affect trustee decisions on investments, including in unlisted equities.
Area 3: Barriers to trustee effectiveness
Fiduciary duties: There is concern that how trustees carry out or interpret their fiduciary duties could be making them ‘risk averse’ and preventing them from considering a wider range of investments that could potentially provide pension members with better returns: “Failing to consider the full range of investment options, where this is appropriate, is a failure of governance and a failure to fulfil fiduciary duty.” The Government is asking for details of barriers that may be stopping trustees from fulfilling their duties effectively, particularly on investments.
Time off and employer support: Another potential barrier is whether lay trustees have sufficient time off from other roles with the employer in order to carry out their trustee duties, this being a statutory requirement, and employer support for this.
The call for evidence closes on 5 September 2023.
Value for money (VfM) framework for DC schemes: consultation response
Background
In January 2023, the DWP, the Financial Conduct Authority and TPR consulted on a new value for money (VfM) framework for the disclosure, assessment and comparison of VfM for DC occupational pension schemes and Independent Governance Committees of workplace personal pension schemes. The new framework will eventually replace the existing annual VfM assessment.
The idea behind the new framework is to have a standardised and transparent assessment that will allow ‘consistent and comparable assessments’ across different DC arrangements and which will move the emphasis from cost to value – the Government believes that in doing so, value and retirement outcomes will be improved. As with the other Mansion House measures, it is hoped that having a ‘long-term focus’ on VfM will ‘encourage’ more scheme investment in productive finance.
The new VfM framework will cover investment performance, costs and charges and service quality with schemes reporting against comparators.
The response
The consultation response covers various aspects of the framework including: how it will interact with other policy initiatives; its scope; how the three main criteria will be assessed; how the VfM results will be set out and published; the assessment process; results and next steps; the interplay with the chair’s statement; FCA matters; and impacts.
By and large, the Government intends to proceed with its original plans. In summary the response confirms the following:
- The new framework will be introduced in phases, with default arrangements used for auto-enrolment being first.
- It is intended that framework data covering up to 31 December in the previous year will have to be published by the end of Q1 in a calendar year with publication of the VfM assessment results by the end of each October.
- The comparison required against other schemes will need to include “commercial schemes sufficiently large to deliver benefits of scale.” It will be market-based rather than having regulator-defined benchmarks (at least to begin with).
- The conclusions of the assessment will need to say on a red/ amber/ green rating system whether the scheme is VfM, and, if not, identify immediate improvement steps to achieve this.
- The Government is considering whether to specify what steps must be taken after the assessment including winding up or consolidating where a scheme is not VfM over two successive years.
- There will be a set process for the comparison, with guidance including a standardised reporting template.
- The Government notes the increasing duplication which will arise between the new framework and the chair’s statement – although the requirement will remain for the time being, how to reduce and eventually remove the chair’s statement as the framework is introduced will be considered.
What next?
The VfM framework will need legislation and the Government intends to introduce this when parliamentary time allows. There will also need to be FCA rule changes upon which there will be a consultation.
Expanding CDC: consultation response
The response to the January 2023 collective defined contribution (CDC) consultation confirms that the Government will consult on draft regulations to expand CDC provision to whole-life multi-employer schemes for non-associated and unconnected employers and master trusts this Autumn. The Government believes that CDC “will have an integral role in the future of pensions in this country” and will improve saver outcomes because the pooling of assets, longevity and investment risks means a longer-term investment strategy can be adopted which should allow for longer investment in growth-seeking assets.
The legislative framework will pull from the existing CDC legislation which relates to single or connected employers but will also utilise DC master trust concepts given certain similarities.
The Government also intends to legislate for CDC decumulation-only schemes (covering benefit access only and not the building up of benefits). It believes that CDC decumulation should be an option for members together with other decumulation arrangements such as income drawdown.
Supporting savers when accessing benefits: DWP consultation
The DWP’s consultation on helping savers understand their pension choices outlines the Government’s proposals for a decumulation framework which will help support savers when they take their benefits as evidence has shown a need for such support – members need to be encouraged to engage with their pensions and require help making informed choices. The DWP hopes that CDC decumulation products will form part of this framework and schemes should look at how CDCs could play a part in the decumulation offering.
The intention is for trustees to be under a duty to offer decumulation services “suitable for their members and consistent with pension freedoms.” The offer will need to be either provided in-house or supplied externally. A default option will step in should a member not want to exercise any of the options offered.
The intention is to legislate for this trustee duty when time permits. Until legislation is in place the need to offer decumulation products will be implemented through TPR guidance.
The consultation closes on 5 September 2023.
Deferred small pension pots: DWP consultation
The DWP consultation on ending the proliferation of deferred small pots proposes setting up a small number of authorised schemes to act as consolidators. The alternative ‘pot follows member’ model outlined in the call for evidence has been dropped. This is because although there were benefits to this model (and drawbacks) the Government believes the consolidator model has potentially more benefits. A single consolidator model is not being taken forward because of the potential for market distortion. The Government also believes that the multiple consolidator model will benefit productive finance because the benefits of scale will allow such investment.
In summary, the proposal is to use a ‘clearing house’ as a central system to which members’ deferred pots should be sent and which will then match the deferred pot with a member’s chosen consolidator or allocate a consolidator where the member does not choose. Pots up to £1,000 will be consolidated 12 months after the last contribution is made. The Secretary of State will have to review the pot size limit at regular intervals.
The consultation closes on 5 September 2023.
The LGPS: DLHC Consultation
The last consultation in the 11 July package is from the Department for Levelling Up, Housing & Communities on proposals covering Local Government Pension Scheme (LGPS) investments and in particular the acceleration and expansion of asset pooling by March 2025, increasing investment in private equity with the aim to reach a 10% allocation level, amendments to the LGPS regulations so that strategic objectives must be set and periodically reviewed for investment consultancy services and a technical change to the definition of investments.
The consultation closes on 2 October 2023.
Pension measures: analysis
The final document analyses the impact of the Mansion House pension reforms and the 2017 automatic enrolment review measures and can be accessed here.
Next steps
There is a great deal in the reform package for the pensions industry to take on board – of course, some reforms relate purely to DC and others to DB so the whole suite of documents may not have relevance to all.
There appear to be some quite significant changes in the offing, some of which are at a more developed stage than others and some of which will depend on a certain level of interest to really take off (CDC and superfunds). We know that the Chancellor expects decisions to be made on all of them before the Autumn Statement so it will not be long before we have more clarity on the direction of travel, especially on those such as the DB options call for evidence in respect of which the Government’s thinking has not yet been fully formulated.