Key announcements: A summary
Immediately following the announcements made by the Chancellor in her November Mansion House speech, the Government issued an interim report as part of the Pensions Investment Review and two related consultation documents. One of the consultations relates to the Pensions Investment Review's aim of "unlocking" the UK pensions market for growth and the other relates to proposed changes to the Local Government Pension Scheme (LGPS).
In the interim report, as a summary of the key Government aims in this area, the Ministerial Foreword states that the report starts to set out the vision for a DC pensions system with "fewer, larger and less fragmented schemes that are more able to invest for the longer term and in the UK, and that can boost returns for UK savers". The key consultation sets out several proposals that, if implemented, would have a significant impact on the wider pensions industry and the way in which pension funds are invested.
The key proposals set out in the Unlocking Growth consultation are to:
- Achieve scale in workplace (multi-employer) DC schemes by introducing minimum size requirements for default arrangements as well as limits on the number of default arrangements; and
- Allow for the override of individual contracts to allow the bulk transfer of assets from contract-based schemes without individual savers' consent.
In addition, the Government is considering:
- The removal of the ability by providers to set differential pricing for the same pension product; and
- The role of employers in pension provision with a view to shifting the focus away from the "cost" of pensions to the "value" provided by pension products.
Interestingly, the Government is not, at least at this stage, making specific recommendations to mandate UK investment targets (outside of the LGPS proposals). We are not covering the LGPS consultation in any detail in this alert but, very broadly, it provides for a series of measures which will require all LGPS funds to delegate the management of all their assets to an asset pool (of which there are eight in total), alongside requiring that "pools conform to a rigorous and universal set of standards". The asset pools would take responsibility for all areas of investment implementation, whilst the LGPS funds themselves would focus their attention on setting the overarching investment strategy, taking into account their membership and funding requirements. The Government envisages that the pools would be required to develop the capability to provide their partner funds with investment advice to support their strategic decisions.
The interim report notes that it, and the two related consultations, have been produced now to allow a full and thorough consultation process ahead of the publication of the Pension Schemes Bill which will be introduced next year. The final report will apparently consider domestic investment from pension funds. In addition, the scope of the second phase of the review will be published "in due course" and will broaden out the review and consider further steps to improve pension adequacy, including assessing retirement adequacy.
It should be noted that our understanding is that the proposals regarding fund size etc. will not apply to "single employer" occupational pension schemes. We interpret the reference to a "single employer" to refer to a "single employer group", as opposed to a master trust which applies to non-associated employers and is within the scope of the proposals.
Finally, it is interesting that, despite industry calls for an update, the Government did not use the Mansion House speech to confirm its thinking on defined benefit surpluses and how these can be extracted from relevant pension schemes and distributed to employers and members.
Minimum size requirements for default funds: In more detail
The consultation, running until 16 January 2025, notes the need to achieve scale in workplace DC schemes. The Government believes that "schemes at a large scale can lead to better governance, deliver economies of scale and help access and invest in a wider range of assets." Two linked proposals are therefore being put forward:
- Multi-employer DC schemes used for auto-enrolment purposes should have a maximum number of defaults; and
- Multi-employer DC schemes' defaults should operate at a minimum size.
The Government is considering as part of the consultation whether, if they go ahead, the proposals should be implemented at the default arrangement/scheme level or at the default fund level. It has said that it is considering this in relation to both proposals, although it has indicated that it is "minded" to implement the minimum "assets under management" (AUM) limit (i.e., the second proposal) at fund level.
Maximum number of default funds requirement
In terms of the restriction on the maximum number of default funds that a provider can offer, the Government is keen to introduce this requirement but wants to consult on what the right number and/or conditions to limit the number should be. It also wants to consider relevant exceptions, e.g., Sharia compliant funds, and to ensure that innovative default funds, those investing in productive assets including in the UK or those offering exceptional value for members can continue to compete in the market.
Minimum size of assets under management requirement
With regard to achieving a minimum size of AUM at default fund level, the Government is not yet committed to a particular minimum AUM figure, but notes in the consultation that, although there is no conclusive evidence on optimal size of AUM at default fund level in DC pension schemes, evidence suggests a greater number of benefits can start to arise at GBP 25 billion - GBP 50 billion (or greater), so this may be a useful indicator of the likely direction of travel.
When will the new requirements be introduced?
Whilst the Government has not ruled out introducing legislation in the upcoming Pension Schemes Bill to enable the introduction of these measures, it has indicated that these new scale requirements would not apply until 2030 at the earliest. It is considering whether a reporting regime should be put in place so that schemes can "staircase up" their value and reduce their default funds gradually over time.
Without consent transfers from contract-based arrangements: In more detail
With the combined aims of removing perceived barriers to consolidation, enabling disengaged members to be transferred to better performing arrangements and to establish equivalence with the trust-based DC market, the Government is proposing to legislate to permit transfers from contract-based arrangements without consent into either a trust-based or another contract-based arrangement (such as GPPs). The Government is also looking to introduce these measures to facilitate the "Multiple Default Consolidator" model that it wishes to bring in under the upcoming Pension Schemes Bill, whereby the estimated millions of deferred small pension pots will be automatically consolidated into a small number of higher quality pension arrangements.
Appropriate protections and safeguards would need to be set out in FCA rules and additional FCA powers may be required to facilitate the introduction of this change. In particular, it is proposed that an assessment would have to be undertaken by an independent third party with sufficient expertise before a transfer could take place. The consultation notes that, for workplace pensions, this role could naturally fall to the firm's IGC. As part of this assessment, the Government currently envisages that it would have to be confirmed that the new arrangement will offer a better outcome to the member.
Employer engagement with workplace pensions
The final main proposal from the Government in this area is to seek to increase employer engagement in offering higher quality pensions, in particular, to shift the focus from "cost" to "value" to members. The earlier call for evidence carried out in advance of the consultation led to suggestions from parts of the industry that the Government should alter the auto-enrolment legislation to place a duty on employers to 'consider' the overall value of the arrangement during scheme selection (and to regularly review this). The Government is consulting on this suggestion but is also asking for input on whether responsibility for pensions could be imposed at Board level, such that a nominated company executive could take responsibility for ensuring the pension arrangement delivers good value retirement outcomes for staff.
Key takeaways for trustees and employers
These proposals, whilst potentially a way off in terms of implementation date, will be particularly relevant to employers providing relevant DC benefits and trustees of DC occupational pension schemes that may be considering further consolidation. Even for those "single-employer" DC occupational pension schemes not currently looking to consolidate, they should be mindful of the Government's agenda to improve the performance of default funds for savers and the wider economy and pay close attention to the new "value for money" changes being introduced. Whilst no immediate action needs to be taken by employers, if the proposals are brought in via the upcoming Pension Schemes Bill, it is likely that they will need to be liaising with their pension providers regularly to better understand their plans to alter and consolidate their DC default funds.
Please speak to your usual contact at Baker McKenzie if you would like to discuss the proposals further.
