By Katie Kershaw, Principal Consultant, Mercer Marsh Benefits
More recently, the revival of the Pensions Commission has been announced, tasked with conducting a thorough review of the long-term future of the UK pensions system and recommending reforms that will extend beyond the term of the current government. So, what changes are underway, and what do they mean for employers and pension scheme members?
Consolidation and the rise of default “megafunds”
This first update in a series focuses on an essential part of the government’s vision: reducing the number of default investment funds used for automatic enrolment (AE). The government envisions a DC market dominated by a small number of “megafunds” that can invest in a broader range of assets, including private markets, support UK economic growth (as outlined in the Mansion House Accord), and drive higher returns for savers.
To continue operating in the AE market from 2030, Master Trusts and group personal pensions (GPPs) must have one default megafund with assets of at least £25 billion. While some exceptions apply (for example, default funds with religious characteristics), trustees and pension providers are now grappling with the detail currently available from the government on how to achieve this. Single employer trusts are exempt. Breathing space may be given to default arrangements with £10 billion in assets in 2030, if they have a credible plan to reach the £25 billion threshold by 2035.
There is also a special pathway for new Master Trusts or GPPs to enter the AE market if they demonstrate strong potential for growth and the ability to innovate. Will we see new propositions enter the market using this pathway?
Some existing Master Trusts and GPPs appear to already have the scale required within their main AE default, however many currently do not, although they may be on track or it may exist within their overall book of business spread over numerous defaults. We still await clarification from the Government on which assets may be included. Action will be required, forcing the DC pensions landscape to change.
A primary action will be the consolidation of AE default funds. Pension providers will need to examine their book and identify those employers and members currently using outdated or underperforming defaults and look to move them into their flagship AE default megafund.
However, consolidation will need to be justified as in the saver’s best interests and any transfer of funds will need to be done within the confines of the law. Cue more government reforms to help this matter along.
New powers and the Value for Money framework
One such reform is within the Pension Schemes Bill currently going through parliament. This Bill grants pension providers a new power to move savers out of contract-based pension schemes (such as GPPs) into another pension arrangement without their consent, provided the transfer is demonstrably in the saver’s best interests. Currently this power only exists for trustees of occupational pension schemes, so it will be a game changer for pension providers, helping them to drive change. This new power is expected to be in place at the end of 2028.
A critical factor in determining whether a change of default investment is in members’ best interests, will be the new value for money (VfM) framework, also being introduced in the Bill, which will apply to all default arrangements of workplace DC pension schemes.
The purpose of the VfM framework is to assess both trust and contract-based schemes on a like-for-like basis, taking a holistic and long-term view of value rather than focusing solely on cost.
From 2028, trustees and managers will be required to publish prescribed data, potentially covering investment performance, costs and charges, and quality of services. Based on this data, schemes will be assessed and rated as fully delivering VfM, not delivering VfM, or an intermediate rating. Based on current information, schemes failing to deliver VfM will be required to have an action plan, which should consider transferring members to schemes that do deliver VfM. Those with intermediate ratings may also need to create an action plan with similar considerations.
Adapting to change: what employers should consider
Employers should note that they do not need to wait for these measures to be in place before reviewing the quality and suitability of their workplace pension schemes. A proactive approach now can provide confidence that your pension offering is suitable for your employees and reflects current thinking and innovations.
Since the introduction of AE in 2012, qualifying schemes have evolved considerably. Digital advancements have dramatically changed the member experience with pension providers constantly looking at new and innovative ways to support and engage members, including the use of open finance and AI.
Investment strategies have evolved to reflect member behaviour and preferences at retirement, and the financial risks associated with environment, social, and governance (ESG) issues. Private market investments are becoming increasingly prevalent, supported by the government, as part of the drive to deliver greater returns for members.
Does your default investment strategy reflect current thinking? A key consideration is whether it supports how the majority of members intend to access their benefits at retirement, or if it supports them purchasing an annuity — the popularity of which has declined considerably since pension freedoms were introduced in 2015. If your scheme has a bespoke investment strategy, when was it last reviewed? Does it continue to meet the needs of your employees, or might an alternative default fund with scale now offer a better solution?
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