DC megafunds won’t automatically boost infrastructure investment

David Lane, chief executive at TPT Retirement Solutions, warned that the proposals instead risked stifling innovation and limiting competition in the DC space.

“Simply introducing a requirement for larger default funds will not increase investment in UK productive assets,” Lane said. “Worse, in the suggested timeframe, the changes would increase costs to employers, holding back growth at a difficult time for the economy.”

Lane continued that, while consolidation could “significantly improve” the DC market, it should take place with a focus on value for money for members, rather than on assets under management.

“Moving to a larger provider or default fund does not guarantee a better member outcome.”

David Lane, TPT

In its consultation document, the government claimed that significant economies of scale can be achieved once pension schemes reach at least £25bn in assets under management.

Paul Waters, head of DC markets at Hymans Robertson, echoed Lane’s concerns. While larger pension schemes often find it easier to access illiquid asset classes such as private markets, he said consolidation requirements should not stifle innovation. 

“The DC market is moving forward quickly, and recent history has shown smaller, more nimble organisations can innovate and deliver positive change,” he said. “It will be important not to lose this innovation.

“At the same time, we understand the government’s aim to achieve scale, and in tandem, to drive investment into UK productive assets. Scale, at some level, is required to invest in private assets but it does not in itself compel investment into these areas – it is a necessary but not sufficient condition for investment in UK productive assets.”

Waters said it would not be “necessary or desirable to eliminate smaller arrangements” if they are large enough to access private markets and deliver good value for members.

“Moving to a larger provider or default fund does not guarantee a better member outcome,” TPT’s Lane argued. “Industry surveys… have highlighted the extreme variability in outcomes and the fact that the smaller providers have often generated the best returns.”

Analysis from the Government Actuary’s Department that fed into the government’s proposals found that the evidence was “inconclusive” around the benefits of scaling up pension schemes and positive impacts on investment returns, with access to expertise and negotiating power often proving more impactful.

The analysis also reported that, while increasing exposure to private markets “may deliver slightly improved outcomes to members”, there was “considerable uncertainty, particularly with the assumptions for projected future investment returns”.

Set policy priorities, government urged

Yvonne Braun, director of policy and long-term savings at the Association of British Insurers, called for the government to “prioritise” policies such as Value for Money to avoid overloading pension schemes and providers.

“In-train policies such as the Value for Money framework and the consolidator model for small pension pots share many of the same aims as the proposed size threshold for megafunds - and legislation to bring about transfers without individual consent is necessary to deliver them all,” Braun said.

“The pensions industry cannot safely implement all four market-shifting policies while also delivering pensions dashboards and a new support model for customers. The government must prioritise.”

Meanwhile, consultancy group LCP in its consultation response warned that consolidation would come with “massive cost and disruption” to DC pension schemes – with much of the cost being borne by members.

“The member perspective needs to remain central and structural changes shouldn’t undermine good member outcomes,” LCP stated. “Large-scale consolidation would require substantial and costly upheaval over a period of years, and we need to ensure that the costs of this, which will ultimately be borne by members, improves their outcomes.”

“It is vital that the interests of members are put at front and centre of any reform agenda and not regarded as an afterthought.”

Laura Myers, LCP

Laura Myers, head of DC at LCP, said: “All of this legislative, regulatory and policy focus on driving towards megafunds for UK master trusts diverts attention from other measures that could deliver a greater level of productive finance on a much swifter timetable.

“Ministers now need to be clearer about what it is they want to achieve and to focus legislation on that rather than solely on scale as a proxy. It is also vital that the interests of members are put at front and centre of any reform agenda and not regarded as an afterthought.”

Hymans Robertson’s Waters also highlighted the importance of contribution levels to improving member outcomes.

“While the qualities of the provider and investment performance are two of the key drivers of member outcomes, the biggest impact comes from the level of contributions that individuals make,” he said. “The long-awaited pensions review, followed by the subsequent delay of the second phase, sends mixed signals to the industry.

“While we appreciate the need to avoid additional costs on UK businesses at this time, that should be an implementation consideration of any proposed changes. The Pensions Review and follow up recommendations are likely to be measured in years not months, and we would emphasise the need to start now to avoid storing up problems for the longer term.”

How to define productive finance

In its response this week, LCP called for the government to explore a “comply or explain” approach on investment strategies to improve the transparency of investment decisions without mandating specific allocations to “productive finance”.

It said the government should be “explicit” about its definition of productive finance to help pension schemes understand the investments ministers want them to target.

Coupled with the “comply or explain” approach, LCP said, this would help pension scheme trustees and pension providers to invest in the best interests of members while making it clear how UK assets and productive finance fit into these decisions.

TPT also highlighted that the megafund proposals did not take into account hybrid pension schemes that combine DC and defined benefit arrangements.

“For many employers, any move to force consolidation of DC assets away from a hybrid scheme could trigger Section 75 debt liabilities and, in extreme circumstances, schemes falling into the Pension Protection Fund if the employer became insolvent due to the debt,” TPT stated.

It could also stop members in such schemes from using DC benefits to fund a pension commencement lump sum at retirement, and cause members to lose benefits such as guaranteed minimum pension underpins.