When the Department for Work and Pension’s (DWP) consultation on how to solve the small pots problem closed, it was followed by criticism of the department’s solution.
Small pots are a bug in the software of automatic enrolment: they are a product of low wages, low contribution rates and rapid movement from job to job. Where people on lower wages move quickly from job to job, they frequently leave behind them a trail of small, deferred pension pots with their former employers’ pension providers.
This problem is growing as there is no easy means of consolidating small, deferred pots. Evidence from other countries suggests that even when it’s very easy people do not voluntarily do it until retirement.
The UK needs a means of automatically consolidating small pots which protects savers and doesn’t create a massive administration burden for the pensions industry.
Pots follows member?
So why the kerfuffle? Much of the hostile commentary has focused on the administration issues created by the government’s proposed solution. But most of the difficult administration issues associated with automatically consolidating pension pots across many different providers are common to all of the proposed models.
When you get into the detail, you would need roughly the same set of processes to automatically consolidate small pots to the active scheme as you would to consolidate small pots to a scheme designated as a personal repository for small pots.
The difference is in outcome – both for the saver and for the provider – and not really in the underlying administration of a future scheme.
And it’s the outcome that’s problematic. The government chose not to opt for the pot follows member option. This would have seen pots under a given cash threshold be automatically pulled or pushed to the active scheme.
That proposal had some strong points, but it would have gradually led to providers playing pass the parcel with larger and larger pots. While the intention was to start with small pots, under £1,000, the reality is that this threshold would have risen over time until much larger cases were in play. Rather than developing a relationship with the saver and investing money for the long term, they would have been temporarily warehousing pots ready to pass them on to the next provider.
The frictional costs of shifting provider every time you move job would have been huge and schemes would have had to have been highly liquid in order to encash and transfer pots, running counter to government’s attempts to shift pension schemes towards illiquid investments.
We accept that some sort of bulk in specie transfer or netting off system might have been developed, but that sounds more like science fiction than a firm proposal.
Regulation and authorisation
Instead, the government has proposed creating a new class of scheme called a consolidator. Each saver will be assigned a consolidator – potentially by asking them to choose. All small pots under £1,000 will be transferred to the chosen consolidator and then they will stay there.
Government seems to have accepted the arguments around moving money once being the best way to lower frictional costs and also thinks that consolidators will be better placed to invest in less liquid assets. They won’t be facing the need to constantly encash and transfer pots that would have been the case with pot follows member.
Furthermore, defining a new class of scheme allows the government to hold a section of the market to a higher regulatory standard. They think that a new authorisation regime, potentially partly based on the new value for money metrics, will drive up standards and transparency between schemes. They also potentially see consolidators as helping to build scale, which they see as being intrinsically linked to value for money.
From a commercial perspective, this is immensely challenging for the industry. The government has suggested that the new consolidator schemes should only be allowed to operate one pot per member and take any amount. That would disrupt business models based on offering employers bespoke pricing. That frequently leads to a situation where a member has two different pots in roughly the same product with the same provider that are charged at different rates. Shouldn’t any provider consolidate multiple pots to give savers the best possible value for money no matter how big or small the pot is?
Having a plan
And, with the implicit intention being to consolidate the market, through building a new class of scheme, the DWP has raised the prospect of providers exiting the market. So, this isn’t just about the technical details of how different consolidation options work. It goes to the heart of what the future of the workplace pensions market looks like.
Of course, there is an election looming and many things may happen to blow current policy off course.
But if the plan for a consolidated market from minister for pensions Laura Trott, who deserves praise for her joined up approach to policy, plays out, the workplace pensions market will be smaller, potentially more transparent and more intensely competitive in five years’ time.
It may have got people’s backs up but it’s a more coherent plan than the industry has seen for some time; and plan tends to beat no plan, most of the time.
Phil Brown is director of policy at People’s Partnership, provider of The People’s Pension
