UK policymakers are determined to tackle the proliferation of small pots in the UK’s pension system, and are keen to drive consolidation of market players into fewer, bigger providers. The government has already signalled its intention to adopt a multiple default consolidator framework to tackle the very smallest pots. But it is also considering more fundamental reforms that would see a lifetime provider model, also known as a pot for life, whereby individuals hold a single pot throughout their lifetime, with employers paying contributions into the pot chosen by the member through a centralised clearing house.
Supporters say the lifetime provider model stops proliferation of small pots, reduces admin costs, increases choice and is easier for individuals to understand. Critics say it could erode employers’ engagement with their scheme, commoditise workplace pensions and reduce competition as the market moves from an institutional to a retail approach.
Australia’s lifetime pension model is often held up as a template for a future UK system. The Australian superannuation system has AUD$3.7 trillion (£1.9 trillion) of assets, for a population of 26 million people, more than three times the value of UK DC assets.
Market consolidation
Australia’s system is dominated by eight providers with more than A$100bn of assets (around £50bn – think 2:1 on the exchange and you won’t go far wrong), which compares with four of that scale in the UK as of 31.12.22. The biggest, Australian Super, had A$300bn of assets at the end of 2023, around 50 per cent bigger than the biggest UK provider, Aviva. But given the maturity of Australia’s DC system, the two systems are arguably fairly similar in terms of market concentration. In fact, while the biggest 8 providers in Australia hold 62 per cent of assets, the biggest eight UK multi-employer providers hold around 83 per cent of multi-employer assets (excluding single-employer trusts). The biggest 11 providers in the UK hold around 94 per cent of multi-employer-provider DC assets. This suggests that while single employer trusts in the UK remain a key target for consolidation, the majority of UK savers, and assets, in multi-employer schemes are in a relatively small number of products.
The acute regulatory pressure on providers has been a big driver of consolidation in Australia, even amongst bigger schemes. In particular, failure of the default performance test has driven unsuccessful market players to find partners and exit the market.
Mercer Super has been the beneficiary of the biggest scalp to fail the test to date, taking over the BT Super, bringing in 800,000 new members and doubling in size overnight to around A$63bn. David Knox, senior partner, Mercer says: “BT failed the performance test two years in a row on their default product. This was a fund that had worked principally through financial advisers, while Mercer was predominately through corporates. But both were in the retail for-profit arena. It was a big deal for us – we doubled in size.”
David Orford, managing director of Optimum Pensions supports the way the investment performance test is driving consolidation. “It is a recipe for reducing the number of funds which is good because we are getting lower costs of administration. Whether that is being passed on to members or not I am not sure.”
Distribution of Australian Prudential Regulatory Authority (APRA)-regulated super funds by net assets
| Fund group | Asset range (A$bn) | Number of funds | Total net assets (Jun23, A$Bb) | % of total assets | Cumulative % of total assets |
| Mega | >200 | 2 | 572 | 26.3% | 26.3% |
| Very large | 100-200 | 6 | 784 | 36% | 62.3% |
| Large | 50-100bn | 6 | 426 | 19.6% | 81.8% |
| Mid-large | 25-50 | 5 | 176 | 8.1% | 89.9% |
| Small-mid | 10-25 | 7 | 127 | 5.8% | 95.7% |
| Small | 1-10 | 21 | 87 | 4% | 99.7% |
| Total sample | 65 | 2,174 |
Source: The Conexus Institute
Performance test
The UK government has said it wants to introduce something akin to Australia’s default performance test, which effectively kicks providers out of the market if they consistently fail to beat their benchmark. Improving the scrutiny and regulation of laggard performers is of course good practice regardless of whatever other policy developments the government may have in mind, but it will be essential to protecting members if a pot for life approach is adopted.
The Australian regulator is currently consulting on whether to change how the test operates.
Knox says: “The big danger of any examination or test is that the trustees then invest in the manner to pass the test. That doesn’t necessarily mean they go for the best returns, because you might have an investment in a green site infrastructure through venture capital
that could do really well. But if it goes poorly, it’s going to affect performance and therefore the probability of failing or passing the test. So instead one might decide to just hug the index.”
Knox’s personal view is that Australia’s current performance test is too crude. “We have a fund that is very ESG oriented, pitched for the millennials, that invests ethically and stays away from fossil fuels. Come the Ukraine war, fossil fuel prices went through the roof. And they suffered, but they were they were investing in a way that their members wanted them to invest.”
Knox believes a solution could be that if a scheme fails on the industry-wide benchmark test, a provider should be given the opportunity to explain the reasoning, and if that was because it was to meet specific client objectives, that should be taken into account.
The Australian performance test benchmarks funds against their chosen asset allocation strategy, within prescribed parameters, not the asset allocation strategy itself. The potential for contradictory outcomes is apparent. A fund with a better asset allocation strategy that falls short of its benchmark could be closed down, whereas a fund that, say, targets cash or bonds well, can pass the test with flying colours.
Michael Berg, principal, investing & superannuation advisory at Deloitte says: “The clear difficulty with the test is it is not measuring the effectiveness of strategic asset allocations, which is normally your major driver of returns. But if you were to declare a very conservative benchmark, it would be easier to pass the test, but you would probably still fail in the market because of where the long term returns land.
“You do still have an interest in outperformance but you do need to be measured and targeted about where you look for that.”
Berg adds: “One of the challenges for governments is it can be quite difficult to invest in areas where there’s a combination of returns and positive social impact being sought. So take renewable energies – that is quite difficult at the moment. Even if you’re confident in the returns over a very long time, there can still be concerns about the volatility or tracking error relative to the index that may be experienced.”
Stifling innovation?
It would be hard to accuse the Australian system of not embracing investment innovation given the wide range of real assets in which its players invest. But there is a challenge to be made with regard to benchmark hugging under the current system. Research from WTW has analysed that average returns for UK and Australian funds are broadly similar. However, the range of outcomes in the UK is far greater, with the best UK defaults delivering higher returns than the best Australian ones, but the worst doing considerably worse. In member outcomes terms, the Australian model, where nobody does really badly over the long term, is clearly better. The challenge for the UK regulator will be to attempt to eradicate the very bad performers in the UK market, while not creating a framework that stifles the ability of those delivering better returns.
It will also need to grapple with how to deal with defaults that perform differently at different points in the life cycle. There are many funds that are near the top of the table for younger savers, but perform less well relative to their peers at other stages in the life cycle. It will be a challenge for the regulator to figure out how to take punitive action against a provider which does very well at one stage but is very poor at another. The policy should also spark debate about what the target ‘landing point’ for schemes should be, given the very different ways that different socio-economic groups draw their benefits.
A further challenge for the UK market is how to deal with the multiple default funds offered by providers. In Australia only one default fund is allowed to play in the super space. If that fails, the provider is out.
Asset allocation
The majority of Australian DC savers are in default funds that do not have a default strategy that derisks. Instead, the typical approach is to have a set asset allocation through the accumulation journey, typically with around 70 to 75 per cent exposure to equities or other risk assets. In the UK debate has trended towards support for a very aggressive approach in the earlier years, up to age 45 or later, with some funds allocating 100 per cent to equity or other high risk/return assets for this savings phase.
Some providers do operate a life cycle approach. When conducting the performance test for these schemes the regulator weights various cohorts.
Regulation and data challenges
Where Australian pensions experts are probably most perplexed with the UK system is in relation to regulation and technology. The UK’s lack of a unique identifier, which appears to have held the pensions dashboard programme back by years, is a big stumbling block.
Dee McGrath, chief executive, retirement & superannuation solutions at technology provider Link Group says: “My understanding of the UK market is that you have your National Insurance number but it is not clean data – my view is that in a three-year time horizon you could clean that data and have a unique identifier. But there is a precursor to that around who is driving regulatory oversight. Clarity of the prudential regulation of the pension that is not split is a requirement to drive the changes.”
McGrath points to the second big challenge that the UK faces – the existence of two regulators regulating the same workplace pensions market in different ways.
McGrath feels that the UK needs to solve the problem of the two competing regulatory landscapes – contract-based schemes regulated by the FCA under rules derived from the Treasury and trust-based schemes regulated by The Pensions Regulator (TPR) under rules created by the Department for Work and Pensions.
“In the UK you’ve got conflicting standards, conflicting approaches. What would drive more rapid implementation of some of these changes is a more singular and streamlined approach to the prudential regulation around pensions, full stop. The government will be looking at this to say, how can we actually benefit from a structurally sound and well performing system? And if they can streamline that, there are national benefits.
“If you are trying to get to a place where you’re making decisions on what you require to have adequacy in retirement, then having different rules, different products, different approaches at a member level does not drive the right outcomes.”
Unravelling the two jurisdictions covering UK workplace pensions will be a complex endeavour. At present, regulators are not able to solve the problem that creates some of the worst member detriment in the UK pensions system – the inability for some contract-based providers to take measures they are overwhelmingly confident are in the best interest of the saver without their written consent – a problem exacerbated by pension freedoms, where individuals in GPPs targeting annuity purchase have been left in these strategies despite the majority of them drawing benefits in other ways.
McGrath also believes consensus will be needed for change to be achieved, and that industry bodies will need to come together and speak with a common voice.
“Before we got to the member election and the member choice elements of the structural reforms, it was all about how you actually remove inefficiencies in the system,” she adds. “And it’s also worth realising this hasn’t been a short journey, it has been over 14 years of a pretty consistent regulatory agenda.”
That regulatory agenda, a very active regulator in the form of the Australian Prudential Regulatory Authority (APRA) and a significant investment in technology means that the wealth of data available to all stakeholders, including members, is huge. But it has taken a significant investment in IT to achieve it.
Danielle Press is a former CEO of Equip Super and has also spent time working at ASIC, Australia’s corporate, markets, financial services and consumer credit regulator. She says getting the legal foundations right at the outset is key. She believes Australia would have done better to establish its system on an equity basis rather than a trust-based basis. “It doesn’t really work having penalties against people set up under trust law. Technically you can’t pay for a breach from the trust. So they had to contort themselves and create corporates to move capital up to the head.”
The strong regulation that exists in the Australian superannuation system is built on a foundation of a relatively simple legal framework and a significant investment in technology, two areas that the UK system often finds challenging.
HISTORY OF AUSTRALIA’S SUPERANNUATION SYSTEM
Australia has now had compulsory superannuation for 32 years, and has evolved its system through significant interventions by the regulator, big investments in technology, the creation of numerous profit-for-member providers and steady increases in contributions. Employers now have to put in 11 per cent of earnings, rising to 12 per cent by 2025 in 0.5 per cent increments. Unlike the UK, there is no opt-out option.
▪ 1992 – Superannuation Guarantee introduces compulsory employer contributions into DC pensions. Unions play a role in establishing profit-for-member (not-for-profit) providers to accommodate superannuation. These come to dominate the Australian market
▪ 2005 – Liberal government introduces choice of superannuation fund
▪ 2014 – SuperStream introduces standardised electronic processing and formatting of data and compliance material for processing contributions between employers, superannuation funds and the Australian Tax Office. Rollout starts with the biggest employers and
takes several years to implement
▪ 2019 – Protecting Your Super legislation introduces limits on fees and requires low balance inactive accounts to be passed to the Australian Tax Office for consolidation. This reduces the number of accounts from 34 million to 22 million. If an employee joins a new company, they can ask for their contributions to be placed in the scheme of their choice. If they do nothing, they will be placed in the employer’s default scheme. After 16 months, if they have an existing pot with a former employer, their current pot will be switched to that one by the tax office.
▪ 2021 – Stapling introduced, seeing workers automatically stay with their existing super fund when changing jobs, unless they actively choose an alternative. Also introduces superannuation performance test for the ‘MySuper’ default fund each provider is required to offer. Providers of defaults that miss their benchmark by more than 0.5 per cent a year over 8 years are required to write to members notifying them it has failed the test. If they go on to fail the following year, they are required to close to new members, ultimately signalling their exit from the market.