Corporate advisers have always advised on switching pension schemes — with cost, poor service, fund choice or better support with engagement typically driving these decisions.
But switching activity remains relatively low. As a component of competition this is a concern for policymakers and regulators as they pursue a revamped value for money framework.
VFM is not a new concept for workplace pensions. But there is renewed scrutiny on this with the publication of a new Financial Conduct Authority (FCA) consultation paper, which will introduce a new traffic light system for VFM. Essentially schemes evaluated as red will be expected to close, consolidate or switch, those with an amber rating must set out plans to improve or consolidate or switch, while green will pass muster. Even before the rules are finalised the pressure is clearly on schemes to improve on many of the key metrics likely to be used.
The consultation paper is long, extending to 128 pages plus annexes including detailed proposed handbook changes. A FCA policy statement with final rules will follow, with HM Treasury and the Department for Work and Pensions working together to amend legislation governing trusts where necessary.
However, to understand the rationale, we quote a consultation response, published last July, as
it encapsulates the high-level intentions of the DWP, TPR and FCA.
The joint response by DWP, TPR and FCA had the lengthy title “Consultation Outcome Government-regulator response to ‘Value for Money: A framework on metrics, standards and disclosures”.
It said: “We believe that standardised, consistent, and transparent data and assessment can drive real improvements and create the sea change in thinking that is needed in the pension sector, encouraging competition, driving good schemes to get better, and requiring poorly performing schemes to exit the market.”
It also summed up policymakers’ frustrations with the market, saying: “At the largest end of today’s workplace pension market, we know that short-term cost dominates decision making. The value for money framework seeks to change this simplistic thinking and has deliberately been designed to shift the focus from cost to value.
“In an inertia-based system, those that make decisions on behalf of savers have a huge responsibility to make good and informed decisions that can deliver for savers over the long term. We want trustees, providers and Independent Governance Committees IGCs to use the framework to ask themselves tough and challenging questions. Do we have the scale and expertise needed to access better outcomes? Can we compete with the biggest and best schemes in the market?”
Secondary switching
But what is the current state of play in terms of switching? Gallagher benefits consulting leader Mark Pemberthy says: “The political and regulatory encouragement for single employer trusts to consolidate with master trusts continues to drive a lot of activity and we expect this to continue.
“We are also seeing an increase in the secondary market, often triggered by corporate activity resulting in benefits harmonisation and the opportunity to combine multiple schemes into one scheme — not always with one of the incumbent providers.”
Steven Leigh, associate partner at Aon agrees. “There is still a lot of interest from single trust schemes, which are moving predominantly to master trust rather than GPP to allow for a bulk transfer of accrued member funds. However, I have seen some employers re-evaluating these types of moves where their DC single trust arrangement is a section within a wider DB arrangement, and there may be an opportunity to utilise a DB surplus to fund some of the company’s DC contributions.
“There is also a focus from sponsoring employers on the value that is being delivered from their current DC scheme. This focus has led to a fairly significant number of switches from one provider to another retaining the same structure, whether GPP or master trust.”
In terms of employer motivations, Leigh says there are usually two main drivers for employers to move schemes.
One is reducing risk, particularly with single trust arrangements where much of the risk of things going wrong, breaching legislation etc. is borne by the trustees and, by extension, the employer.
The second is improving value. “It is no longer about looking for the cheapest option, if it ever was, but is more about understanding what DC savers are actually getting from their pension and how this compares.
“There is a huge range between the upper and lower investment performance for the main DC provider default options. If savers are consistently getting 3, 4 or even 5 per cent higher returns each year, then arguing about 0.1 per cent in charges becomes a much lower priority than making sure the provider default option is consistently delivering the net returns that DC savers need for an adequate pension.”
Assessing the smaller end of the market, Cavendish Ware associate director Roy McLoughlin says: “Things don’t move as much as you might expect – due to inertia and due to cost. And employers have to pay a fee to have support when changing.
“If you are with a bigger provider, it is unlikely you move. We did see one provider where admin collapsed, and employers were saying ‘get me out of there’ so we did move some. They have improved now.”
He says corporate activity, in terms of life office mergers and deals, can also worry advisers, but actually that involves concerns about having to move again at a future date after the initial selection.
He says he sees Hargreaves Lansdown and Fidelity ‘on the scene’ but they tend to want schemes of a certain size. There is less choice for smaller schemes and the relatively small number of advisers advising them. “I see a lot of companies who have set something up and lost touch with their adviser.”
Royal London’s customer lifestage director Rory Marsh says: “It is a really busy space just now from both a policy and competitive market point of view. Our focus is to make sure that the key objective of the system remains that customers get great retirement outcomes.
“The value for money framework proposals will make it easier for participants in the market to understand what they could be getting and compare. In the absence of transparency around what value employees could get from different schemes, it is natural to focus on price. But what is encouraging is that this isn’t what employers are looking for. They come to us and it starts with service and long-term performance, although price is important. But these changes will make it more transparent and comparable.”
Value-driven world
Corporate advisers argue that they are also already in a value-driven world. Pemberthy says: “In our experience, lower charges are never the reason for switching, we always focus on value rather than cost. It is a competitive market for good quality schemes, and we are seeing providers offer very attractive terms at the moment.”
In terms of the lower earnings band, he adds: “Removal of the lower earnings band should further improve scheme financial profiles, and therefore improve pricing – albeit there is a counter risk that extending AE to younger members may increase overall member turnover rates, which could potentially result in any benefits from higher contributions being offset.”
When asked specifically how VFM tendering will contribute to market switching, Pemberthy says: “VFM will help to reinforce the focus on value rather than cost, but schemes will only compare themselves to a small number of competitors therefore advisers will still need to undertake their detailed research to have a qualitative view on the whole market. We already seek to negotiate efficient transitions in order to maximise value for members. Administration features and quality of communication support also continue to be important differentiators. Bespoke investment options are no longer a high priority for most clients. However, this does put more onus on the design and quality of the default fund and wider fund range.”
Leigh says VFM could lead to less switching: “The proposed VFM rules should make it easier to compare providers on a like-for-like basis, at least across the metrics they are being asked to disclose. This should make it clearer for employers to see how their provider stacks up. There will also be more of an onus on providers themselves to make changes where they are falling behind, which may lead to less need to switch provider in the pursuit of better value.”
Market inertia
However addressing the reform, the Lang Cat head of public affairs Tom McPhail says: “Overall, it feels like there is a huge amount of inertia in the market. There is a lot of work involved and risk in moving. My sense is things have to get bad before anyone says let’s move this. The market is somewhat ossified.
“If you go back to the Competition and Markets Authority study of the sector. I would argue that things are still pretty dysfunctional with that principal/agent imbalance. We have IGCs and that helps, but I have yet to see an IGC reach a level where things are so uncomfortable and you are running your scheme so badly, we are going to tell you to shut it down. That might be doing a slight disservice to some IGCs members, but it’s all a little cosy.
“There is a business opportunity. Someone should be publishing this and creating this comparison platform. Comparing one scheme is difficult because there are bespoke charges. We have about 15,000 schemes, three dozen master trusts, and about a 1,000 own trusts. Way too many. A few dozen would provide it from a competition point of view. If I were the pension minister I would be saying to all providers, life companies and consultancies with their own master trusts, have one set of charges for all your employers as Nest does.”