Government plans to close under-performing schemes could backfire and lead to poorer returns for everyone, according to some industry professionals. While many said action needs to be taken against poor value schemes, there were concerns that the process to weed out the worst performers could result in ‘herding’ behaviour and a more conservative attitude to risk, potentially impacting longer-term returns across the industry.
Public policy has led to increased participation in workplace pension schemes. This in turn has prompted increased government scrutiny of scheme operations, particularly in relation to those deemed to be offering poor value.
This was evidenced by Chancellor Jeremy Hunt’s recent Budget announcement. As well as requiring DC pension funds to disclose investments in UK businesses, costs, and net returns by 2027, he has also suggested that underperforming pension funds be closed down.
Questions remain as to how this policy might work in practice. For example, over what time would performance be measured? Industry professionals caution that challenges remain ahead, not least regarding governance disparities, potential herding behaviour, and the wider market ramifications of such a change. Many stress the need for regulatory decisions not to lose sight of longer-term value over more immediate gains.
Governance Disparities
Barnett Waddingham partner Mark Futcher highlights a stark contrast between ‘open’ and ‘closed’ books of business in the pension sector.
He states: “There is a stark difference between ‘open’ books of business and ‘closed’ books of business. Most open books are well governed and run – if they are not then the IGCs, master trust trustees and providers themselves should have a clear plan to improve value. If not, then there are numerous consultants and advisors who can help. If the Government believe that they are not being well governed, then they need to review the role and remit of those governing bodies. There is some appalling value in ‘closed’ books of business.”
He says he would like to see a governmental review of governing bodies’ roles and remits to address governance issues more effectively.
Futcher says he like to see more attention focused on those in closed pension scheme. “Hopefully the members who are trapped in closed back books of business will be moved to modern, well governed, better value products. There will be some consolidation in modern open books – such as the master trust market. Generally, workplace DC is much better value than individual retail policies.”
Potential Herding
Concerns have also been raised about the potential drawbacks of “herding”. Royal London head of investment solutions Kenneth Scott says: “There is a danger of ‘herding,’ where scheme providers and trustees gravitate towards a common investment approach to avoid becoming an outlier.”
He adds: “While there are some advantages to this in terms of consistency, it is likely to stifle innovation and may undermine entirely any efforts to encourage greater investment in illiquid, unlisted assets.”
Short-term focus
Scott warns that performance metrics are, by their definition, more likely to be focused on shorter term periods.
“There is a risk that the time horizon for comparing performance is shortened, which may reduce the appetite to invest in high-performing, longer term strategies which may return less in the short-term.”
He says this could undermine retirement outcomes for many and says there was a need to balance short-term metrics with broader benefits offered by scheme providers.
He adds: “There is a significant risk that short-term investment performance becomes the overriding ‘value for money’ measure, at the exclusion of all the other benefits a scheme provider can offer, and that we lose sight of the main driver of better outcomes, which is adequate savings rates.”
However Scott said it was important to address the issue underperforming schemes that jeopardise customers’ retirement outcomes. He advocates measures to support employers and employees in transferring their savings to alternative schemes if necessary.
“There is a case for focusing on investment performance where there are perpetually under-performing schemes, causing material harm to customers’ retirement outcomes.
“Consideration will need to be given as to how employers and employees are supported where they need to move their savings to another scheme, in the event their current scheme closes.”
Market Effects
WTW retirement business director David Robbins says it is also important to consider how government-driven consolidation might impact market dynamics.
According to Robbins: “The effect on the market depends on where the regulatory bar is set – and on any second-order effect from highlighting performance even where there is no regulatory intervention. That is impossible to predict without details, but if Government appetite for consolidation remains strong, this will be a new lever to pull.”
In connection to this, Scott draws parallels with Australia’s ‘super’ schemes. “The proposals here are largely based upon a similar initiative in Australia, where poor performing funds have to write to customers when they underperform in a given year, then close if that persists over two years. If we take that approach in the UK, there may be little appetite to do anything other than follow market practice.”
Robbins also highlights international comparisons, particularly with Australia’s pension scheme evaluation regime. He underscores concerns raised by the Australian Treasury’s consultation regarding strategy implementation versus the quality of the strategy itself.
Robbins says: “The Australian test focuses on how successfully a strategy is implemented rather than on whether the strategy itself is any good. Challenges such as these will not be specific to the southern hemisphere.”