The pension industry has entered 2023 with worries and concerns on multiple fronts. Employers and members face a very difficult economic environmental and double-digit inflation which has also brought turmoil in markets. There is a constant stream of reforms from regulators, and providers are having to do more with less.
DB schemes face an inquest following last autumn’s paroxysm in bond markets which led to an acute crisis for leveraged LDI.
DC scheme have grappled with the more conventional investment challenge of poor bond market performance which has seen TPR most recently raising concerns about lifestyling.
Corporate advisers see cost pressures all along the chain but with big worries for members first and particularly the risk of opt outs due to cost-of-living pressures.
Cavendish Ware associate director Roy McLoughlin says: “The biggest fear is people opting out – people going to employers and saying: “I can’t pay my 3 per cent”. Advisers have a major part of play in this conversation and sometimes revisiting the whole concept again of why save in a pension.”
“I do worry if people have no adviser or have lost touch that they will make decisions with big long-term consequences. If they stop, restarting contributions isn’t going to happen in three months’ time.”
It that is part one, says McLoughlin, part two is to talk to the employer. It may be to re-emphasis why a pension is provided though in some instances it could be a reminding that they could be breaking the law.
On a brighter note, he says that “many employers are reaching out to us and saying can you help us with the benefits structure so we can ensure that employees feel appreciated”.
“Employers in the SME world are seeking out advice about looking out for their staff, not just with pensions. They feel an obligation towards staff.”
Cranfield Capital professional trustee Andrew Cheseldine says: “Value for member is something everyone is concerned about – both regulators and the DWP. But in the schemes I am involved with, we haven’t seen much of an increase in opt-out rates.”
However, he wonders if the sector has yet to feel the full impact of high inflation and low pay rises yet. There are other cost pressures too.
“There is stress on providers. You might be on a flat AMC charge, and your costs are going up but your fund values haven’t gone up by an equivalent. Even if you are paying £1.25 or £1.50 a month plus 30 basis points, that isn’t going as far. It is used for a combination of pay, services, even heating and light for your offices. You are having to work quite hard on the basics, even before looking at investment.
“You can’t increase your £1.50 and X per cent charge significantly with the charge cap, and inflation-proofing is not built it. Even with regulatory costs, you are paying a minimum of £1.30 in TPR fee and compensation fund per member per year. If you have a £1,000 pot and are charging 30 bps that is only £3.00 a year.”
Yet amid these operational challenges, there is, he points out a snowballing level of increasing regulatory pressure from both TPR and the FCA.
There will be further announcements about value for members and inflation, On ESG, “the regulators are gradually ramping up.”
Consultants are helpful but only up to a point as they have cost pressures too. Zedra client director Richard Butcher says DB faces a tough LDI crisis post-mortem. “To be clear – not the LDI post-mortem – the principle is alive and well. Although this was a crisis caused by the September un-costed fiscal event, several operational and contractual flaws became apparent as the system was thrown into acute stress. These will be picked apart during 2023 no doubt, with finger pointing and litigation.
He says there will be a final push toward buyout. “Many well-run schemes are funded there or there abouts now. They need to do their final prep and try and jump into the inevitable buy out queue that will form.”
In DC, Butcher says an increasing number of employers are looking to switch into master trusts, so there will be more consolidation during 2023.
For the smaller schemes, there will be a need to prep for consolidation. Butcher also echoes the concerns of Cheseldine and McLoughlin. “The cost-of-living crisis will increase the number of vulnerable members, with the implications of that being more that more support will be needed. The risk of increased opt out rates and scam risk will both increase.”
Calum Mackenzie, partner at Aon, envisages something of a transformation in investment approach. He says: “The gilt market volatility and its impact on the LDI market will be the key driver of pension scheme investment strategies in 2023. Reduced leverage will force the biggest change to portfolio design in a decade. The world of low-risk growth, hedged liability risk and low funding volatility is not possible. Tough choices need to be made between liquidity risk, hedging levels and returns. This may well have to be done in a recessionary environment where company covenants are probably weaker.
“The ultimate destination of pension schemes will drive asset allocation – those focused on buyout are likely to look to lock down risks and align portfolios with the insurance market. Those with a longer-time frame will be in a strong position to capitalise on less-liquid assets being sold at attractive prices.”
He says that pension scheme trustees and sponsors will also look hard at governance. Tough questions will be asked around how the gilt market volatility was handled, preparing for future volatility and how best to use trustee and sponsor time. We expect to see greater demand for solutions that can help pension schemes manage higher collateral levels while maintaining diverse portfolios.
This is likely to drive renewed interest in fiduciary management or other forms of delegation. “Underpinning all pension investment strategies will be a continued and increased focus on sustainability. This will be driven by a combination of regulatory, risk management, corporate and opportunistic factors. 2022 was testing for many pension schemes. 2023 will be the year of big investment change.”
On the legal front, David Saunders, Sacker’s senior partner, identifies four big developments – the Single Code of Practice, the dashboard, DB funding and investment and climate disclosures.
He says: “TPR’s new single code of practice is imminent and will bring with it requirements for schemes to have an effective system of governance (“ESOG”) and to carry out an own risk assessment (“ORA”). While this shouldn’t represent a major shift in existing practices for in-scope schemes, trustees will need to review their scheme’s governance policies and practices to identify any gaps that need addressing. This could be a significant undertaking for many schemes.”
He notes that the ESOG and ORA requirements do not technically apply to master trusts, as equivalent provisions are imposed through TPR’s authorisation and supervision regime. However, he suggests that master trusts may still want to carry out a cross check against the ESOG/ORA requirements since, in Sacker’s view, TPR will still expect these standards to be met.
A set of dashboard consultations closed this month and he expects developments to pick up speed with the first staging date for larger schemes on 31st August.
He says that DB schemes and sponsors will need to keep a very close eye on the new funding and investment requirements as they come down the track.
Saunders notes that TPR’s draft new DB funding code was published for consultation just before Christmas and designed to perform what he describes as “an essential double act” with the funding and investment regulations which the DWP consulted on last year.
The new regulations will require DB schemes to have a funding and investment strategy and to submit a written statement of that strategy to TPR, with the code setting out much of the detail of how to go about complying in practice.
Saunders adds that the consultations raise questions around just how flexible the new regime will be for different types of schemes, and whether the regulations could alter the existing balance of powers between schemes and sponsors when it comes to funding and investment matters.
Finally, 2023 will look different for many schemes in relation to ESG duties. The scope of the DWP’s climate governance and reporting regulations is now extended to include occupational schemes with relevant assets of £1bn to £5bn. “Many will be publishing their first climate reports during 2023.”
Separately, the FCA’s rules on enhanced climate-related disclosures for FCA-regulated pension providers were extended from 1 January 2023 to include in-scope schemes with assets under management of over £5bn.
Some are concerned that it all adds up to a huge amount of work.
Matthew Arends, partner and head of UK retirement policy at Aon, says: “The issue of the sheer amount of activity surrounding pension schemes and a talent ‘crunch’ across the industry did not go away during 2022 – if anything, it’s got worse. The list of big initiatives to be tackled has not shortened, so schemes
and providers need experienced people to understand what’s needed and to make major projects happen – whether that’s dealing with GMP equalisation, the dashboard, changes to the funding regime or several others. The fear is of ineffective implementation of too much change, done too quickly.”
Some want a fundamental change in direction this year. Barnett Waddingham partner Damian Stancombe, who leads the firm’s creative agency DrumRoll says that it can feel like regulators are trying to hit every base at one point in time. But for him, the real issue is “pensions apartheid, an increasingly few haves, with a large number of have nots”.
He feels that reforms are often focused on today’s world not the future landscape where a lot of people will have to keep working in some fashion.
“We need to stop predicating it around what today looks like with wealth is in the pensioners worlds and very few in the workplace are going to save enough for an aspirational retirement.”
“When you look at UK plc we will not all retire at the same time. Whatever we do, we seem to be going round in circles. DC was never meant to be the primary place for provision – it was a top up for state and DB, but we have mostly removed the two other pillars and left DC floundering on its own. No-one is going to put 20 per cent of their salary into it, as they can’t afford to.”
He says the one place to start might be to make sure people make the most of what of they have saved, to not let them screw it up with their retirement savings, whatever the amount, and that is where education should be concentrated.