IMA RESPONSE TO DWP CONSULTATION. Meeting future workplace pension challenges: improving transfers and dealing with small pension pots

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1 IMA RESPONSE TO DWP CONSULTATION Meeting future workplace pension challenges: improving transfers and dealing with small pension pots March 2012

2 IMA Response to DWP Consultation: Meeting future workplace pension challenges 1. The IMA is pleased to have the opportunity to respond to the DWP consultation on transfers and small pots. 1 In various capacities, IMA member firms have a significant interest in the future of UK pension provision. They manage assets for the full range of pension schemes and funds operating both in the UK and internationally, including defined benefit (DB) and defined contribution (DC) schemes and national pension reserve funds. Some IMA members also have specific pension company subsidiaries operating bundled (ie. administration and investment platform) DC schemes domestically and abroad. 2. In general terms, we agree with the premise of this consultation. Stranded small pots can be a barrier both to efficiency and to member engagement. As the UK goes through a paradigm shift in retirement provision over the next decade, one incentive for individuals to engage more closely with their pension saving will come from a better understanding of what they have saved and still need to save. Pot amalgamation offers a potential way to achieve this, although there are a number of issues arising that we explore in our response below. 3. The consultation document presents two models for change: a process using a central aggregator and a system where pot follows member through different workplace schemes. 4. Both models present significant challenges. However, there is a conceptual issue that is common to both and which is fundamental. If the stated general aim is to avoid small pots ever remaining small and to minimise stranded accounts, then over time what the Government is talking about is an amalgamation mechanism that potentially affects many millions of pension pots. If it is to be judged a success, an aggregator scheme may have a high number of accounts with significant balances. Alternatively, pot follows member might eventually not be a policy that is focused solely on small pots. The DWP is absolutely correct therefore to be considering whether upper limits will be needed on any automatic processes. 5. Our conclusions are as follows: Pot follows member is far more workable from a member perspective than an aggregator. In addition to delivering against DWP policy principles, it also avoids some potentially difficult commercial issues for the Government. 1 The IMA represents the asset management industry operating in the UK. Our members include independent fund managers, the investment arms of retail banks, life insurers and investment banks, and the in-house managers of occupational pension schemes. They are responsible for the management of over 3.9 trillion of assets in the UK on behalf of domestic and overseas investors.

3 IMA response to DWP consultation: 2 However, pot follows member does have a number of challenges, both with respect to contractual obligations, consumer choice and investment efficiency. Care will be needed in automating the process and it may be useful to explore whether it is possible to produce a virtual alternative to physical consolidation. We do not believe that defining specific quality criteria for schemes accepting transfers would be helpful for an automated process. If the Government and regulators are happy for a scheme to be used for the purposes of automatic enrolment, it does not seem consistent from a policy perspective to imply that some of those schemes are not viewed as representing good quality or value. We would question the notion that a single pot is at all times and for all people the best outcome. There may be reasons such as scheme features, investment options available and perceived provider risk that would incline individuals to maintain several long-term pension plans or long-term savings vehicles. These are different considerations to the crystallisation challenge as retirement approaches. There is a wider issue affecting this project: the ability of members to understand their wider pension entitlement, including the state pension. This entails the need for a more integrated approach between state and supplementary workplace or personal provision. We suggest that Government considers how consolidated statements and projections can be made available as a standard feature for all pension savers. Responses to selected questions Q2. Do you agree that there are current barriers to transfers? 6. Many of the challenges preventing what would be regarded as efficient behaviour by consumers in the long-term savings market are behavioural. The reasons that individuals are not saving more, have fragmented savings pots or do not buy the best annuity available are not fundamentally related to supply-side issues. However, it is also absolutely clear that Government, regulators and industry can and must do more to help consumers make decisions that are more optimal. Industry has already begun developing systems to improve the efficiency and speed of pension transfers and amalgamation. We support further efforts in this area. Q5. Taking account of our principles for reform, which of the two models in Chapter 5 and 6 do you think has the most merit? 7. Pot follows member is our preferred option: It has an intrinsic logic and conceptual simplicity. It would be compatible with the principle of member engagement, helping to connect individuals with their pension saving.

4 IMA response to DWP consultation: 3 It would continue to support a workplace savings culture where the employer can play a considerable role in pension provision. It would not necessarily require a large new provider infrastructure and would avoid a potentially problematic tender process to be the UK aggregator or aggregators of choice. Indeed, our understanding is that the technical capabilities of moving money and assets through the pensions industry are advancing significantly and could be upgraded to support an automatic transfer process. 8. We do not believe that the DWP s concerns about moving to a lower quality scheme are justified in the context of the overall automatic enrolment policy. If the DWP, FSA and TPR are satisfied about the quality of a scheme for the purposes of automatic enrolment, moving from one scheme to another should not present a difficulty. True, charging and governance structures may be different. However, the implication of Government concern about an individual s pot following from the pension scheme of Employer A to the pension scheme of Employer B is that Employer B should not potentially have been automatically enrolling into that scheme in the first place. This presents a higher-level policy challenge for the Government and regulators if they are unhappy about the nature of any given scheme. 9. However, pot follows member does have a number of challenges that might require further consideration. The first set are the specific arrangements that govern the relationship between scheme and scheme member, where explicit consent is not provided by a member. In a contract-based arrangement, significant constraints exist with respect to the ability of providers unilaterally to terminate contracts. It is likely to be far more workable for any regulatory regime concerning small pot amalgamation to apply only to new pension contracts. 10. We would also point in particular to potential investment issues. Any automatic transfer system would need to ensure that time out of the market was minimised given the risk that significant market movements could result in forgone returns as a result of tardy administrative processes. 11. As important is any potential disconnect between the investment strategies taking place in different schemes involved in a transfer. There are a variety of investment strategies, including those that use techniques to smooth returns or de-risk towards the end of working life, that may require careful intervention with respect to a system that eventually uses pot follows member as the norm for transfers. Once again, this underlines the importance of the definition of pots for the purposes of automatic transfer. Q6. Do you have any other suggestions for a process to overcome problems associated with small pots and improve transfers? 12. With respect to engagement, we would suggest that the Government consider a further policy initiative to bring together information about both private and state pension entitlement. Pot amalgamation in isolation will not

5 IMA response to DWP consultation: 4 do enough to improve the ability of individuals to understand their likely pension entitlements and the implications of these for future saving requirements. 13. The scale of the challenge facing individuals saving for DC pensions is well illustrated by the fact that to guarantee the ability to pay household electricity and gas bills at today s prices out of a private pension could require a pot of 34, It can be expressed in all sorts of different ways, but the underlying point is the same. Significant saving provision is required to generate levels of retirement income that may look modest in comparison to the overall size of the savings pot. 14. An individual just seeing the projected value of a private pension could well therefore be overwhelmed rather than motivated. Including the value of the state pension would provide a more complete and potentially reassuring picture. The basic state pension on its own provides an indexed income of around 5, In current DC pension terms, that equates to a pot of over 160, There is an additional purpose served by a dual presentation of this kind. Evidence is mounting that savers simply do not believe that the state pension will be available to them in the future. While the state pension remains an abstract, undependable concept, there is a risk of collateral damage for public confidence in the pension system as a whole. Consistent presentation may help to reassure savers as well as discourage future governments from arbitrary changes to the welfare system. 16. Presenting combined state and private pension forecasts is not a new idea, but extending this universally would mark a significant shift. The calculation and presentation of forecasts is not straightforward. There are significant reservations within the pensions industry about the methodologies currently used under the Standard Money Purchase Illustration (SMPI) regulation, for example. More work needs to be done around the potential for using stochastic simulations, rather than deterministic scenarios that could be potentially misleading. Q7. We would be grateful for views on how DB transfers should be treated and whether we should also consider applying any transfer solution to DB rights. 17. This area should be handled with great care given that DB and DC are fundamentally different in nature. An apparently small benefit, eg. 400 a year, would still require an equivalent pot of over 10,000 on an indexed 2 This calculation is based solely on private pension arrangements, and does not take into account the availability of state pension income or benefits. It takes average household gas and electricity prices from provisional DECC data for 2011 ( 1,175) and average publicly available index-linked annuity quotes for a non-smoking 65 year old male, which offered 3.4% at 23 February Using a level annuity, the cost would be 20,350 (based on a rate of 5.8%). 3 Based on the 2012/13 rate of a week.

6 IMA response to DWP consultation: 5 basis. While this still might make sense for an individual, the issue is far less straightforward than a DC to DC transfer. Q8. Do you agree that under an automatic transfer system, members should have the right to opt out? 18. Much will depend upon the definition of small pots here. Introducing compulsory transfers is potentially very problematic from an individual choice perspective. Equally, however, designing an opt-out system could add undesired levels of administration and cost to a process whose purpose is simplicity. Q9. Do you agree that individuals should be required to take advice in an automatic transfer system, provided sufficient safeguards are put in place? 19. Requiring advice will complicate any automated process and potentially work against the Government s principles of simplicity and affordability, since it is not clear how mandatory advice would be funded. However, this is an important question since it once again draws attention to the definition of pot size for the purposes of automated transfers. For very small pots (eg. < 2,000), it is hard to see why it would be appropriate to consider advice. Once pot sizes increase (eg. above 10,000), it may become increasingly necessary for individuals to be aware of the implications of transfers. This may not require formal financial advice, but it is likely to require at a minimum very good quality of information. 20. We would again highlight our reservations about the consistency of an approach that suggests that setting key standards such as low charges and sensible investment strategies (p.33) is important in the transfer market. If Government and regulators are satisfied with the quality of schemes for automatic enrolment, this should extend more broadly. We believe that this highlights the role of good scheme governance, rather than prescriptive rules and requirements. In this respect, we support the approach taken by the DWP and TPR to date. Q10. Do you agree that solutions to address the expected rise in small pots after automatic enrolment should also be designed to take account of the existing stock of small and dormant pension pots? 21. This question raises some significant legal questions around contract terms in the contract-based part of the market. More exploration of these questions would be helpful so as to ascertain how straightforward it would be to apply an automatic transfer process. Our current understanding is that it would be very difficult in many cases. Q11. What are the particular challenges and benefits created by introducing one or several aggregator schemes? 22. We are not convinced by the aggregator proposal for a number of reasons, primarily that it may fail to meet the Government s goals of improving retirement outcomes through minimising the number of pots stranded or lost in the pension system.

7 IMA response to DWP consultation: This risk of complication can be illustrated as follows: Employee X leaves Employer A with a small pot (defined in this example at < 2,000) and arrives at Employer B. Inertia and/or an automated regulatory requirement means Employer A sends the small pot to the aggregator, while Employee X joins the pension scheme of Employer B through automatic enrolment. Employee X stays a number of years at Employer B who has a good scheme and builds up a pot of around 11,000, too large for the aggregator under the rules in this model (but any level of definition of a small pot leaves this possibility). Employee X now leaves Employer B, goes to Employer C and joins their pension scheme. He currently has three pension pots, only one of which is in the aggregator. He stays a number of years with Employer C, again building up enough pension contributions not to be considered a small pot. He joins Employer D. He now has four pension pots. Meanwhile, his aggregator pension is still < 2,000 + net investment return charges. 24. This example draws attention to a second risk in the aggregator model: nonengagement. It is not clear how using an aggregator will help to promote employee awareness or interest in their pension arrangements. It could also undermine one of the goals of workplace pension provision: encouraging employers to take an active interest in providing pension arrangements for employees. 25. A third problem with the aggregator proposal relates to our point in paragraph 4 about pots building up over time and the implications of that consolidation for the commercial role of the aggregator. To illustrate: Employee Y leaves Employer A with a small pot (defined by the Government as < 2,000) and arrives at Employer B. Employer A sends the small pot to the aggregator, while Employee Y joins the pension scheme of Employer B. Employee Y stays a very short period of time at Employer B who has a good scheme, but that still only builds up a small pot. The pot goes to the aggregator when Employee Y leaves. Employee Y moves to Employer C, stays for a year and subsequently has a career pattern based on short employment and low contributions. The aggregator eventually has small pots from five employment contracts, and the account builds up, with investment returns, to be worth 15, What is not clear under this example is whether the aggregator then becomes the core provider for Employee Y, ie. no longer a manager of small pots, but a manager for those who only build up small pots in any one employment.

8 IMA response to DWP consultation: 7 Q12. Do you agree with the aggregator scheme characteristics set out? 27. The characteristics with respect to product design (third bullet) should be no different to those required under automatic enrolment. Default funds should have a very clear investment objective and deliver against that objective in the most efficient and cost-effective manner. Q13. Could the pensions industry offer an aggregator scheme with these characteristics? 28. Yes, but there is a significant question about the set-up costs and the competition implications of a single aggregate provider, which could over time build up a very large asset pool. Such implications could be magnified in the event that the definition of a small pot moved well beyond the levels currently being discussed (around 2,000, compatible with commutation levels in occupational schemes). Q14. Have we correctly understood the implications of there being one or several aggregator schemes? Q15. Should there be several aggregator schemes or one? 29. While having more than one aggregator scheme might in principle help to mitigate competition risks, a whole series of additional questions arises, such as which aggregator a member pot goes to, particularly in the absence of an engaged employer and/or employee. One option might be a carousel, but this raises issues familiar from the early Personal Accounts / NPSS debate about the governance implications of a potentially random designation process, even if there is a common front end. We believe this is problematic and another argument against the use of an aggregator. Q16. What are the advantages of NEST acting as the aggregator scheme? 30. The obvious advantage is that NEST exists and will be a recognisable brand in the pension market, having a universal service obligation for the purposes of automatic enrolment. However, there are two issues here: first, whether NEST itself is set up logistically to serve such a function. This will be a matter for NEST to answer. Second and more importantly, whether it is appropriate for a Government-created scheme to take on this role, particularly given that contributions and transfers are currently limited. 31. Given our general reservations about the competition implications of the Government designating a single provider to be an aggregator for small pots, we do not believe that NEST does offer a solution that would be any better than an alternative single aggregator. On the other hand, having NEST coexist with a single aggregator also seems untidy. 32. Whatever path is chosen by the Government to better amalgamate small pots, the consultation also raises the issue as to whether the contribution and transfer restrictions on NEST need to be lifted. The IMA supported the initial restrictions given the uncertainty surrounding the impact of the reforms and the unique role that NEST was designed to fulfil. Our central concern focused on the competition implications if NEST became too dominant. We still

9 IMA response to DWP consultation: 8 believe that caution should be exercised with respect to the position of NEST, while recognising that a small pots amalgamation programme may require some relaxation with respect to transfers. Q17. What is the best approach to defining a small pot for this option? Would it be preferable for: Default transfers to be compulsory if the pot is under a certain size Default transfers to be voluntary for schemes Default transfers to be compulsory under a certain size, but voluntary within a band 33. This is a difficult set of questions. In addition to issues over consumer choice and the possible role of advice, the definition of pot size might determine the commercial viability and eventual market position of the aggregator service. 34. Overall, we believe that transfers should be compulsory for very small pots, but as we illustrated in our answer to Q.11, one of the basic problems with the aggregator is that it could end up moving a very small pot and leaving it isolated from an individual s other savings. Q18. Should there be a transfer limit on pots below a certain size and if so, what should happen to the pot? 35. There should be no minimum limit in an automatic enrolment environment, particularly one where short service refunds are abolished. Otherwise, there is a risk of undermining Government policy on the minimisation of small pots. Q20. Are the existing protections for individuals sufficient for this option where pensions follow people from job to job? 36. Where schemes are qualifying schemes for automatic enrolment, then this should be seen as sufficient protection. Q21. Should a pot size maximum be applied to pension pots that are automatically transferred? If so, what should the maximum be? 37. This consultation is about small pots. Therefore, there does need to be a maximum limit. The assumption that an individual would under all circumstances be better off amalgamating their pension savings into a single DC savings pot during the accumulation phase is incorrect. There might be a number of reasons why individuals who are engaged with their savings might wish to retain one or more of their pension pots, eg. access to specific investment funds or strategies not necessarily available on all platforms, access to specific tools or web services and diversification of provider risk. Q22. How could a central database successfully match members with their pension pots? 38. This question raises a broader issue as to whether the Government initiative needs to be a physical amalgamation or whether it could potentially be a virtual amalgamation, ie. a record-keeping facility that can provide a full

10 IMA response to DWP consultation: 9 overview of pension savings regardless of where the underlying pots are invested. Such a virtual facility could be valuable in a case, as described in the previous paragraph, whereby an individual does wish to maintain a number of pots. Equally, where there may be operational reasons why it is complex to amalgamate, the virtual facility could also play a role. Although ambitious, there is a further goal worth exploring that we raise earlier in our response (Q6): eventually linking total private and state entitlements in a single communications format. Q23. To what extent could the pensions industry deliver a suitable electronic platform / database? 39. The financial services industry has already been developing the technologies more efficiently to handle transfers, be they ISAs, funds or pensions. Clearly, existing providers in the pension transfer market, notably Origo, will be better placed to give a view on capacity and the limitations of existing technology. However, much will depend upon what the Government is trying to achieve, particularly with respect to the automatic nature of the process. A basic pot follows member service is likely to be very different in scale to a virtual pot project, creating a universal record-keeping service for UK pension pots.