DC consolidation has been on the Government’s agenda for some time. Now the DWP has published a call for evidence, suggesting that the push to consolidate will be ramped up.
Consolidation involves winding up small DC arrangements and moving active members and accrued DC pots to larger schemes. Typically the chosen destination will be a master trust – a multi-employer occupational pension scheme which operates on a commercial basis. Master trusts are subject to an authorisation and supervision regime run by the Pensions Regulator.
The Government believes that consolidation will often be in members’ interests, on the basis that larger schemes tend to be better-governed, and offer better value, than their smaller counterparts. And consolidation is already underway: the number of DC schemes is declining by 8-10% per year. But for the DWP, the journey is proving too slow. It wants to “accelerate the pace of consolidation” over the next five years.
Government strategy will focus initially on schemes with assets of less than £100m. The trustees of such schemes are already required to produce an extended value-for-members assessment, comparing net returns with those under larger schemes. Where trustees are unable to conclude that their scheme offers good value for members, they are required to tell the Regulator what steps they will take, either to improve value or to consolidate with another scheme.
As a firm, we have advised on many consolidation exercises, including transfers to leading master trusts. Such exercises require a joined-up approach as between the employer and the ceding trustees. The employer will want to ensure that the receiving scheme is the right home for its workforce and its future contributions. The trustees will need to carry out their own due diligence when deciding whether accrued DC pots should be transferred.
There are also technical issues, which may mean that consolidation is a difficult call for trustees. For example:
- Investments – The ceding scheme may offer sophisticated investment options (e.g. actively-managed funds) which the receiving scheme is unwilling to replicate. Master trusts typically offer only a small range of “vanilla” funds.
- Charges – Under the ceding scheme, all overheads may be picked up by the employer. Under master trusts administration costs are usually borne by members.
- Tax – A transfer to a master trust may jeopardise some types of tax protection, at least where the ceding scheme is a hybrid arrangement which will retain liability for members’ DB benefits.
There are work-rounds for many of the technical issues. However, the DWP acknowledges that the issues are barriers to consolidation. Perhaps in due course the Government will legislate to make the process easier.
Whatever the final outcome, the direction of travel is clear: consolidation will be a key theme in years to come. However, sponsors and trustees of small DC schemes should not jump to the conclusion that consolidation is right for them. Many small schemes are well-governed and deliver good value. They may also have tailor-made features which a master trust cannot replicate. The Government may take the view that large is beautiful, but this is not a case of “one size fits all”.