Employment and pensions

Improve or consolidate: all change for defined contribution schemes in October 2021?

Published on 8th Oct 2020

Trustees need to address value for members as consultation encourages consolidation of smaller schemes and removal of barriers to illiquid investment

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The government is consulting on a series of changes to apply to defined contribution (DC) pension schemes and sections from October 2021. The changes affect all DC schemes and sections but have a particular impact on the trustees of DC schemes with assets of less than £100 million.

For all DC schemes and sections, the changes will affect the content of their chair's statement and scheme return, but bring clarity (and, hopefully, help) in the area of costs and charges.

For DC schemes with assets of less than £100 million, a new requirement to complete and report the outcome of an annual "value for members" assessment will mean that, if the scheme is not offering value, the trustees will need to decide whether to continue to operate – and agree and report specific actions to improve the value – or move to consolidate with a larger scheme such as a DC master trust.

Trustees concerned that their scheme may not offer value are expected to make improvements before the first assessment is due, so early action is recommended.

Consolidation and illiquid investments

In early 2019, the government consulted on proposals to make it easier for DC pension schemes to invest in less liquid assets such as real estate, green energy projects, other infrastructure projects, and venture capital.

The idea behind the 2019 consultation was that investment in illiquid assets would help to improve member outcomes and engagement. The government made a series of proposals aimed at increasing the demand for less liquid investment.

The original proposals were that:

  • The trustees of larger DC schemes or sections should explain their policy in relation to illiquid investments in their statement of investment principles (SIP) and, perhaps, their default SIP;
  • The trustees of these larger DC schemes or sections should include, in their implementation statement, a report on how they have followed their policy on illiquid investments;
  • The trustees of smaller DC schemes or sections (perhaps ones with less than £10m in assets or less than 1,000 members) should extend the scope of the value for members assessment in their chair’s statement to include an assessment of whether it might be in members’ interests to be transferred into another scheme such as an authorised master trust, and consider whether members would benefit from scheme consolidation at least once every three years; and
  • There should be a different way of checking compliance with the DC charge cap where trustees invest in illiquid assets, in recognition of the fact that many of the funds offering illiquid investments charge a performance fee.

The government has now published its response to this consultation, combined with a new consultation on changes to become law with effect from October 2021.

What's changing?

In the new consultation, the government confirms that it has decided not to pursue the first two of the 2019 proposals. Instead, this consultation pursues the themes of encouraging the consolidation of smaller DC schemes and removing barriers to illiquid investment.

The government believes that "consolidation is the most effective way to ensure that all savers are receiving the best value from well governed schemes that can achieve economies of scale" and will "deliver greater opportunities for members to access a more diverse range of investment products and investment strategies to the benefit of both the pension saver and the broader UK economy".

Proposals, draft legislation and guidance are put forward in four broad areas: value for money (both specific to DC schemes with less than £100m assets and to all schemes), performance fees and the DC charge cap, reporting costs and charges, and a group of other changes to the law.

Value for money

For DC schemes with assets of less than £100 million that have been operating for at least 3 years , the government intends to change the law to encourage consolidation so that, from 5 October 2021, the trustees:

  • must complete an annual, more detailed, "value for members" assessment taking account of new guidance (a draft of which is included in the consultation) and report in their chair's statement on how their scheme provides value for members; and
  • report the outcome of the assessment in their next scheme return and, if the scheme does not provide value for members, say whether they are going to wind up the scheme and transfer its members to another scheme and, if not, the reasons why and the action they are going to take or have already started to take to improve value for members.

As part of the more detailed value for members assessment, the trustees will need to compare net returns and levels of costs and charges to those of at least three other "large" occupational or personal pension schemes (the suggestion being that "large" means assets of £100 million or more), at least one of which would be willing to accept the scheme's members if the trustees were to decide to wind up and consolidate.

If the scheme does not provide value for members, the government would expect the trustees to wind it up and consolidate unless they are "realistically confident that required improvements can be made" and will be made "and/or where the wind up and exit costs may exceed the costs of making such improvements, and/or … there are valuable guarantees that would be lost on consolidation". The Pensions Regulator would be able to use its existing powers to issue an order to wind up the scheme, or to remove and appoint trustees.

For all schemes offering DC benefits other than from Additional Voluntary Contributions alone (not just those with assets of less than £100 million), the government intends to change the law so that, from 5 October 2021, the trustees must:

  • publish the net return on investments of their default and member-selected (or self-selected) funds in their annual chair's statement and make the information publicly available free of charge on a website (with the aim of improving transparency for members and helping schemes with assets of less than £100 million with their value for money assessments); and
  • confirm the total amount of assets held in the scheme in their annual scheme return.

Schemes with assets of £100 million or more should also review the new draft "value for money" guidance, as this says that they "are not required to have regard to the sections of this guidance that refer to assessing value for members" but "may however find it useful and good practice to do so when assessing the extent to which the costs and charges of their scheme present value for members".

Performance fees and charge cap

In the area of performance fees and the charge cap, the government concludes that it is possible for trustees to develop a diversified portfolio without paying performance fees. However, it acknowledges that in cases where a performance fee represents best value for members, the current charge cap mechanism limits the performance fees that schemes can pay. In view of this and other concerns, it intends to change the law so that:

  • from the first charges year beginning after 5 October 2021, where a member is only in the default fund for part of the charges year (and so the trustees have to test charges against a prorated charge cap based on the length of time the person was a member), trustees will be able to ignore some performance fees when testing against the prorated cap; and
  • from 5 October 2021, the costs of holding "physical assets" (for example, real estate or infrastructure) are formally excluded from the charge cap.

The government also intends to:

  • publish the outcome of the separate review of the level, scope and operation of the charge cap towards the end of this year;
  • develop a "multi-year approach" to calculating performance fees to give another option to schemes where a smoothing period is needed to give access to illiquid assets (and has asked for views on how this might work); and
  • update the charge cap guidance to clarify the treatment of underlying costs in investment trusts.

Reporting costs and charges

The government is also proposing a series of changes to clarify the statutory guidance for trustees on reporting costs and charges. These changes are to prevent "unintended interpretations … which result in unnecessary anxiety for trustees, and the production of information in levels of both complexity and volume that are not required, and may be unhelpful for scheme members".

The changes in the draft updated guidance include confirmation that "[t]he Statement of Investment Principles, the Chair’s Statement (inclusive of charges and transaction cost information, value for money assessment and default SIP), and the relevant section of the Annual Report (the implementation statement) do not necessarily have to be produced as a single web-page or PDF document”.

Other changes

The government intends to change the law so that, from 5 October 2021:

  • it is clear that the trustees of "wholly insured schemes" (who usually have no discretion as to how the insurance company invests) are excluded from the requirement to set out in their statement of investment principles their policy in relation to their arrangement with any asset manager;
  • the requirement to produce a default statement of investment principles will start to apply to with profits funds offered as a default (at the moment it does not); and
  • it is clear that the costs disclosure requirements apply to funds that members have previously actively selected, and in which members remain invested, but which are no longer offered to members.

Actions for trustees

The consultation will be open until 30 October 2020.

The trustees of all DC schemes or schemes with a DC section need to understand how the intended changes will affect their scheme.

Trustees with assets of less than £100 million need to start to think about the new "value for members" assessment and, if they have concerns, about action they can take before October 2021.

The general message from the consultation is that, if a scheme is not providing value for members, then it must improve or consolidate.

There is also a strong suggestion that the government expects schemes to start addressing any concerns about value for members now. It accepts that "some poorly performing schemes that fail to meet the standards under the new assessment may be able to improve sufficiently without needing to consolidate", but confirms that it "would expect … that such schemes would make these improvements before their assessment falls due."


* This article is current as of the date of its publication and does not necessarily reflect the present state of the law or relevant regulation.

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