The unintended consequences of DC consolidation: is bigger better and is less more?
Estimated reading time: 4 minutes
The number of DC schemes in the UK is rapidly falling. The level of regulation, legislation and governance burden on DC schemes is increasing. Therefore, so is the level of associated operational cost and risk – leading to a number of schemes closing and members’ assets being moved elsewhere, mainly to Master Trusts.
We’re also seeing consolidation in the number of established providers, including for example: Scottish Widows / Zurich; Aegon / Blackrock; Friends Life / Aviva.
The regulator’s new authorisation regime is leading to the smaller less viable Master Trusts exiting the market as rapidly as they sprang up; either by winding up completely or being absorbed by the larger Master Trusts. 18 months ago there were 100 or so Master Trusts in the market – this could reduce to around 40 in the next six months.
Why consolidation?
The general consensus of a consolidated DC market is that it is a good idea. After all it should bring economies of scale and reduced risk:
- Economies of scale can lead to cheaper charges and as funds grow it provides more opportunity to invest in different types of assets, such as infrastructure or other illiquid assets, which are suited to pensions due to their high yield potential and long term positive returns.
- As assets grow, so do providers’ profits, which should create more opportunity to innovate and provide better, more advanced services to members.
However, are there disadvantages too? Are there any unintended consequences?
Lessons from overseas
To study this, we travelled to Australia and to an industry more mature than the UK’s and a place where “scale” is the watchword – it holds in total around $3 trillion of assets under management, and growing! However, it is also where the decrease in the number of standalone schemes (or “Corporate Funds” as they call them) has been stark.
The number of Corporate Funds fell by 96% in the 11 years to 2014. And this trend has continued, with the number of these schemes reducing from 44 in March 2014 to 24 by December 2017.
At the end of both trips, we came away thinking big is not necessarily always best. The largest schemes still continue to grow, but not necessarily because of proactivity in the market; more perhaps because the mandatory contribution system and the positive investment returns post credit crunch means they can’t help but not.
Also, with the natural growth of these schemes has come some behavioural traits that we couldn’t help but notice.
- Most of the larger schemes have limited focus on supporting members in the later years as they approach retirement. Instead they still tend to focus purely on asset gathering, as this is where the profits are made. (Just something to bear in mind … when we first visited Australia in 2014, the largest industry funds called themselves “not for profit” organisations. Three years later when we visited again, propositions hadn’t changed, but they had begun calling themselves “profit for member” organisations. A nuanced change perhaps, but one which could explain this continuing behaviour.)
- There’s little development in the at-retirement space. Some providers we spoke to have concluded that “there is no reward for innovation” for essentially helping members take money away from the pension system.
- With limited support from providers, it increases the risk of members making irrational decisions at retirement. For example, whilst members have the full suite of options on how to draw benefits in Australia, drawdown is the typical method used. However, members are commonly not drawing enough, as they are nervous about drawing too much and exhausting their pension pots too soon. Better education around retirement benefits is a necessity, but is not something being driven by the providers.
- As employers are keen to remove governance risk from providing pension benefits, they are moving employees’ assets to schemes with much less flexibility in terms of design and the ability to tailor benefits that work best for the workforce.
- And with fewer providers over the longer term, it means less competition, creating little downward pressure on charges and ultimately limited differences between the providers’ propositions.
Back to the UK
Consolidation is the “game in town” in the UK, particularly as the regulator’s latest proposals are for smaller schemes in future having to document and justify why they shouldn’t wind up.
As an independent consultancy, we are becoming more and more involved in scheme wind ups and transitions to, mainly, Master Trusts. This is often despite the fact that some of these schemes are very well run and are focussed on providing the best benefits possible for the members. However, the governance burden and operation costs have often got too much, meaning the only feasible option is to move members’ assets elsewhere.
Arguably there is no better time to move to a Master Trust. Even though we still await the results of the authorisation process, we know which providers are likely to be approved, as we know those where growing their DC book is core to their business model. Currently, the market is extremely competitive with the younger Master Trusts wanting to create scale as quickly as possible, and the more mature Master Trusts wanting to create a stronger foothold. Providers are effectively “buying” assets by offering very low charges and, in some cases, offering to foot the bill for asset transition costs (reaching into the hundreds of thousands of pounds of cost in some cases).
These competitive terms will not be around forever.
Be careful for what is wished for
Biggest is not always necessarily best. We could be heading to a future where we have only a few providers / schemes, which offer increasingly similar propositions and are purely focussed on asset gathering, rather than improving outcomes for members. Gone could be the days when there are a good number of schemes designed specifically for the membership and who endeavour to provide the best benefits possible for members. For one, I sincerely hope this will not be the case!