Small defined contribution pension schemes face big regulatory changes

The government’s decision to subject smaller DC schemes to an enhanced value for money assessment could have ramifications across the wider industry


Smaller occupational defined contribution (DC) schemes must now undergo a new and enhanced value for members (VFM) assessment. While the new system aims to secure the best possible deal for pension savers, it could have implications for adviser costs, fund administration and more. 

In October the UK government and The Pensions Regulator (TPR) introduced the new VFM assessment for DC schemes with less than £100m. These funds must compare their costs, charges and investment returns against three other schemes. They also have to conduct a self-assessment of their governance and administration in line with seven key metrics.

The schemes must then report the outcome of the assessment in their annual chair’s statement and provide the findings to TPR in a scheme return. If the trustees can’t demonstrate that their scheme offers VFM, they will be expected to wind it up and transfer their members into an alternative scheme.

Auto-enrolment success

The move has been partly prompted by the success of auto-enrolment, with more of us than ever saving into DC schemes. TPR does not want anyone to “be left languishing in poorly governed schemes which do not offer the same value as larger schemes,” as its executive director for regulatory policy, analysis and advice, David Fairs, puts it. 

It’s thought the government believes larger schemes have the resources available to ensure good governance. They can also negotiate lower charges thanks to economies of scale. 

“Smaller schemes are perceived by the government as having more limited investment opportunities, whereas a large master trust with assets in the billions may be able to take advantage of significant infrastructure investment opportunities,” says Suzanne Burrell, pensions partner at Shoosmiths, a law firm. These might include transport projects and efforts in the sustainable energy space.

The master trust authorisation regime also set a high bar for every pension scheme in the UK with requirements including proof of financial stability and a test to check that those running the scheme are fit and proper to do so. With every master trust now demonstrating that it provides VFM for its members, this was the natural next step for the DWP and TRP.

“I’ve seen a number of our clients move their defined contribution schemes into master trusts in recent years and this has been easier to accomplish following the introduction of the authorised master trust regime,” says Burrell. “It’s likely that the new value for money assessment results in a further wave of consolidation of DC savings.”

Some employers, she observes, may have taken a deliberate decision to retain a DC scheme in-house so that that they don’t have to unravel some of the benefits that they provide. These might include a “with-profits” policy, which is aimed at smoothing out the peaks and troughs in the value of members’ investments caused by market volatility. 

The benefits might also be provided as part of a hybrid arrangement in a scheme which covers both DC and DB benefits. Although hybrid schemes are not exempt from the VFM, some believe the DWP might look at them if their assets exceed £100m but the DC element is less than £100m.

Costing time and money

Whatever the benefits to savers and the country’s infrastructure, establishing the new regime could take a significant amount of management time by administrators and drive up adviser costs, in the short term at least. As a result, some schemes might opt to look for consolidation opportunities to manage these additional costs and administrative requirements, even if they can tick the VFM box. 

Where schemes can’t satisfy the VFM requirement there will be even more work to do. However, that could provide companies with the time and space to rethink their pension fund strategy and ensure that whatever new scheme they introduce meets not just their rewards objectives but their corporate culture. Could their scheme help play a role in their corporate social responsibility (CSR) or environmental, social and governance (ESG) goals, for instance?

The requirements could boost master trusts. “This is the biggest opportunity to grow their client and asset base since the introduction of automatic enrolment,” says Mark Pemberthy, principal and benefits consulting leader at Buck, a pensions, HR and employee benefits consultancy. “The major master trusts are all positioning themselves to be the merger scheme of choice and the next few years will define the shape of the DC market for years to come. Similarly, asset managers continue to work hard to win investment mandates from the master trusts in order to participate in the rapidly growing DC pension market.”

The move by the DWP and TPR could accelerate the growth of master trusts, which added £30bn in assets in 2020, largely thanks to contributions from auto-enrolled members, according to research by fintech firm Broadridge. They will enjoy a growth rate of 24% a year to amass £461bn in assets by 2029, by which time they’ll account for 75% of total trust-based assets.

Expanding scope

However, many wonder if the VFM assessment requirement will now be extended to larger schemes. Last summer the DWP gathered evidence on the barriers and opportunities for greater consolidation of schemes with between £100m and £5bn of assets under management. It will publish a summary of the evidence received and an indication of its next steps in the coming months.

David Snowdon, DC director at master trust provider SEI, believes that the market for master trust services will become increasingly buoyant. “Companies thinking of making the move in 2022/23 should be mindful of potential capacity issues as many others seek to join a master trust,” he warns. 

While they should provide value for members, that doesn’t mean all master trusts are the same, Snowdon adds. “It’s important to find the right fit for your scheme members, with providers out there varying between frills or no frills, off the shelf or tailored, mass market and bespoke,” he says. “And with a consolidating, contracting master trust market, employers should make sure they choose one that’s here to stay.”

Some experts believe these changes will accelerate the consolidation in DC schemes, a development the government has encouraged. The next few years are set to see an increasingly competitive market as smaller schemes decide which master trust to join. This VFM initiative will have interesting ramifications for the entire pensions industry.