On July 10, in the Mansion House speech, the U.K. government unveiled a package of proposals aimed at tapping into pension sector funds in order to boost investment into new technology startups.

The proposed reforms focus on defined contribution, or DC, pensions, but also touch on defined benefit, or DB, arrangements.

The pension-related proposals were all put forward with three golden rules in mind:

• Securing the best possible outcomes for pension savers;
• Prioritising a strong and diversified gilt market; and
• Strengthening the U.K.’s competitive position as a leading financial centre able to fund the U.K.’s public services.

Many in the pensions sector, while supportive of the three golden rules and the proposals, may be a little cautious about the impact of them on influencing trustee investment decision making and the savings pots of many U.K. workers.

Investments and the Mansion House Compact

Chancellor Jeremy Hunt announced a package of measures in his Mansion House speech that are designed to boost investment by U.K. institutional investors in U.K. high-growth companies to benefit the U.K. economy.

These investments may produce greater returns than current investment strategies, but there is also a chance that they won’t.

So, while this move has been applauded by entrepreneurs, those in the pensions sector may be urging caution.

All investment decisions made by trustees need to be consistent with trustees’ duties. This includes acting in the best interests of members, which primarily means the best financial interests, and ensuring the security, quality, liquidity and profitability of the scheme’s investment portfolio as a whole.

It does not seem that the government intends to imminently legislate to change the legal duties of trustees, although the government has said that it intends to look at the culture of investment decisions and take steps to improve the understanding of pension trustees’ fiduciary duties to ensure good saver outcomes.

To try to unlock money following the reforms as quickly as possible, the chancellor has asked the British Business Park, a government-owned economic development bank, to explore how the government can play a greater role in establishing investment vehicles. This will complement the £250 million of support that the government has made available through the long-term investment for technology and science initiative to incentivise new industry-led investment vehicles.

We all know that investments carry risks. This is particularly evident in a DC context as members’ pots are individual. This means that the ability to share risk is limited, which is a stark reminder that ultimately it is the member who bears the investment risk.

However, it is still commonly understood that bigger pension schemes are more likely to have the ability to “weather the financial storm” better than smaller pension schemes.

In the Mansion House speech, the government recognised that funds can only optimise returns from a balanced portfolio if they have the scale to do so. The government wants to facilitate a program of DC consolidation to ensure that funds are able to maintain a diverse portfolio of assets and deliver the best possible returns for savers.

Interestingly, the Mansion House speech also unveiled an arrangement called the Mansion House Compact with nine of the largest pension providers, representing around two-thirds of the U.K.’s entire DC workplace market, to invest at least 5% of their default DC funds into unlisted equities by 2030. The hope is that the rest of the DC market will follow suit that could unlock up to £50 billion of investment into high-growth companies by 2030.

The chancellor believes that members of DC schemes could benefit from a £1,000-a-year increase to their pensions from investments in high-growth assets.

Some would point to the fact that the voluntary nature of the arrangement offers pension providers a choice, but who will bear the risk should such investments go wrong? It will be the member ultimately.

Although members could choose to move their pots into investment options, they select themselves so are not tied to the provider’s choice, if a scheme’s membership does not actively engage with their investment options, this could cause some discomfort to trustees who might consider the proposal could potentially fly in the face of their fiduciary duty to act in the member’s best interests.

DC Consultations and Policy Papers Responses

With the aim of utilising pension funds for investment, HM Treasury and the Department for Work and Pensions, or DWP, also published various consultation documents, policy papers and responses on a variety of DC policies with the aim of prioritising the best outcomes for members, maintaining a strong gilt market and strengthening the U.K.’s economy.

Value For Money Consultation Response

The joint consultation response from the DWP, the Pensions Regulator, or TPR, and the Financial Conduct Authority on the value for money framework clarified that investment decisions should be made on the basis of long-term returns, not simply cost.

It is important to note that the value for money framework is different to the trustee duty to assess the value for members. The value for members duty essentially requires trustees of certain schemes to, at least once a year, assess the extent to which charges borne by members represent good value for members and report certain information relating to the value for member charges in the annual DC chair’s statement.

The overall aim of the value for money framework is instead focused on the wider picture of ensuring that savers in DC pension schemes receive better retirement outcomes. The framework is intended to provide:

a transparent, standardised way for schemes to holistically assess and evidence value for money outcomes and the actions they are taking to improve the value they provide to savers.

The joint response acknowledged that within the value for money framework there is a balance to be struck between requiring sufficient data to enable useful comparisons, and the costs and complications of doing so.

The shifting of focus from cost to value aims to encourage the consideration of opportunities to invest in a broader range of investments, including listed and unlisted asset classes, for diversification over the longer term with the potential for higher returns for savers and boosting economic growth.

While being beneficial on the one hand, on the other hand this could potentially risk encouraging un-trustee-like behaviour when making investment decisions.

Under the value for money proposal, there is also a shifting of focus from costs specifically toward longer term performance outcomes and performance to help savers whose savings were being eroded in underperforming schemes.

Under the proposals, underperforming schemes will be required to take immediate action to improve or wind up and consolidate if this is in savers’ best interest. While this has savers’ interests at the heart of it, it would clearly be an extension of TPR’s intervention powers.

While somewhat surprising in some ways, in other ways, it is to be expected. It is consistent with the move to a more robust regulatory regime, particularly against the introduction of the stronger TPR powers under the Pension Schemes Act 2021.

Consolidation

The government’s focus on consolidation is also not a new concept.

Building on the feedback received, the DWP has decided to proceed with extending the collective DC regime so that it can apply to non-associated multi-employer schemes. At present, it just applies to single or connected employer schemes.

Collective DC schemes are considered a good middle ground between traditional DB and DC schemes. This is because members of collective DC schemes are promised a target retirement income that can be adjusted up or down to reflect the scheme’s investment performance.

In a collective DC scheme, contributions for employers and members are fixed, and investment and longevity risks are shared collectively among the members. Therefore, the planned extension of collective DC schemes will be welcome news to many as the structure removes some of the challenges with long-term investment and spread risks across the membership.

Response to Call For Evidence and Further Consultation on Deferred Small Pots

Another aspect of consolidation is dealing with small pots. The government has concluded that the multiple default consolidator model is the optimum approach, which ensures that members’ eligible deferred pots are consolidated into one scheme.

Key proposals include:

• Consolidation of small pots with an upper limit of £1,000 with no lower limit set;
• That there needs to be a period of 12 months since the last contribution was made; and
• That a “clearing house” will be established to act as central point informing schemes where to transfer a member’s eligible deferred pot.

The government believes that this model addresses the deferred small pots challenge and has the potential to provide greater net benefits to members.

The DWP is keen to build member choice into this model where possible to support engaged members to make active decisions about their retirement savings.

Therefore, the DWP proposes that members will be given the option to choose their designated consolidator, alongside the option to opt out of consolidation if they believe that it is not in their best interest.

The deferred small pots issue is not a new one, and sometimes such pots can be lost completely. The government is right to look for solutions. Whether the consolidation method works and helps optimise the DC pension sector for utilisation and investment into the market is yet to be seen.

Defined Benefit Reform

The government is looking to introduce a statutory regime for the compulsory authorisation and supervision by TPR of DB superfunds and other consolidation models.

Until this happens, DB superfunds will still need to meet the requirements of TPR’s interim non-statutory regime.

The government is also exploring the possibility of the Pension Protection Fund in DB consolidation. Discussions about expanding the PPF’s remit to be a vehicle for consolidating retirement schemes that are not in distress are encouraging.

The PPF has people’s trust and a track record of performing well, demonstrated in the DWP’s departmental review report of the PPF that concluded that the PPF is a “well-run public body offering high standards of service and value for money to those who use it and pay for it.”

It is clearly always beneficial to seek to improve member outcomes and support the U.K. economy.

However, the proposal will need careful consideration. Nobody will want to see schemes engage in risky behaviour on the basis that they can opt into the PPF or the good behavioural changes around funding being unwound by inadvertently rewarding employers that have not funded their schemes well.

There is also the question of how the PPF as a DB consolidator will fit alongside the current PPF regime and other DB consolidators. If the mechanics of the PPF as a consolidator for schemes not in distress can be developed successfully, it is likely to be greeted with open arms by the pensions industry.

Conclusion

Improving the retirement outcome for savers is at the heart of everything we do in the pensions industry, but care will need to be taken to ensure that there is not a risk of jeopardising the hard-earned savings of members in riskier investments.

Trustees will need to be mindful of the new proposals in light of their fiduciary duties.

Caution should be exercised to make sure that, if the proposals take off, it will not be another headache to trustee investment decision making.

Beth and Riccardo’s article was originally published in Law360, here.