A small pension pot compromise?
Consumer groups (including the TUC) and the government disagree about what to do about the many small DC pension pots that will multiply once automatic enrolment starts. But is there room for a compromise that can meet the concerns that both sides have about the other’s position? I think there might be.The government backs a “pot follows member” approach – where when someone changes job their pot follows them to their new employer. Critics of this approach – such as ourselves – say that this could lead to people losing out if the new employer’s scheme is inferior to the one they leave. There are also practical problems as many do not move employer in an orderly way, and the previous employer has no easy way to find out where a former staff member has moved.
But the government has rejected our preferred approach of allowing a limited number of high quality schemes to act as aggregators. with NEST given a new public service obligation to accept all small pots (though in a way that does not impose extra costs on other NEST members). The ministerial slogan is “one big pot”. Modelling of a pot follows member approach shows that this achieves the greatest degree of consolidation.
I still think the consumer groups (and others such as the NAPF) are right, and, on this at least, the minister is wrong. But continuing the argument from two polarised positions does not lead to consensus. And while I’d like to see Steve Webb change his mind, I suspect that it is unlikely. As everyone in the pensions world agrees that we should try and make changes through consensus, I have been trying to think through whether is some way that we can come up with a compromise, that can also help drive up the quality of pensions.
A good starting point is to look at the basic principle on which each side builds their case. For consumers and many in the industry, the worry is consumer detriment ie people will see savings moved from a good to a less good scheme. Even supporters of pot follow member recognise this problem. The practical difficulties are real, but are not ones of principle. If they can be overcome, they are not a deal breaker.
People who back pot follows member say that an aggregator approach does not do enough to consolidate pots. If someone moves from one employer to another, moving their old pot to another pension scheme such as NEST, does nothing to reduce the number of pots. This should be a key objective as a smaller number of pots should lead to a more efficient system and thus drive down charges. The only way to use an aggregator to reduce pot numbers would bve to have a single scheme, which would lead to a monopoly supplier. To identify these arguments is not to endorse them, but to recognise that a synthesis must be able to answer these concerns.
So how might such a compromise be struck?
One way might be to have a system that sees pot follows member as the default, but only allow automatic transfers to schemes that can pass a quality threshold tougher than the one used to test whether a scheme is good enough to be used for automatic enrolment. A body, such as the Pensions Regulator, would effectively license schemes eligible to accept automatic transfers.
If someone moves job to a new employer that does nor offer such a scheme or stops working for whatever reason, their pot could be transferred to a single aggregator with NEST the obvious contender. This would also be an option for employers who lose track of where their former employee has moved.
Other multi-employer trust based schemes would be highly likely to pass the quality threshold so would effectively act as aggregators in the sectors that they cover, even though the transfers would be under a pot follows member approach.
It is possible to see this model driving up standards. Employers who do not offer a scheme good enough to qualify for auto-transfers may well face hard questions about why not. It would introduce a regulator policed kite mark for DC pension schemes. It could get tougher over time and be used as a tool to lever up the quality of pension provision. It could be helpful in gaining the scale and good governance that are pre-requisites for a decent DC system.
This approach might lead to slightly less pot consolidation, but that seems a price worth paying if there is a guarantee that all the consolidation that happens is good for savers. As it would provide some reassurance on scheme quality it might well encourage people to consolidate bigger pots when employees move jobs to an employer with a good scheme. It’s easier to make one big pot from medium as well as small pots.
The key determinant of this hybrid model would be the quality threshold for schemes eligible for auto-transfers. Too weak and it would not produce sufficient safeguards against consumer detriment. At the other extreme it loses its pot follows member default and becomes an aggregator approach.
The key test would have to be charges as that is the most obviously measurable characteristic of a DC scheme, but there is a strong case for looking at other issues such as governance, quality default scheme design and other issues.
Of course there are many details in such an approach, but it offers a way of reconciling the two sides of this argument in a way that meets the core concerns of both with anyone having to do too much of a U-turn.