The Department for Work and Pensions has narrowed down the solution to the small pots issue to either the creation of default consolidators or the introduction of pot-follows-member legislation.
The preferred solutions are part of a call for evidence, launched on January 30, as a part of a series of reforms to defined contribution saving, as reported by Pensions Expert.
Since 2018, the value of lost pension pots in the UK has risen by 37 per cent, from £19.4bn to £26.6bn, according to research from the Pensions Policy Institute.
There have been warnings that the proliferation of small pots could damage the financial sustainability of master trusts, and the credibility of auto-enrolment as a whole.
Moves were made to ban the charging of flat fees and move to a universal charging structure, despite some resistance from industry players.
The two models proposed are a further step from the last report of Small Pots Co-ordination Group - jointly convened by the Association of British Insurers and the Pensions and Lifetime Savings Association — which in June recommended three potential solutions to the issue.
Automatic transfers to consolidator
Under the default consolidator model, deferred small pots which are eligible would transfer automatically to a consolidator, with members being given an opportunity to opt-out if they want to.
There are a variety of ways through which a member could be allocated to a consolidator scheme, such as this being the first scheme the individual is enrolled with when first joining an auto-enrolment scheme.
There could also be a list of approved consolidators for the member to choose from, or for those not taking the opportunity to make an active decision, they could be allocated to a consolidator from a carousel system.
Besides asking the industry what the key benefits and risks of this solution are, and who should be able to be a consolidator, the DWP is also keen to explore the option of a single default consolidator.
This option was discounted by the Small Pots Cross-Industry Co-ordination Group “on the grounds that it could have a potentially significant distortive effect on the pensions market and could be costly for government to run as a solution".
But the government believes this “approach requires further consideration, recognising the potential value of the simplicity it could offer”.
“Furthermore, it is unclear whether a private sector solution would effectively address the deferred small pot challenge, as such, a state-backed solution may be required to deal with non-economic pots,” the call for evidence stated.
Pot-follows-member resurfaces
Under the pot-follows-member model, when an employee moves jobs their deferred pension pot in their former scheme would automatically move with them to their new employer’s scheme, if it meets the chosen eligibility criteria for automatic consolidation.
Pot-follows-member was a system launched by former pensions minister Sir Steve Webb, which was due to come into effect in 2016.
However, in October 2015, Baroness Ros Altmann, his successor as pensions minister, halted the process of introducing the system to allow auto-enrolment to be completed.
The DWP stated this “approach should enable greater levels of consolidation to be achieved”. Nevertheless, “there will be some situations where it may cause complications and a consequent increase in administrative burden, for example, the position of multiple job holders”.
Member-exchange off the table
The member-exchange model, the trial for which initially ground to a halt due to changes in the minimum pension age legislation, has been dropped as a preferred solution by DWP.
For this model, the principles were tested with three master trusts, and can identify a small deferred pot in one master trust and an active pot in another master trust and merge the two into the active pot.
“While we do not believe that member exchange represents a complete solution to the small pots issue, we welcome this industry initiative as one which can make an early and immediate impact. It will provide evidence and analysis to support development and delivery of large-scale automated solutions,” the DWP said.
One of the reasons for DWP to prefer the two other models is that those solutions provide the least amount of administrative burden for employers, which is one of the five criteria the chosen approach to the small pots issue will have to comply with.
The other criteria include the delivery of overall net benefits for members through improved value for money outcomes, achieving a meaningful impact on the number of existing, and flow of new, deferred pots; complementing member engagement on their savings journey/retirement planning; supporting a competitive, sustainable and more efficient workplace pensions market and commanding confidence in the system for savers and taxpayers.
Other considerations
The government noted the deferred small pots challenge is a “two-pronged one", since there is a need to “design a solution that can address the existing stock of small pots, and which also tackles the continued flow of new small pots”.
“Recognising that it may not be easy to distinguish between the two,” the DWP is asking the industry if there be an initial focus on managing the flow of new pots or removal of the existing stock, and where does the balance of impact lie for each of the solutions presented.
The government is also keen on establishing what is the value of a pot to be considered small, since “setting the maximum value at too low a level may result in insufficient consolidation,” while if the limit is set too high, there is an increased possibility that members may be put at risk of greater detriment as a result of their pots being moved into a single scheme which has differing and more costly charge structures or lower investment returns”.
Finally, the government is also asking what the correct timeframe is to consider that a pot should be eligible for automatic consolidation.
PLSA head of DC, master trusts and lifetime saving Alyshia Harrington-Clark said: “The government has rightly recognised that efforts need to be made to address the small pots issue, which is detrimental to savers, and causes market inefficiencies.
“If unaddressed this could lead to over 20 million small pots by the end of the decade.
"Industry has and will continue to work hard to support government efforts to resolve to these complex problems for the future of consolidating small pots and implement mass market automatic enrolment solutions.”
maria.espadinha@ft.com
