The industry response to the publication of the eagerly anticipated report from the Department of Work and Pensions (DWP) about how to tackle the small pots problem only served to underline what a serious issue this is.
December’s report was just the beginning because it will be tough to fix but the size of the task ahead is growing, meaning that it’ll be harder to tackle the longer it’s left.
Small deferred pension pots have been considered a significant issue since the inception of automatic enrolment in 2012. It has always been the case that workers moving jobs would leave behind stranded pots. The phenomenon has multiplied under auto-enrolment because the policy brought in those people who shifted employment far more frequently and whose salaries were lower. The Pensions Policy Institute estimates that as a consequence of this combination of deferred pots and a mass workplace pension system, there’ll be a staggering 27 million dormant small pots in circulation by 2035.
This all presents a challenge for pension providers, particularly the master trusts which serve the auto-enrolment market which now boasts more than 10 million savers, because they may never generate the fees required to cover the costs of their administration. Regulatory levies are currently also calculated by number of members rather than assets managed on behalf of the members of that particular provider. The consequence is regulatory costs have fallen disproportionately on schemes with large numbers of deferred small pots.
These are the schemes which have done the heavy lifting when it comes to bringing many millions into saving via auto-enrolment. Higher financial burdens for schemes becomes a problem in turn for their active savers, since a cross-subsidy is required from the fees charged to them to cover the cost of administering the unprofitable pots. The problems for savers don’t end there. A trail of small pots makes it difficult for those employees with small pots to keep track of their pensions and to keep on top of what they need to save in order to generate a reasonable retirement income. Both members and providers have a strong interest in fixing the problem and both will benefit from removing unnecessary costs from the workplace pensions system.
The working group’s report is a reasonable first step and gets a lot right – both the working group and DWP have done well in a short time to synthesize diverse views and come up with a way forward.
The first thing they have recognised is the need for an automatic solution to consolidate small pots held by different providers. The experience of Australia and small dormant super accounts is that the number of pots an individual has grows early in someone’s working life and these aren’t voluntarily consolidated until people approach retirement. Having a dashboard that facilitates voluntary consolidation, hasn’t been enough to solve this problem.
The second is the need for administration reform. Again one of the main lessons of the international experience is that transfers need to be cheaper, exchange of data needs to be rendered easier by an industry-wide standard and that there’s a need for a rock-solid identity verification process so that automatic consolidation can be done securely. Recognising that there are potential overlaps between the administration changes needed to power a consolidation solution and the components of the UK pensions’ dashboard, it seems likely that the data standard used by the dashboard might become the default standard to power a consolidation system.
There’s a lot more work to be done on consolidation models as well. The report recommends further work on pot follows member and on “consolidators”. The former would consolidate dormant pots to the active pot, while the latter would establish a single destination for all an individual’s deferred small pots. Both DWP and industry will need to look in more depth at how these consolidation options might work.
The report also recommends that the industry take forward work on “member exchange”, a variant of pot follows member. Member exchange is attractive as it might be possible to consolidate small pots using the bulk transfer regulations. This would remove the need for further legislation and might enable master trusts to make faster progress on the problem.
The serious work starts now and there needs to be a durable partnership between the pensions sector and the DWP in order to reconfigure a large part of how workplace pensions work.