The UK can pride itself on having the third-largest pension system in the world, but the relative inefficiency of the UK defined contribution sector needs to be addressed, claims David Rowley who as a British journalist based in Sydney has spent the last three years reporting on Australian superannuation.
- The UK may have the third-largest pension system in the world but it lacks scale.
- Fewer larger schemes are able to negotiate better deals with providers and asset managers.
- The market could learn much from markets such as those in Australia and the USA.
By the standards of countries such as Australia, Denmark, New Zealand and the USA, the UK lacks scale and is a poor purchaser of fund management services for its defined contribution (DC) schemes.
The Pensions Regulator lists 36,370 UK DC schemes. Many of these are the business equivalent of lemonade stands at school fetes, where by comparison the Australian financial regulator has only 120 superannuation funds registered to act as live default MySuper providers.
However, even here in Sydney and in Melbourne it is widely held belief that 120 funds is too much.
The argument runs that funds with sub AU$2bn (£1bn) in assets lack the scale to purchase fund management services cheaply, to allocate investments effectively and to communicate with members in line with world best standards.
By contrast, a recent survey of UK DC funds found only one single sponsor scheme (HSBC) with assets over £1bn.
These very same concerns about scale are leading to a shake-up of the Local Government Pension Scheme, but it is not yet scheduled for DC.
Susan Martin, chief executive of the London Pension Funds Authority, writing in the New Statesman in September, spoke of the weaknesses of the soon-to-be-changed Local Government Pension Scheme (LGPS) system: "A total of 89 separate funds investing individually results in inefficient administration and communication, as well as more serious challenges that include higher levels of spending on investment fees, an inability to compete for larger investments and reduced access to long-term alternative asset classes that better match pension liabilities."
Everything that Susan Martin says about the LGPS applies to DC funds too.
The need for change in UK DC is made apparent by the growing economy of scale being enjoyed by the 30 or so Australian super funds with more than AU$2bn in assets.
On the news section of such super fund websites you can find announcements boasting of reductions in fees or new products and services at no extra cost. Talking to the chief investment officers of these funds, one also hears of the growing trend to bring investments in-house or of having the scale to strike partnerships with fund managers to gain cheaper and more tailored assets.
Notably, in January in a story little reported in the UK, AustralianSuper, the AU$90bn DC fund lifted its ownership stake in the Kings Cross development, London (a 27-hectare office, residential, school and leisure site) from a 25% stake to 67.5%. That Australian savers bought this prime piece of real estate and not UK pension funds is all down to what Susan Martin describes above as "an inability to compete for larger investments".
The biggest holders of DC assets on scale in the UK are not single employer sponsors or master trusts, but the insurers. The insurers are loud voices when expensive or complex regulation is touted, but rarely heard when it comes to the benefits of scale in investment. Indeed, where Australian funds always boast of the amount of assets they hold and the purchasing power it gives their members, it is rare to hear the UK insurers do that.
On his Pensions Playpen blog in December, Henry Tapper hinted at the nature of the problem, by highlighting the passivity of the insurers.
"It's been a long time since the mainstream insurance companies really spoke for their customers," he wrote. "Nowadays, if they talk to the market, it is with the help of an outside agency. Scottish Widows have recently spoken through the PPI, when Aviva wanted to speak about pension choice, they did it under cover of Defaqto. It is as if they are embarrassed to speak for themselves."
The large insurers offer professional, UK market leading products with a profit margin attached, but they would appear to lack the missionary zeal of international DC funds such as those in Australia, to improve the member experience, member outcomes and reduce fees.
As such they would also appear to be excluded from the international club of pension funds, which is dominated by not-for-profit, multi-employer funds, who through their shared goals are willing to co-operate and share best practice. Out here in Australia, I talk to superannuation funds that are in regular contact with Canadian, US, New Zealand, Scandinavian pension funds and a few UK DB funds such as the Universities Superannuation Scheme.
Aside from the issue of not-for-profit and for profit funds, the UK industry more generally needs to visualise how it could whittle down the management of DC to thirty funds of scale and move away from the culture of corporate schemes.
NEST, NOW and the People's Pension, plus the operations run by Aviva, Standard Life, Friends Life and Legal and General would naturally play an enlarged role in a streamlined system. But there are probably only around ten among the largest employers who have the generosity and the culture to run schemes separate from these providers. All others should be looking to outsource everything to a provider that aspires to international best practice and to passing on the benefits of scale to its members.
The idea that an employer needs a white-labelled scheme from an insurer, as my ex-employers in the UK did, to keep up the pretence that they are offering their employees a paternalistic, market-beating employment package is an anachronism.
The pension provider is the brand that employees should trust in, not the employer. An employer should gain kudos from telling its employees how smart it is for choosing the best provider instead.
Any of these notional 30 British DC funds of scale should be able to do a better job of telling members how generous and special their employer is. A world class provider of pension schemes should be twice as good as any employer in communicating with employees. It is likely to provide a better continuity of experience – as Steve Webb once highlighted while pensions minister, we have on average 11 separate employers in our lifetime.
The cause of this situation is partly that UK employers have historically paid a wide range of contributions depending on the relative generosity of their employment package. In Australia, the vast majority of employers pay the government stipulated 9.5% to employees, so uniformity is already built into the system.
The other 30 funds
Beyond the above-mentioned DC schemes of scale, in the notional system of 30 funds of scale there should be a public sector DC scheme for those employees not fortunate enough to be deemed eligible for defined benefits.
If the Australian experience is anything to go by there should also be traction for a retail and restaurant workers scheme, regional schemes (Wales/ Scotland/ Northern Ireland) and any industry represented by a strong and numerous union or professional body. In Australia, such regional schemes are beginning to make local investments of scale that have the potential to resonate with members, while the industry schemes can negotiate attractive tailored insurance for their members.
There is also scope for religious and ethical funds. Christian Super and Australian Ethical are two strong brand names in Australia. Both are run by people who live and breathe their values unlike the token ethical or religious investment options offered by mainstream providers because they feel they have to, rather than because they are passionate about them.
So when will scale happen for British DC? According to Jelf Employee Benefits head of benefits strategy Steve Herbert, this is only once auto-enrolment is complete and there is a new government in 2020.
"After 2020 a bit more blue sky thinking will come into play - with industry, savers and politicians all looking at pensions planning in a far more open and logical fashion," he says. "Only then can I see the UK learning the lessons of engagement and better delivery from other geographical areas."
This speed of change is far too slow. The UK system by its very scale will put itself right, but it faces spending at least a decade behind international best practice while it does this.
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