The DWP has taken a controversial step in opting for ‘pot follows member’. John Greenwood looks at the consequences
The DWP’s decision to opt for the ‘pot follows member’ option has not only polarised opinions between providers with different agendas. It has also opened a new front between the Coalition and Labour.
Last month pensions minister confirmed that pension pots will follow employees when they change job, potentially halving the number of dormant pots by 2050, a move designed to halve the number of dormant pots by 2050.
Dropping the aggregator model proposed by some life offices, the DWP said it had opted for ‘pot follows member’ because of the potential for reduced charges and because it is the most popular option with savers, according to ABI research.
But it is also being portrayed as a victory for commercial pension providers over a statist centralised approach. It is a decision that puts the Conservative/LibDem coalition, the ABI and several pension providers in the victor’s corner, with Labour, the NAPF and a different group of providers crying foul.
Both sides’ arguments have merit. Shadow pensions minister Gregg McClymont argues the ‘aggregator’ approach, whereby small pots would only be automatically transferred to low-charge trust-based arrangements, rather than following employees to schemes offered by commercial providers, would ensure better value for consumers in the long run.
McClymont says: “This announcement is not the best deal for pension savers. Ministers must put the saver’s interest at the heart of what they do. Steve Webb’s proposals on small pots fail this test. The Government’s statement today could misleadingly give the impression that they have widespread support for their proposals – they do not.”
The NAPF certainly does not support it. Chief executive Joanne Segars says: “While the Government’s idea is one way to solve the problem of small pots, it does not tackle the risk that people might see their pension transferred to a worse scheme with higher charges and weaker governance. There is a real risk of a pensions lottery where people could be automatically transferred into better or worse schemes without them being aware of the impact. It will be interesting to see how the DWP’s plans will ensure better outcomes for members.
“We believe a better solution would be to allow people to transfer their pensions into large-scale, low-cost aggregators which are simpler and better placed to deliver good member outcomes. We urge the Government to reconsider its preference for ‘pot follows member’.”
Savers do not need to move from a 0.3 per cent to a 1.5 per cent scheme to suffer the sort of negative effect Segars warns of as even modest increases in charges will erode pensions. The NAPF calculates that if someone with a pension pot of around £10,000 and an annual management charge of 0.5 per cent was then moved into a pension with an AMC of 0.9 per cent a year, then they will lose around £1,500 or 10 per cent of their pot after 25 years.
Aegon has expressed its disappointment that a virtual data hub is not part of the small pots solution. Aegon regulatory strategy manager Kate Smith says: “A virtual data hub has advantages over the ‘pot follows member’ model as it can give one view – in one place – of the individual’s pension without physical transfers. We still believe a virtual data hub has a role to play. However, we are pleased that the government has listened to industry concerns and has decided to limit automatic transfers to automatic enrolment schemes, with a consultation on various cap limits.”
The DWP is considering four levels of limit for automatic pot transfer – £2,000, £5,000, £10,000 and £20,000.
Debate will now focus on what ‘small’ is. Some also argue that once pot follows member is in place for auto-enrolment, it cannot be long before it will spread across the rest of the industry.
Fraser Smart, managing director of Buck Consultants says: “Eventually the same rules should apply to small defined contribution pots whether they are generated by automatic enrolment schemes or any other occupational pension scheme. Having one rule for an employee who is made to automatically enrol and another for a colleague who voluntarily joined his employers occupational pension scheme seems a little odd, although trying to deal with all historic small pots in one go would be a mammoth task and perhaps a step too far at this time.
“I would argue that £20,000 is a small pot – though perhaps not in the way the Government would define one. Let’s take the case of an individual who has 5 such £20,000 pots at age 65 making a total of £100,000. On today’s figures with a half spouse’s pension and limited annual inflationary increases he could expect to get an annual pension of £3,000. In other words £20,000 buys you about £600 a year in pension, so it’s a small pot.”
Another feature of pot follows member is the fact that providers will have to keep running to stand still. Yes, providers gain as much as they lose overall, but only as long as they are active. Pot follows member should mean closed book providers will come under real pressure. Commitment to the market will become paramount, which should work in consumers’ favour to some degree.
There is clearly still a long way to go until final rules are agreed, and many arguments to be had until now and then. But the DWP has taken a decisive step, even if it does leave itself open to claims it has caved in to the wishes of higher-charging commercial providers.