Revisions need to be made to UK contract law to facilitate the mass migration of defined contribution (DC) schemes, a pensions think tank has said.
The Pensions Institute, part of the Cass Business School, said the revisions were needed, as some members currently reside in poor value schemes, with contract law acting as a barrier to a solution.
The recommendation came after its paper, ‘VfM: Assessing value for money in defined contribution default funds’, made a raft of suggestions to improve member outcomes.
The report said some older, pre-2013 contract schemes were characterised by sub-optimal asset management, high charges and adviser commissions.
Contract law currently requires individual authorisation from members to make changes to their DC pot.
This is difficult given pots are often stranded after a member has left his employer.
Debbie Harrison, visiting professor at the think tank, said mass migration would allow members with existing pension provisions to access value for money – not just for future contributions, but also for their built-up pots.
The call echoes analysis conducted by the think tank that showed high charges have the largest detrimental effect on end outcomes.
It said a replacement ratio of a member’s final salary to its annual pension income was the only meaningful measure of a member outcome.
From the default funds it analysed, replacement ratios based on auto-enrolment minimum contributions ranged from 15.3% to 23.8%.
The institute’s analysis showed that, with each percentage point increase in charge, the replacement income reduced by around 20%.
“This difference was largely due to the charge differences,” said David Blake, director of the think tank.
The analysis modelled outcomes against mean replacement ratios and associated risks, creating an ideal investable frontier.
“The best performing schemes are placed on the frontier, and, only the low charge schemes lie on this frontier,” Blake said.
“While cheapest is not synonymous with best, there is no evidence higher charges can buy investment strategies that deliver superior [replacement rate] performance.
“Default funds with low charges were consistently among the best performers, with those with high charges among the poorest.”
The institute’s analysis also highlighted the benefits of switching from a high charge to a low charge.
“Switching for a high charge scheme to a low charge scheme after 20 years, and with 20 years [of investment] left, still creates a massive improvement in fund outcomes,” Blake said.
The institute’s other recommendations for the DC market included defining the term ‘value for money’, with a total expense ratio in the region of 0.5% suggested.
In addition to amending contract law, the regulation of DC schemes needs to be reformed. Without this, the think tank says, regulatory arbitrage will make a mockery of the private sector pensions system.
Harrison also highlighted the expected consolidation in the master trust arena as AE moved forward and the DC market grew.
Single-employer DC trusts will also shift to muli-employer ones, as defined benefit (DB) schemes are wound up.
“The battle to secure market share between now and 2018 is going to be bloody,” Harrison said.
“The government and regulators must ensure that, in a market where competition is weak, the schemes that emerge as victors do so because they offer genuine member value for money.”
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