The government is keen to limit the proliferation of small deferred pots, which some experts have said risk undermining the entire system – but what could potential automatic consolidation mean for the investments of DC schemes? 

 

The government last year created a working group to look at how the growth of small pots should be addressed, after proposals for a pot-follows-member system were abandoned in 2015. The group batted the ball back into the court of the pensions industry last December, asking it to come up with ways to enable automatic and automated large-scale, low-cost transfers and consolidation for the auto-enrolment market. The Pensions and Lifetime Savings Association and the Association of British Insurers have since set up an industry group looking at the practicalities of different consolidation models, with the aim of reporting back this summer. 

 

 

If the UK does introduce automatic consolidation it will also have implications for the cash flows of DC schemes, which could be forced to transfer not just small incoming but also outgoing pots. At the moment, large auto-enrolment providers like master trusts are flooded with cash. Master trust Nest alone takes contributions to the tune of roughly £400m a month, creating a challenge for the fund to allocate the money in capital markets. 

 

 

Nest is planning to have about 15% of its assets in illiquid investments such as infrastructure and private equity and is currently building this up. The government is keen on such investments and seeking to facilitate DC investment in illiquid assets to aid the UK’s economic recovery from Covid-19 among others, so could there be a liquidity crunch in future if small pots have to be paid out? 

 

William Chan, head of DC investment at consultancy Hymans Robertson, said large master trusts like Nest would win from small pot consolidation as they would capture more of the smaller pots over time, while smaller DC schemes could see greater outflows than inflows. 

 

This “will lead to greater consolidation of DC schemes because it’ll force those who are not seeing the inflows to either consolidate or wind up or figure out a new way to retain assets”, he said. 

 

However, one complexity in the UK system is that master trusts, unlike Australia’s superannuation system or the Dutch pensions market, are not organised according to industry sectors. This could mean that employees – particularly those in high turnover industries like hospitality or retail - would see their pot moved from one big master trust to another each time they change job.  

 

In the long-term, this could lead to “interesting master trust dynamics”, Chan observed, suggesting that there could in future be a premium attached to employers with a more stable workforce. 

 

There are also questions around how the issue of small pots would be addressed in the contract-based market, where the member has a direct contract with the provider. Chan said the government would have to change legislation in such a way that a member has to provide consent when asked about consolidation.  

 

 

For Stephen Budge, a principal at consultancy LCP, the question of asset flows and investments depends on the definition of a small pot. In the case of accounts containing less than £1,000, “it is mainly an administration issue”, he said, but if it is larger, then “schemes will need to consider the flow of members and the shape of assets”. 

 

“Most schemes are awash with liquidity so there is unlikely to be a major issue,” he believes. 

 

Still, auto-consolidation is likely to increase the level of turnover in portfolios and schemes, and this could increase costs across the industry, he warned. “Work will need to be done to make these more efficiently run to counter increasing costs,” he said. 

 

A report by the Pensions Policy Institute suggested earlier this year that for small pots to be consolidated at scale, the UK will not get around setting up some form of centralised system, saying a central platform could reduce transaction costs.