Solving the small pots problem

The Government has launched a consultation on proposals to eliminate the proliferation of small pension pots by introducing a solution involving multiple authorised default consolidators. Initially, the proposed solution would apply to deferred pots with a value of less than £1,000. Based on current data, this would help to eliminate up to 61% (12.1 million) of the existing deferred pots below £10,000, with a combined value of £4.2 billion.

The consultation follows a call for evidence, Addressing the challenge of deferred small pots, launched in January 2023, which sought views on, and evidence to support, the development of two potential large-scale automated consolidation solutions - a default consolidator model and pot follows member.

Preferred solution

Respondents to the call for evidence recognised the potential merits of both solutions and, as such, there was no consensus over an optimal solution. Despite the fact respondents considered pot follows member may be simpler for members to understand, the Government has decided to pursue a multiple default consolidator solution for the following reasons:

• with pot follows member it was generally felt there would be a greater risk a member could move from a well performing scheme to a poor performing scheme causing member detriment, although the Government noted this risk should reduce over time as a result of its proposed Value for Money framework;
• due to the frequency of transfers likely required as part of a pot follows member approach it might reduce the capacity for some schemes to invest in illiquid assets, working counter to the Government's focus on productive finance;
• with a pot follows member approach members’ pots may quickly reach the maximum limit for consolidation (even if the maximum pot limit was increased over time) and, therefore, get stuck with potentially multiple unconsolidated smallish pots. This would limit the overall level of consolidation unless a significantly higher pot value is set – however, this would run counter to the feedback received in the call for evidence which suggested the Government should start with a lower maximum limit;
• with pot follows member there is the possibility a member’s pot will not catch up with them where they have frequent job changes. Complications will also arise for members with multiple jobs, who have more than one active pot;
• on the other hand, the default consolidator approach, aligns more effectively with the Government's desire for a more consolidated workplace pensions market, with a small number of authorised default consolidators providing greater value for their members through the economies their scale brings;
• the proposals for enhanced authorisation criteria for schemes to act as a consolidator should help ensure there is less risk of detriment to members where their deferred pot is transferred to a consolidator; and
• having a small number of consolidators, will enable them to generate scale at a greater rate opening opportunities to invest in productive finance benefitting the wider economy.

How this might work

The consultation sets out the core framework for a multiple consolidator approach and seek views from respondents on whether they agree with the proposals.

The key elements of the proposed framework are:

• Eligible pots – The Government is proposing that:
  • a pot would be eligible for automatic consolidation 12 months after the last contribution is made into it (although it recognises the framework will need to cater for members who are taking career breaks, including those on parental leave, people who have temporarily opted-out of pension saving but who may opt back into saving with the same employer and seasonal workers who may return to a previous job);
  • the pot size limit will initially be set at £1,000, with a statutory requirement on the Secretary of State to review this limit at regular intervals; and
  • there will be no minimum pot value for a pot to be eligible for automatic consolidation.
• Authorisation regime – The Government will create a proportionate regime which will enable the relevant regulators to authorise a small number of schemes to undertake the role of being a default consolidator. Master trusts will be required to apply to be default consolidators. The Government will also work with the FCA in the development of the regime and to explore whether contract-based providers could seek authorisation to act as a consolidator in relation to contract-based schemes they operate.
• Central clearing house or register - To support the delivery of the Government's chosen approach, there will need to be a central point or system to store and manage the data needed to identify members' deferred and active pension pots, allowing sending schemes to identify where a member’s deferred pot should be transferred. The consultation sets out two options to enable this:
  • the first would involve the creation of a clearing house that can act as a central body to communicate between the sending and receiving pension scheme, but also contact the member in cases where no active decision has been made regarding the chosen consolidator; and
  • the second, would see the creation of a central register which schemes and providers would be able to access to match their deferred pots to the correct consolidator.
• Member choice - Under the proposed solution, a member would be able to choose which consolidator they would like their deferred pots to be transferred to. They would also be able to opt-out of automatic consolidation.
• Default consolidator – The consultation sets out two options to determine which consolidator vehicle a member's deferred pot would be transferred to where the member does not make a choice:
  • the first would see small pots allocated between the authorised consolidators at a level proportionate to their market share. This is designed to mitigate concerns of further promotion of an oligopoly amongst the largest providers by all schemes growing, in terms of small pots transferred in, at their current rate; and
  • under the second, where a member already has a deferred pot with a consolidator, this scheme would be the member's consolidator scheme. In cases where a member has pots with multiple authorised consolidators their deferred pots could be allocated to the consolidator scheme that holds their largest deferred pot.

The Government recognises both options have their limitations; therefore, they are also interested to hear views on whether there would be a more appropriate method of allocating a consolidator to a member who does not make an active choice – including whether it would be better for this role to sit with a clearing house rather than the deferred member’s scheme.

• Process – At a high level the consolidation process would consist of the following components:
  • a scheme will identify an eligible deferred pot. The scheme will then contact the member providing them with the relevant information to help them decide whether to opt out of automatic consolidation or not. Where the member does not opt-out, the scheme will contact the clearing house to identify the member’s consolidator scheme;
  • in cases where a member has not yet chosen a consolidator scheme, the clearing house will contact the member notifying them of their options to choose a consolidator and explaining what will happen if they do not make a choice within a set time period; and
  • following this, the scheme holding the deferred pot will receive notification from the clearing house of the designated consolidator scheme chosen by or allocated to the member and will begin initiating the transfer of the deferred pot.

The Government recognises it is important this process can be done in bulk, rather than at an individual level enabling schemes to deliver this efficiently and at low cost. It plans to work closely with industry to ensure the process of transferring and matching individuals at scale to their deferred pension pots can be undertaken in a streamlined and cost-effective manner.

Is more radical reform needed?

While the proposed solution will result in a significant reduction in the current stock of deferred small pots, and enable the consolidation of future small pots, the Government recognises it will not eliminate the future flow of deferred small pots. This would require a more fundamental change to the automatic enrolment framework.

The Government suggests a potential way of addressing with this in future might be to introduce a system of ‘stapling’, as seen in Australia, where the members active pension pot is assigned as their pot for life, unless they actively choose an alternative provider. The Government thinks this would create an environment which is easier for a member to engage with, but recognises it is some way off in the UK.

Next steps

The Government has indicated it plans to establish a Delivery Group in late 2023 to work with interested parties to develop a viable, efficient and cost-effective automatic consolidation transfer process for sending and receiving schemes which minimises burdens on pension schemes whilst balancing the need for simplicity, member security and speed. As part of this, it will also explore the most appropriate liability models to ensure that members remain protected.

The consultation itself closes on 5 September 2003.

Comment

It is good that the Government has now identified a preferred solution so that steps can be taken to implement a solution to address the problem of small deferred pension pots. The proposed framework has much to commend it. However, careful thought will need to be given to the details. In particular:

• the development of an efficient, low-cost automated bulk transfer process to enable small pots to be consolidated cost-effectively;
• how to identify and exclude small deferred pots linked to members who are on parental leave or who have ceased contributing for more than 12 months but who may resume contributions and remain with the same employer; and
• the extent to which members can identify their consolidator of choice (for example, will members only be able to choose from the authorised consolidator vehicles) and how this choice will be made and recorded.

Consideration also needs to be given to how any automated transfers will be reflected on pension dashboards to avoid confusing members who might otherwise wonder why their deferred pension pots have disappeared.

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