UK Chancellor of the Exchequer Rachel Reeves has big plans for the nation’s growing defined contribution (DC) schemes.
Set to manage close to £800 billion ($1.5 trillion) by the end of the decade, DC funds are attracting attention as the Labour government looks to direct investments into so-called “productive finance”, consolidate small pension pots, increase returns and improve retirement outcomes.
It’s not difficult to see some parallels between the objectives of Australian and the UK DC markets, which is why at various stages this year, UK policymakers and funds have embarked on fact-finding missions in conversation with their Australian counterparts.
One such fund is the £37 billion ($71 billion) National Employment Savings Trust (NEST) – a scheme set up by the government to facilitate auto-enrolment, and the biggest UK workplace pension provider.
NEST head of retirement Mark Rowlands tells Investment Magazine, the sister publication of Professional Planner, that in a February trip, the fund met with major super funds including AustralianSuper, Australian Retirement Trust, HESTA, Hostplus and Aware Super, independent experts including the Conexus Institute* and Sydney University academics, and the regulators.
Rowlands says that he had one big question for super funds going into the trip.
“The bit I was looking for was: had you cracked decumulation? Had you solved how to provide lifelong income for members?” he says.
“And the conclusion I came up [with] was…no you haven’t, and you’re actually no closer to it than we are in the UK. In some ways, I think our thinking is perhaps a little bit more advanced.”
Based on the conversations NEST had, Rowlands says super funds’ focus on the retirement space still relies heavily on individuals making choices, but he is “unconvinced that individuals can manage their money in retirement”.
“They can’t manage their money because they don’t know when they’re going to die, they don’t know when the future inflation is, they don’t know what a sustainable drawdown rate is,” he says.
“I just don’t think that’s going to work.
“But in other aspects of accumulation – the policy environment, the value focus – you’re significantly ahead.”
Unsure of stapling
In some ways, the UK is still dealing with the problem Australia had 20 years ago, which is that people have scattered deferred pension pots with different employers, Rowlands says.
However, the only way for UK employees to bring different pots together now is through a voluntary action – which is time-consuming, expensive and even “frightening” for some people, he says.
The UK is considering an automatic transfer measure, where if a small pot is in an eligible scheme for consolidation and is under a certain threshold (to be determined, but such as £10,000), it will automatically be transferred into a regulated, good value arrangement.
Only after solving the small pots problem can the UK move into the next phase of consolidation, which is coming up with a lifetime provider model, Rowlands says. When asked if similar legislation to stapling would benefit the UK market, he says it’s “too early to say”.
“The supers I met with were at pains to say stapling is relatively new – two years in, and it’s almost too early to say what impact it’s had,” Rowlands says.
“What we don’t have is a clearing house. One of the big differences between our two systems is your tax office, as I understand it, acts as a central clearing house. We don’t have anything like that. All that is in the weeds and hasn’t yet been resolved.
“I think the government are probably going to end up salami-slicing it into manageable pieces, and the first bit will be small pots and auto-consolidation, and then they’ll look harder at the lifetime-provider model and learn from stapling.”
Fees vs values
However, one aspect where the UK and Australian markets have different positions is around fees and costs. Despite the downward pressure from Your Future Your Super performance test, fees in Australia are still nowhere as low as in the UK.
NEST provides its services through a combination of two charges, Rowlands says, which are an annual management charge “north of 0.3 per cent” applied to funds under management, and – if a member is actively contributing – a 1.8 per cent charge on contributions.
“At a single charge that equates to about 45 basis points. From what I learned from the supers, when you roll all their different charges up, they’re typically charging in excess of 120 basis points,” he says.
The UK is introducing a Value for Money (VFM) framework which is its version of the performance test, but with its own policy nuances. For example, VFM actually wants to make funds put less focus on cost.
“The UK has been on this race to the bottom on fees for many years, to the detriment, in some ways, of investment diversification…and engaging adequately with members,” Rowlands says.
“So the VFM drive in the UK is very much to get the focus on value rather than cost.”
There are two assessment methods proposed. One is to compare a fund’s VFM against a regulator-defined benchmark; and the other is to compare the VFM with three other market participants, chosen by the trustee. The government acknowledged that the latter approach could expose the evaluation to be gamed.
The outcome is proposed to be presented in green (VFM), amber (not currently VFM but with appropriate actions could be), or red (not VFM). The results need to be publicly disclosed, and the UK government is considering giving regulators the power to consolidate or wind up non-VFM funds.
Rowlands says NEST is broadly supportive of the VFM framework but acknowledges there are details to tease out and room to learn from Australia’s YFYS experience, especially if the government wants to push forward with the productive finance agenda.
“That is only going to gather momentum… and we’ve got to make sure the value for money focus doesn’t lead to herding of investment in a way that everybody tries to follow a baseline or an index, and it be a disincentive to the nation-building/productive finance agenda,” he says.
Learning from the principles
While it is beneficial for pension systems in different countries to cross-pollinate, Mercer senior partner David Knox warns that simply transplanting one country’s structure to the other won’t work.
Knox is lead author of the Global Pension Index – an annual report that compares retirement income systems around the world – where Australia received a B+ rating and UK a B rating last year.
“Every country has their own culture, their own history, and their own expectations [with the pension system],” he says.
He points to the OECD data being used to construct this year’s index, which suggests the participation rate of working-age people in a private pension system is 78.5 per cent in Australia, whereas in the UK is 50 per cent – although he adds that there are an additional 5 per cent of people in personal schemes.
Then there’s the difference between contribution rates: UK auto-enrolment requires an 8 per cent minimum contribution, while Australia’s Super Guarantee is pushing towards 12 per cent. The UK also has a more significant presence of defined benefit schemes.
The government pension setup also matters, Knox says. The age pension in Australia is means-tested while everyone receives state pension in the UK.
“That automatically changes the environment, and it gives you a base on which to then build your private pension,” he says.
“In Australia, superannuation for many people is replacing the age pension – our age pension is about 28 per cent of the average wage. The UK state pension is about 21 per cent, so it’s a bit lower, but still paid to everybody.
“That’s part of the culture and part of the context that you’re working within, so you just can’t take the Australian system and say, ‘UK, copy us’…Industrial relations are different. Employment Relations are different.
“What we should be looking for is ways of learning from each other’s principles.”
*The Conexus Institute is an independent think-tank philanthropically funded by Conexus Financial, the publisher of Professional Planner.
