Pension Schemes Bill [HL]
Monday 19th December 2016
(7 years, 11 months ago)
Lords ChamberPension Schemes Act 2017 View all Pension Schemes Act 2017 Debates Read Hansard Text Read Debate Ministerial Extracts Amendment Paper: HL Bill 79-I Marshalled list for Report (PDF, 70KB) - (15 Dec 2016)
17:22 - Division on Amendment 6 - Ayes: 209 / Noes: 204 - Amendment 6 agreed.
Baroness Drake
“Scheme funder of last resort
Notwithstanding the provisions of section 8, the Secretary of State shall make provision for a funder of last resort, to manage any cases where the Master Trust has insufficient resources to meet the cost of complying with subsection (3)(b) of that section.”
Baroness Drake (Lab)
My Lords, a key purpose of the Bill is to protect the pension pots of ordinary people from being raided in the event of a master trust pension scheme failing. At the moment, the considerable costs, including administrative costs incurred when a failing scheme is wound up and the members transfer to another scheme, are borne by the members themselves through the charges imposed. The intention of the Bill is to prevent that happening in future. It places a capital adequacy requirement on authorised master trusts to have available sufficient resources to meet such costs in the event of failure and provides for members’ pots to be transferred to another master trust. The Government argue that, in the event of a scheme failure, the capital adequacy and transfer regime will always work. There is no provision if it does not.
The provisions in this Bill, while welcome, cannot guarantee that there will always be sufficient resources available to a failing scheme to finance the costs of wind-up or that another master trust will always willingly pick up all the pieces and costs. No regulator is infallible. The amendment introduces a requirement on the Secretary of State to make provision for funds of last resort to manage those instances of failure. It does not prescribe what that provision should be—for example, a pension scheme with a last-resort public service obligation, or an obligation on master trusts for tail-risk insurance. But without such a provision, the Government cannot claim as they have that from the day it becomes law the Bill will protect scheme members and their pots from the costs of managing failure.
The reasons for this amendment are several: the Pensions Regulator will need to rely significantly on the judgment of its supervisors to assess whether a master trust meets the requirements for ongoing authorisation, to assess not only against current risks but also future risks and make judgments on when it is necessary to intervene. It will not be regulating a legacy system but the future evolving and expanding system, covering millions of members for a very long time. The Bill places a prohibition on using members’ pots to fund a wind-up, but that does not mean that it will all sort itself out. If providers go insolvent, who ultimately will ensure that the wind-up and transfer actually happens? Pots could be left in limbo for many months. Even if the trustees have a legal duty to make such a transfer, they will not be able to pay for advice and administrative services to enable it to happen.
The year 2008 taught us that even the grandest institutions with strong reputations can fail. No regulator can guarantee to remove all risk, and the Pensions Regulator is no exception. However exceptional, a situation could arise whereby a failing master trust will not have sufficient resources on wind-up. Regulator assessment of capital adequacy requirements may simply have been wrong. I hope that that never occurs, but the Government cannot guarantee that it will not. Administrative disarray, failure of controls in the outsourcing to third-party administrators, major computer failure or other failures can hike up costs and cause costly delay in wind-up.
I recently read The Prudential Regulation Authority’s Approach to Banking Supervision of March 2016, and paragraph 44 says:
“The PRA’s supervisory judgements are based on evidence and analysis. It is, however, inherent in a forward-looking system that … there will be occasions when events will show that the supervisor’s judgement, in hindsight, was wrong”.
The resolution regime when a trust fails provides for transferring members’ pots to another master trust. The Government are relying on the industry to always step up to the plate, but they cannot be certain that it always will. I am sure that there are master trusts now that are already concerned about what that means and will not want to commit to being part of a panel or carousel of providers which will always guarantee to accept the transfer of members. They may consider the unknown future exposure to costs or the liability for the administrative errors or failures of a failed scheme too unpalatable. They may want to cherry pick, leaving a less-profitable section of the members stranded. It is not difficult to imagine the sorts of problems that could occur. The Government cannot assume that the increase in scale achieved from accepting a transfer of members from a failed trust is a sufficient incentive for another provider to always volunteer to rescue.
Baroness Bakewell of Hardington Mandeville (LD)
My Lords, I support this amendment, to which I have put my name, and would like to add to the very eloquent case made by the noble Baroness, Lady Drake; namely that it is very important that we provide protection for members when a master trust fails and give confidence in that regard. In the event of a failure there must be a guarantee backed by the Government. While I accept that we do not expect there to be many failures, there will undoubtedly be some. Therefore, it is necessary to provide protection for that eventuality. This amendment would provide a fall-back position when every other avenue has been exhausted.
The Minister of State, Department for Work and Pensions (Lord Freud) (Con)
My Lords, I will address Amendment 6, which was tabled by the noble Lord, Lord McKenzie, and the noble Baronesses, Lady Drake and Lady Bakewell. This is a valuable opportunity for us to discuss member protection, which is clearly at the heart of the Bill and the master trust authorisation regime.
It is not clear why an amendment has been tabled that would require the Secretary of State to make provision for a scheme funder of last resort should a master trust have insufficient resources to meet the cost of complying with the duties arising from a triggering event and to cover the cost of running the scheme on. I simply do not believe this issue requires such a sledge-hammer given all the mitigations against this risk which the Bill introduces, to which I will return briefly later on. The intention behind the amendment is a lingering concern that a failing scheme might not be able to cover the cost of transferring its members’ accrued rights out. However, to require the Secretary of State to provide for a scheme funder of last resort would be a costly and disproportionate response. Unfortunately, the amendment does not provide any details of how such a scheme might be achieved at reasonable cost. It would appear to require quite large-scale infrastructural change—the noble Baroness, Lady Drake, mentioned the idea of creating an institution with a PSO. There would need to be transparency in the schemes to which the facility would apply, and we would need to prevent any moral hazard in its application.
I am aware that schemes have failed in the past, and I understand that in some cases these failures have proven expensive to resolve. However, those failures have almost entirely occurred in schemes offering defined benefit pensions. The risks in those types of schemes are very different and the complexity of their structures can make them much more difficult to wind up than a master trust offering defined contribution benefits. If a defined benefit scheme which has been operating for a long time fails, it is much more likely that it will be more time-consuming and expensive for that scheme to close than it would be for a master trust scheme. In the case of master trusts, the noble Lords have inadvertently blown the risk out of proportion.
On the mitigations I mentioned earlier, the Bill contains a raft of measures which address the same risks that the amendment is seeking to address. The financial sustainability requirement is a key risk mitigation as, among other things, it requires schemes to satisfy the Pensions Regulator that they have sufficient financial resources to comply with their continuity strategy in Clauses 20 to 33 and to run on, following a triggering event. On application for authorisation to operate, a master trust must satisfy the regulator that it has sufficient financial resources, and post-authorisation the regulator has an ongoing duty to monitor the scheme to ensure that it continues to be financially sustainable.
In carrying out its supervisory role the regulator will assess the amount of money that the scheme requires to meet its costs, taking account of its size, the assumptions set out in its business plan, the available assets and the financial strength of the scheme funder. Furthermore, to ensure that any resources are available at the point of need, a regulation-making power enables the Secretary of State to specify requirements that the scheme funder must meet in relation to the assets, capital or liquidity. This power might be used to require certain funds to be put aside and only accessible for specific purposes, and to impose requirements about the liquidity of any capital so that it is easily realisable. Should a scheme fail, Clause 33 prevents the trustees from increasing the charges paid by members during the event-triggering period, so members’ pension pots are protected.
To prevent schemes winding up with the records in disarray and without the financial resource to put things right, one of the authorisation criteria requires schemes to satisfy the regulator that they have appropriate administration systems and processes such as record management, IT systems, and resource planning. Schemes will be subject to regular monitoring.
To pick up the specific concern mentioned by the noble Baroness, Lady Drake, about the impact of an IT system failure on a scheme’s records, the requirement is for appropriate systems and processes, including back-up systems. The Pensions Regulator has not so far come across a master trust experiencing a computer failure; in practice, failures have been due to schemes not being financially viable.
Finally, it is inappropriate for the Government to intervene in the market by making provision for a scheme funder of last resort. First, such an intervention might undermine member protection by creating a moral hazard that disincentivised schemes from protecting their members. Secondly, if the Secretary of State were required to make provision for a scheme funder of last resort, this could disrupt the normal operation of the market by deterring other master trusts, or scheme funders, from retaining public confidence in master trusts and rescuing a failing scheme. We already know of some master trusts that have been consolidated by being taken over by others. In the extreme, the taxpayer could end up having to pick up the tab for failed schemes. However, the essential argument is that Clause 33 protects members’ savings from being used to pay for the costs of winding up or transferring. With that explanation in mind, I urge the noble Baroness to withdraw her amendment.
I now turn to Amendment 23, which may provide some redress for my views on Amendment 6. This amendment introduces a new clause relating to compensation for fraud, and it may provide some mitigation for noble Lords’ concerns. In addition to protecting members’ interests through the master trust authorisation regime, we are ensuring, through the introduction of this new clause, that members in master trust schemes are protected from the risk of fraud. It will allow regulations to be made that modify the provisions on fraud compensation in the Pensions Act 2004 so that they can be more applicable to master trusts and to any other occupational pension schemes to which all or some of the provisions of Part 1 of the Bill apply.
At present, fraud compensation payments can be made to occupational pension schemes where certain conditions are met. These conditions include that the value of the scheme’s assets has been reduced and that there are reasonable grounds for believing that this has been due to dishonesty. Also, all the employers in relation to the scheme must have gone out of business or the businesses must be unlikely to continue as going concerns.
Master trust schemes are occupational pension schemes, and we think it is right that they should qualify for fraud compensation payments and that their members should be entitled to this protection in the same way as members in other occupational pension schemes. However, as master trusts are used, or are intended to be used, by multiple employers who do not need a connection to each other, they would be likely to have difficulty meeting that last condition on the insolvency of all the participating employers. Therefore, our intention is that regulations will remove this employer insolvency requirement for master trusts and add other conditions to make fraud compensation more suitable for these types of schemes. These regulations would, of course, be subject to consultation, which would allow us to engage with stakeholders in developing them.
I hope that the noble Lord, Lord McKenzie, will feel that on balance he has moved somewhat ahead in respect of these amendments.
Baroness Drake
I thank the Minister for his response and will address some of the arguments he put. The amendment does not introduce a sledge-hammer: it leaves the provision to the Secretary of State. It does not require a large infrastructure to deliver such a provision. It can be as straightforward as requiring master trusts to have tail-end risk insurance. It can use a precedent that is used in many other areas of identifying a provider or operator who carries the public service—
Lord Freud
I should make it clear to the noble Baroness that we looked closely at tail-end risk insurance. It works within the legislation and the regulator can accept it. We have not made it a major issue at this stage because, at the moment, no such insurance is available in the market. That may change, of course.
Baroness Drake
Perhaps I may finish my point. I understand what the Minister has described but is he saying that the Government will consider a provision such as tail-end risk insurance?
Lord Freud
I am saying that the clause is carefully drafted to allow tail-end insurance as part of the capital adequacy when the regulator looks at what is required. We are not in a position to do any more at this stage because that particular insurance is not available in the market. It may well become available in the market as people see the requirement.
Baroness Drake
I come back to my point that I am seeking not to tie the Government down to a particular provision or how they choose to interpret it, but to answer the question that no Government or regulator can guarantee that they can remove all risk of regulatory failure. In the Bill at the moment—unless the Minister wishes to contradict me—I can find no provision as to where responsibility would fall in the event of such failure occurring and there is not the funding to deal with the wind-up and the transfer.
I do not accept that it increases the chances of moral hazard. The Bill gives the regulators considerable power to set tough requirements. Indeed, the whole purpose of the regime is to address the moral hazard of introducing a profit motive into a trust-based arrangement. The existing regulation and legislation does not deal with that. However much we iteratively discuss this—I welcome the Minister contradicting me—in the event of a regulatory failure and a trust that does not have the means to finance wind-up, there is nothing in the Bill to show how a member is protected.
Lord Freud
I am grateful to the noble Baroness for inviting me to intervene again. Under the Bill, if there are costs, they will not fall on the members, so who is she trying to protect? As to my point about the sledge-hammer, if we could have found tail-end insurance, which the noble Baroness mentioned, it would have been cheaper. Other ways that I can think of are quite expensive. It is not appropriate to suggest a solution that is not available.
Baroness Drake
The Government are asserting that the costs will not fall on the member because they have put in place a prohibition to say that the costs will not fall on the member. However, if the member is in a master trust of some size which has to go into wind-up, and there are not the resources to deal with that wind-up, there is no answer to the question of who will bear the costs. An answer has to be given, and this amendment is asking the Government to put in place a provision to give effect to that prohibition and say that there will be an alternative provision to ensure that the costs do not fall on the member. I do not believe that the Minister has answered the questions. There are millions of people with potentially billions-worth of assets under the regime, and this is a fundamental question which remains unanswered.
Lord Freud
The noble Baroness has been so generous and I will take the opportunity to go over this because it is slightly back to front from normal. This is not like a defined benefit scheme worth billions of pounds which are at severe risk. This is about the costs of moving the money that is attached to individual people to another master trust. It is a completely different order of risk. I know that she is coloured by what she has seen in the defined benefit world, but this is quite different. It is a much smaller risk. As I have said, in any case the costs do not fall on the members and the mitigation issue is disproportionate.
Baroness Hollis of Heigham (Lab)
My Lords, I hope that my noble friend will pursue this point because, unless the Minister can give a categorical assurance, this is the only way to ensure that the Government take the issue seriously and pursue a remedy that is appropriate to the risk that she has outlined.
Baroness Drake
I thank my noble friend for her support. I am not coloured by the defined benefit experience at all because I am quite capable of distinguishing between the two. I am sure that I understand the risk posed in this draft legislation. However, I come back to the point. The Government may wish to assert that the costs of winding-up and transferring could be considerable if the records are in disarray, if no master trust is willing to pick up the pieces, or if other problems occur. The Government can assert as a matter of policy that the costs will not fall on the member, but there is nothing in this Bill to copper-bottom that they will not. I feel that the Minister has not answered that question. I am not proposing a sledge-hammer and I am not tying the Government’s hand, but they must introduce a provision which states that if the policy is to prohibit increasing members’ costs when a wind-up after a failure occurs, in extremis if there is regulatory failure that provision will come into effect. I am not persuaded by the Minister’s reply and on that basis I wish to test the opinion of the House.
Lord Freud
“( ) The first regulations that are made under this section are subject to affirmative resolution procedure.”
Lord McKenzie of Luton
Lord McKenzie of Luton
My Lords, I will also speak to Amendment 10 in this group. Amendment 9 takes us back to scheme funder requirements, which we debated in Committee.
Our concerns expressed at that time were about the rigid nature of the provisions requiring a scheme funder to be constituted as a separate legal entity and for the activities of such entities to be restricted to the particular master trust. Our concerns remain, and in particular include representations made to us that preventing a single provider supporting more than one master trust could inhibit consolidation and the ability to rescue failing schemes. Further, where the scheme funder is currently part of a wider, well-capitalised legal entity—perhaps an FCA and PRA-authorised insurer—to force a restructuring could weaken and not improve the position of the funder.
Our original amendment was to delete the requirement for the scheme funder to be a separate legal entity and to carry out activities only for the master trust, replacing this with a requirement that the scheme funder should be approved by the Pensions Regulator. The Minister—the noble Lord, Lord Young—rejected this approach, arguing that it would make it more difficult for the regulator to obtain transparency on the financial position of the funder and its financial arrangements with the master trust. Our revised amendment therefore requires that the scheme funder be constituted and carry out its activities in a manner that enables its financial position and the financial arrangements between it and the master trust to be transparent to the regulator. It sits alongside the regulations that will set out the requirements of the scheme funder accounts. It may well be that some will choose the existing formulation of the Bill to do this. Others may have a different approach, especially if they are existing trusts. However, they must satisfy the regulator as to the transparency of the arrangements. Moreover, they must continue to satisfy the regulator on this point.
On 21 November, the Minister in the House of Lords, at Hansard col. 1789, rejected the idea that the Bill’s existing requirements placed restrictions on shared services or would lead to the disruption of existing business. The requirements are apparently not designed to require the unpicking of any shared service agreements. We suggest that this analysis is suspect. From what the Minister said, it would seem perfectly possible for a scheme funder to receive a charge from a group or associated company for services it has received, presumably with an arm’s-length profit uplift, but not for the scheme funder to make a charge for services it has rendered, with or without uplift, because this would be outwith Clause 10(3)(b). If the issue is transparency, what assurances are received by an incoming group charge which cannot be obtained in respect of an outflow?
Shared service agreements do not necessarily arise by all costs originating in one entity that are then allocated across a group. Individual companies might bear costs, all or part of which are contributed to a pool and then reallocated across all or some of the group entities, and there may be a changing pattern from year to year. Incidentally, whereas in the Government’s formulation a scheme funder may not charge for services to another company, associated or otherwise, it seems there is nothing to inhibit the flow of dividends upstream. Is this right? What is the position of a scheme funder which provides a guarantee to another entity? Is the provision of a guarantee an “activity” for the purposes of Clause 10(3)(b) or not?
It is important that these group flows are transparent—we accept that. But the assertion that the regulator’s task is easy when dealing with inward group flows but more difficult for outward flows from the very entity that is being regulated seems difficult to sustain. The Minister said that he expected costs allocated to master trusts to be transparent to the regulator through the business plan accounts and other related documents. If transparency can be achieved in this manner for inflows, why not outflows from the scheme funder, or indeed for it having more than one business line?
Of course, we accept and support the significance of the scheme funder in these arrangements and the importance of being clear as to its financial strength. However, as outlined already, are not the Government in danger of throwing out the baby with the bath water in circumstances where a scheme is funded by an FCA-regulated entity with the robust capital requirements that this entails? Further, the Government have yet to answer how the clause currently works in circumstances where the master trust provides benefits other than money purchase benefits. If there were any activities carried out for non-money purchase benefits, which seems inevitable, the scheme funder would appear to fall outside the definition of a “separate legal entity”. Is this correct?
The Minister is also on record as suggesting that groups of companies are used to restructuring their statutory accounting arrangements to reflect changes in focus. That may be true, but it does not mean that it can inevitably be achieved without costs, especially taxation, if non-group entities are involved.
We look forward to hearing from the noble Lord, Lord Flight, on Amendments 11 and 12, the thrust of which appears to enable a scheme funder to carry on other activities, as well as those for the master trust, although these must be disclosed to the regulator for the purposes of assessing financial sustainability. If they have the effect of allowing the scheme funder to carry on the scheme and other activities, but with the obligation to disclose, we will indeed be making good progress on the issue.
Finally, can the Minister say whether Clause 39 could be used to carve out certain schemes from the requirements of Clause 10? Do the Government have any plans to do this, and what types of schemes might be involved if they do? Although we are on Report, the scheme funder provisions remain troublesome, with many unanswered issues. We urge the Government to take this away for another go at Third Reading. In the meantime, I beg to move.
Lord Flight (Con)
My Lords, Amendments 11 and 12 in my name seek broadly the same objective as that of the noble Lord, Lord McKenzie, and would enable a funder to do other things but subject to the regulator having to approve them. The fundamental issue here for the insurance industry is that the funder being a separate entity does not really work. The Bill will introduce additional cost for master trusts offered by insurers, potentially to the detriment of existing scheme members, as these schemes already operate under stringent FCA and PRA regulation.
As noble Lords will know, a number of insurers offer master trusts to members in addition to group personal pensions and alongside other business lines. Insurers currently manage risks across a number of product lines and they all operate under stringent FCA and PRA regulation. It seems to me that members of master trust schemes used for automatic enrolment should meet high solvency and reporting standards but that the Bill should not introduce additional requirements on master trusts offered by insurers where suitable protections are already in place.
The key concern is the definition of a scheme funder as set out in Clause 10, which specifies that it,
“must be constituted as a separate legal entity”,
and must not carry on any other activities. The Government have stated that the purpose of this clause is to better enable the Pensions Regulator to assess the financial sustainability of the scheme by increasing transparency of the assets, liabilities, costs and income of the master trust. I do not really see that Clause 10, by itself, meets the policy intent of providing the transparency to assess the financial sustainability of a master trust, since as a “separate legal entity” it can still transfer risk to other entities.
A key benefit of a master trust being part of a wider and well-capitalised legal entity is that the scheme can, if necessary, draw upon this capital. Members of master trust schemes offered by insurers currently benefit from this additional security. Many of the ABI’s members view this as a key selling point to employers who have chosen their master trust schemes. It is fortunate that the Bill will be moving on to the other place because I would ask the Government to continue negotiations with the insurance industry on this point, either with a view to satisfying it that the Government are right or to accepting its views. It is not entirely satisfactory if the key provider industry is not comfortable with this issue. This does not go into territory which I would personally want to put to a vote, but it needs further discussion with the industry.
Lord Young of Cookham (Con)
My Lords, I am grateful to the noble Lord, Lord McKenzie, and to my noble friend Lord Flight for tabling amendments which are, in their objectives, all broadly supportive of the Government’s position: that there should be transparency about a master trust’s financial position, including the financial arrangements between it and the scheme funders and the strength of those funders, in order to support the Pensions Regulator’s financial supervision.
Amendments 9, 10 and 11 would all have a similar effect: to remove the requirement that the scheme funder,
“be constituted as a separate legal entity”,
that does not carry out any activities other than master trusts. Although they are well-intentioned, these amendments raise problems of their own. Amendments 9 and 10 would have the opposite effect to transparency, because scheme funders would be unclear as to whether the manner in which they carry out their activities and are constituted is sufficiently transparent to the regulator for the purpose of its financial supervision. This is partly because the arrangements between scheme funders and master trusts will vary enormously across schemes. Amendments 9 and 10 would, by removing much of the substance of the scheme funder requirement in Clause 10, make it more difficult for the regulator to assess compliance and make its financial supervision of the scheme more challenging.
Following the exchange in Committee, we have explored this issue further, but the Government and, more importantly, the Pensions Regulator believe that ensuring transparency about the status of the financial arrangements between the master trust funder and the master trust is essential to this new regime and to the regulator’s assessment of the financial sustainability of the scheme. The requirement to be a separate legal entity achieves this objective. I do not pretend that this is not without cost to some insurance companies—a point that was raised earlier—but the alternative provided by this amendment is not equipping the regulator to make a key decision that could impact on the security of thousands of scheme members.
Amendment 12 may be technically flawed because Clause 8 relates to the financial sustainability of the scheme, not of the scheme funder. It is worth noting that the regulator can assess the financial strength of the scheme funder through its accounts, required under Clause 14, in any event. The Government believe that the most clear and straightforward way to achieve the desired level of financial transparency is through the requirement in Clause 10 for the scheme funder to be set up as a separate legal entity whose only activities relate to the master trust. This will also protect the interests of master trust scheme members. However, this does not prevent scheme funders, such as insurance companies, operating other lines of business through another vehicle.
I was asked whether a scheme funder can support more than one master trust. A scheme funder can support more than one master trust by setting up separate legal entities for each scheme. On the question of whether there is anything in the Bill to inhibit the flow of dividends from the scheme funder outwards, the Bill does not impose any direct restrictions on the flow of dividends from or to a scheme funder, so long as the scheme is financially sustainable. The noble Lord also asked whether the provision of a guarantee by a scheme funder is an activity which the clause prohibits. A scheme funder can provide a guarantee in respect of the master trust to which it is the scheme funder.
It may be that the amendments are intended to address certain underlying concerns: first, about the cost of corporate restructuring to meet the requirement to be a separate legal entity; and secondly, about double regulation, an issue that was raised in Committee. The practical and legal requirements for setting up a business entity should not of themselves be burdensome. It is quick and easy to incorporate a company in the UK, and the Government make a company’s ongoing filing requirements as simple as possible to comply with. However, we recognise that, to meet this requirement, some companies offering master trusts among other lines of business would have to undergo corporate restructuring. To address this, we are working with key stakeholders to develop a proportionate approach to regulation that minimises the burden on business without undermining the Pensions Regulator’s ability financially to supervise schemes through transparent financial structures and reporting.
Noble Lords may recall from earlier debates that the financial sustainability requirements that master trusts have to meet in order to operate have been developed to address the specific risks faced by the members of master trusts. However, if we identify an overlap between our requirements and those of other regulatory regimes, the Secretary of State has a regulation-making power in Clause 8 that can require the regulator to take those regulatory requirements into account when assessing whether a scheme is financially sustainable. We believe that power to be sufficiently flexible to prescribe, for instance, that if the scheme funder has an enforceable guarantee from a financially sound parent company, such as one that meets the PRA’s capital requirements, the regulator must take that into account when assessing whether the scheme has sufficient resources to meet the specified costs. Let me re-emphasise our commitment to proportionate regulation, striking an appropriate balance between member protection and minimising the burdens on business. We are working with key stakeholders to ensure that we understand their concerns.
Noble Lords also expressed related concerns about how the requirement for a separate scheme funder in Clause 10 applies to master trust schemes that offer both money purchase and non-money purchase benefits, a point raised by the noble Lord, Lord McKenzie, a few moments ago. Noble Lords have highlighted the interaction of that requirement with the provision in Clause 1 that the provisions are to be taken to refer to the master trust,
“only to the extent that it provides money purchase benefits”.
My noble friend and I have had productive conversations with noble Lords opposite in the past week, although not as productive as they would have liked. I expect those to continue. The team at the DWP is looking at all options that are open to us, but at this stage I regret I cannot commit to a timetable, nor can I commit to returning to the issue before Third Reading. However, noble Lords should be reassured of our very firm intention to take further action during the passage of the Bill.
I hope that the points I have made are sufficient to explain why the Government are of the view that these amendments would not be appropriate, and that the noble Lord will feel sufficiently reassured not to press them.
Lord McKenzie of Luton
My Lords, I am grateful to the noble Lord, Lord Young, for his response to the amendments. I would say to the noble Lord, Lord Flight, that we end up with the same objectives and the same analysis about what we want to achieve, if with a slightly different way of going about it. However, I am disappointed with the response from the noble Lord, Lord Young. I am not sure whether he specifically dealt with the point about whether Clause 39 could be used to carve out some of the schemes in some of the circumstances we have particular concerns about, and, if so, which of those schemes could be the subject of that carve-out. That might be one route to partially addressing some of the problems. I do not know whether the noble Lord wants to come in.
Lord Young of Cookham
I am happy to give the noble Lord the assurance he has just asked for.
Lord McKenzie of Luton
I was not asking for an assurance but for an answer.
Lord Young of Cookham
The regulations in Clause 39 give the flexibility the noble Lord has just asked for.
Lord McKenzie of Luton
I am grateful to the noble Lord, but would be interested in knowing how they might be used and in the Government’s intent, because potentially that gives a route to addressing some of the issues we are concerned with. I regret also that the Government are not yet in a position to answer the question about non-money purchase benefits. This has been on the table for a little while and seems to me to be a straightforward tactical issue which has one of two answers: either it can be made to work or it does not work, in which case I suggest there is quite a serious flaw in the structure of these provisions.
We understand that to help the regulator get maximum clarity on transparency, there needs to be a separate vehicle which only provides activities to the master trust, but it seems to me that the Government are not putting into the balance the consequences of going down that route. As the noble Lord himself I think acknowledged, the consequences could include a restructuring of a group, which might have costs. It certainly could include disruption of all the shared services arrangements, and again I do not think we have the answers to why the Government believe it is okay to have shared services charged into a company which is providing activities to the master trust but not in the other direction. It seems to me the same level of transparency could effectively be made available to both.
If there is any comfort in this, it is that there appears to be some ongoing dialogue with the industry. I think we can be comforted by that, but it is a great pity that the Bill leaves us with this provision, which has been seen as a bone of contention for a long time and was flagged up some time ago. Frankly, the issues is completely unresolved. I am tempted to test the opinion of the House, but it is Christmas. We are a long way from achieving clarity on this issue, but in the circumstances I do not think dividing would achieve very much. I beg leave to withdraw the amendment.
Lord Freud
“( ) The first regulations that are made under this section are subject to affirmative resolution procedure.”
Lord Freud
“( ) The first regulations that are made under this section are subject to affirmative resolution procedure.”
Lord Freud
“( ) The first regulations that are made under subsection (3) are subject to affirmative resolution procedure.”
Lord McKenzie of Luton
Lord McKenzie of Luton
My Lords, I shall also speak to our other amendments in this group, Amendments 20, 21 and 22. They take us back to another issue that we discussed in Committee: the substitution of a new scheme funder where a triggering event has occurred. Depending on the circumstances, one of two continuity options has to be pursued. Continuity option 1 requires the transfer out and winding up of the scheme, while option 2 involves an attempt to resolve the triggering event. At present, continuity option 1 is mandatory on the trustees where certain of the more significant triggering events are involved. These are where the Pensions Regulator issues a warning or determination notice concerning decisions to withdraw a scheme’s authorisation, or where a notification that the scheme is not authorised has been given.
In Committee we pursued an argument to the effect that the Pensions Regulator should be enabled to cause the matter to be resolved by the replacement of the scheme funder. We argued that transferring the responsibility for a master trust to a new scheme funder could provide a quick answer to a collapsing master trust, costing less and helping members because it keeps the scheme intact and avoids unnecessary investment transition costs and expenses for Members. This has been acknowledged by the Government. However, the Minister rejected our amendments, particularly on the grounds that it was the role of trustees to run and manage schemes. They have the fiduciary duty to act in the best interests of members and should not be second-guessed by the regulator in this regard.
The Minister asserted that the outcome of substituting a new scheme funder was available to the trustees under continuity option 2, subject to the full requirements of adoption including the preparation of a comprehensive implementation strategy. We accept that as far as it goes, and agree that the substitution of a new scheme funder can be a way of resolving the triggering event. However, it does not provide a route where option 1 is mandatory on the trustees. That is why our Amendment 19 would allow for a new scheme funder to be put in place under option 1, in accordance with regulations to be added to the long list included in Clause 24(4) under our Amendment 21. Amendment 22 would require the submission of an implementation strategy.
We have heard from the Government no good reason why the substitute scheme funder route should not be available for all triggering events, although the Government may argue that for triggering events one to three, matters are likely to be more serious than for a change in a scheme funder to be the way forward. Will the Minister confirm that he would routinely expect the regulation around option 2, including the substitute funder, to be considered before the regulator formally moves to withdraw authorisation?
Amendment 20 is a rerun of a debate in Committee, and on rereading Hansard we consider the matter sufficiently covered. I beg to move.
Lord Freud
I shall take the opportunity to go through the matter of transfers because there has been a lot of discussion of it and this at the heart of it. I will pick up what we did in Committee, where the amendment from my noble friend Lord Flight referred to automatic transfers. I confirm that we will look to revisit automatic transfers once the market has absorbed the recent reforms.
The next issue was that we announced in 2016 that we would ensure that the pensions industry launched the pensions dashboard, which would allow people to see in one place their retirement savings from across the industry, which they could consolidate, and the Government would support the industry in doing that.
We then moved on to touch on transfers between default funds—for example, where a trustee may wish to move members out of an old default fund into a new one because they think the old fund is not offering value for money. There, we were concerned whether members might get left behind. This would be for the trustees to consider and act on under their fiduciary duty, not for legislation.
Then we had issues about bulk transfers in place at the moment, which require an employer connection and an actuarial certificate. There, I confirm again that we would have a call for evidence to consider the potential changes to DC to DC transfers. The last point that we visited was about the transfer from a master trust which is failing. Again, I confirm that where a scheme is acting under option 1 following a triggering event, the Bill applies, not the current provision under legislation relating to bulk transfer without member consent.
I think that sets a useful context for consideration of the amendments. Amendment 20 makes two additions to what will be covered by the regulations that must be made under Clause 24. Clause 24 sets out the detail of continuity option 1 and the requirements. In this situation, the clause requires that the trustee must identify one or more master trusts to which members’ rights must be transferred. The regulation-making power set out a number of matters connected with how this process should work. The intent is for members to be able to continue to save with as little disruption as possible and to protect the rights that they have accrued.
The regulator is aware of the need for schemes to be available that have been authorised into which members can be transferred. Experience to date has shown that there are good-quality schemes in the market. From our discussions with both master trusts and pension industry bodies, we are aware that they are keen to demonstrate the reliability of master trusts and for members to have confidence in them as a vehicle for pension saving, and there are therefore likely to be some available to take in transfers. For many master trusts, making themselves available to take a transfer would offer the opportunity to take in a number of members that they have not had to actively source—clearly, they get the benefits of scale.
Employers and members also have reassurance provided by NEST. Although a master trust could not itself do a direct bulk transfer to NEST—as the employer must first establish a connection with NEST—an employer could chose to sign up to NEST and move its workers across. NEST is required to admit any employer and any worker enrolled by the employer to meet its automatic enrolment duties.
The master trust industry has expressed an interest in developing its own panel of providers to assist with addressing situations where a master trust fails. Although we cannot guarantee that there will be a large number of master trusts looking to take on members of any failed master trust, we are confident that there is adequate provision within the market overall.
The second part of Amendment 20 would require that regulations made under Clause 24 set out what would happen to any non-money purchase benefits where a master trust which has mixed benefits was going to transfer the money-purchase benefits out of the scheme and cease to operate in respect of those benefits. We do not believe that that is necessary. We have been careful to design the master trust authorisation to target the risks to money-purchase benefits in these structures.
Therefore, if authorisation is withdrawn from a master trust which offers mixed benefits, it will be required to stop operating in relation to the money-purchase benefits only. It may still continue to operate in respect of the non-money purchase benefits if it is compliant with the relevant requirements of the non-money purchase benefit regime.
Where the scheme as a whole is winding up, existing provisions governing how non-money purchase benefits are to be discharged will apply to those benefits. That is clearly an issue of avoiding duplication.
On the question asked by the noble Lord, Lord McKenzie, the regulator can decide to encourage the scheme to substitute the scheme funder where this is appropriate, and before it moves to withdraw authorisation. The flexibility is there. Adding on the requirement that one option must be looked at before the other would probably reduce flexibility.
Amendments 19, 21 and 22 seek to make provision that continuity option 1 also allows for the substitution of a new scheme funder. Clause 23 sets out the two continuity options that must be pursued by trustees when a master trust has a triggering event. Unless authorisation has been withdrawn or refused, trustees will have a choice as to which continuity option they pursue. Clause 24 describes continuity option 1. Continuity option 2, under Clause 25, is when a master trust resolves its triggering event itself. The legislation does not specify how the event can be resolved, which is deliberate. It means that it encompasses a wide range of options, including the substitution of a new scheme funder. The trustees have the freedom to choose how best to resolve the event their scheme has had.
Clause 26 sets out the duty on the trustees to submit an implementation strategy to the regulator. Our aim is that members continue to save in a pension. Under continuity option 1, the situation is such that to protect members’ rights it is necessary that the scheme transfer these rights out and wind up. The event that led to continuity option 1 will often not be about the scheme funder, so a new scheme funder would not rectify the issue. If the Pensions Regulator has had to withdraw authorisation, a new scheme funder will not be the right response. It is likely the regulator will have ensured the trustees considered this at an earlier stage. Under continuity option 2 the aim is that the triggering event is resolved.
The amendments seek to provide that continuity option 1 also covers the substitution of a new scheme funder, which seems to be a misunderstanding of what is provided in the Bill and would cut across how the two options are intended to work. Where the trustees have the choice about which to pursue, they can try to resolve it. Identifying a new scheme funder is just one of the ways to get that resolution. We do not want to limit schemes’ options which is why we did not list particular solutions. The substitution of a new scheme funder already comes within continuity option 2 and its process.
We agree that where a master trust has experienced a triggering event, a new scheme funder could be identified, and could be the most appropriate resolution of a triggering event. This should be an option open to the trustees. That is why we have made the provision for continuity option 2. Continuity option 1 is solely about transfer out and wind up. The amendments would cut across the way in which the options and indeed, the regime as a whole, works in the Bill. With these explanations I ask the noble Lord to withdraw his amendment.
Lord McKenzie of Luton
My Lords, I am grateful to the noble Lord for setting the context and picking up on some of our previous debate on transfers. The purpose of the amendment was to test whether it is possible to have a replacement of a scheme funder when you are in the triggering circumstances that take you into continuity option 1. As it stands, if you are in continuity 1 processes, you have to follow the route of transfer and wind-up; you cannot have a replacement scheme funder. The purpose of the probe is to try to understand why that is. One route to deal with it is that, before getting to a triggering event, 1, 2 or 3, the regulator will have a process with trustees and there can be a nudge which takes us into continuity 2. I understand that, but I think the Minister has confirmed that if it is just straight continuity then that is it, you have no hope of having a replacement scheme funder. I am still a little unclear as to why that would be so.
I think the noble Lord said that substituting new scheme funders would not generally be appropriate given the state of the scheme, so it has to be addressed by these other arrangements. But that does not mean that there would not be arrangements where that could be entirely appropriate. So I think that there is still a bit of a gap in the Bill. However, having said that, I think that we have given it a good airing. I beg leave to withdraw the amendment.
Lord Freud
“Fraud compensation
(1) The Secretary of State may by regulations modify sections 182 to 187 of the Pensions Act 2004 (fraud compensation) as they apply in relation to—(a) Master Trust schemes;(b) schemes to which some or all of the provisions of this Part apply by virtue of section 39.(2) Regulations under this section are subject to negative resolution procedure.”
Lord Freud
“(2) The Secretary of State may by regulations make provision that is consequential upon any provision of this Part.(3) Regulations under this section may amend, repeal or revoke any provision of—(a) an Act passed before or in the same session as this Act;(b) subordinate legislation (within the meaning of the Interpretation Act 1978) made before the passing of this Act.(4) Regulations under this section that contain provision mentioned in subsection (3)(a) are subject to affirmative resolution procedure.(5) Otherwise, regulations under this section are subject to negative resolution procedure.”
Baroness Drake
Baroness Drake
My Lords, there are four key references to administration charges in this Bill: Clauses 12 and 27, the continuity and implementation strategies for addressing how members’ interests will be protected in a triggering event; Clause 33, the prohibition on increasing members’ charges during a triggering event period; and Clause 40, the statutory override power of any term of a relevant contract on administration charges.
The power of the Secretary of State and the regulator to demand information on, and intervene on, the level of administrative charges, is a key part of the armoury in this Bill for protecting members’ pots. Clause 38 gives a definition of administration charges: that it,
“has the meaning given by paragraph 1 of Schedule 18 to the Pensions Act 2014”.
That schedule relates to the power of the Secretary of State to prohibit or cap administrative charges, as illustrated by the 0.75% cap on charges, excluding transaction costs, on workplace pension scheme default investment funds. But there appears no explicit reference to transaction costs in the definition of administrative charges in paragraph 1 of Schedule 18 to the 2014 Act, and no explicit reference to transaction costs in Clause 38.
The purpose of this amendment is to make it clear that any reference to administration charges in this Bill can include transaction costs, so ensuring that the Secretary of State and the Pensions Regulator have the fullest powers of intervention needed to fully protect members’ charges in master trusts. The transaction costs are an important determinant of the net return into the saver’s pot.
In recent weeks, including since this Bill was introduced into the House, three reports have been published. One addressed disclosure of transaction costs and two provided sustained evidence of continuing dysfunction and weak competition in the pensions and asset management industry. On 5 October 2016, the FCA published a consultation paper proposing rules to improve the disclosure of transaction costs in workplace pensions. Given the potential for multiple parties to be involved in managing pension investments and for transaction costs to be incurred at different levels, the FCA considers it essential that any rules of disclosure,
“enable the flow of information to the governance bodies of those schemes”.
It proposes that all those managing investments should report administration charges and transaction costs to pension schemes and intends to publish its rules in the second quarter of 2017.
On 13 December, the DWP and FCA published their joint review of industry progress in remedying poor-value workplace pensions, following the 2013 OFT report that revealed that more than 333,000 members of workplace pension schemes were still suffering annual management charges in excess of 1%. The review also found that most providers had not fully reviewed the impact of transaction costs in their value-for-money assessments and had no immediate plans for such a fuller review. Providers using in-house investment management services were singled out for particular criticism.
In November, the FCA published its Asset Management Market Study interim report, which provided a hard-hitting critique of the “sustained, high profits” that the industry has earned from savers and pension funds over the years—fund management firms, which three in four British households rely upon to manage their pensions.
The remedies proposed by the FCA include requiring investment managers to adopt an all-inclusive single charge for everything; an up-front estimate of transaction costs; and raising the fiduciary bar for the general obligation to treat customers fairly to a new requirement to act in the best interests of investors. The report also contains a withering critique of “active management”. A recent article in the FT pulled together all the adjectives deployed by the FCA:
“Underperforming, overpaid, too profitable, too expensive, too opaque, too unaccountable and too conflicted”.
The report is quite extraordinary. It compares the net return on a £20,000 investment over 20 years to show the impact of charges. Assuming the same return before charges, in a typical low-cost, passive fund, an investor would earn £9,455 more on a £20,000 investment than an investor in a typical active fund. This figure rises to £14,439 once transaction costs have been taken into account. In an exquisite example of laconic drafting, the FCA reports:
“We find that there is no clear relationship between price and performance—the most expensive funds do not appear to perform better than other funds before or after costs”.
The report makes it clear that seemingly small differences in fees and transaction costs can lead to significant losses for investors over time but finds that more than half of ordinary investors are still unaware that they were paying fund charges, let alone what they are.
I hope that the Government will force a pace on transparency and act to control unfair fees and transaction costs incurred by people who are saving, often through their workplace pensions, and an increasing number through these master trusts. But insofar as the Bill addresses the authorisation, supervision and resolution regime for master trusts, this amendment makes it clear that any reference to administration charges in any provision in the Bill can include transaction charges, so ensuring that the Secretary of State and the Pensions Regulator have the fullest powers of intervention needed to protect members’ savings in master trusts, particularly during triggering event periods. I beg to move.
Lord Freud
My Lords, the effect of Amendment 25 would be to widen the definition of administration charges for the purposes of Part 1 of the Bill, so that it is capable of including transaction costs. It may be helpful if I explain that we considered the inclusion of transaction costs when developing this policy. We concluded that the provision that has been made in the Bill under Clause 33, including prohibiting an increase in administration charge levels after a triggering event, was sufficient to minimise the risks faced by savers in master trust schemes.
The term “administration charges” may prompt Peers to believe that the prohibition in Clause 33 applies to only a narrow range of costs and charges faced by members. This is not so. Among the charges intended to be caught by the administration charge definition are fees on set-up, entry, exit, and regular and ad hoc fees paid not only to administrators but also many fees paid to governance bodies, regulators, asset managers, investment consultants, lawyers, accountants, auditors, valuers, bankers, custody banks, platform providers and shareholder service providers.
In the majority of cases, trustees do not currently have access to information about transaction costs. Including them within the scope of the prohibition under Clause 33, therefore, would place many trustees in a difficult position. I can assure noble Lords that we acknowledge the need for improved transparency and understanding by trustees about the transaction costs which the members of their schemes will bear.
Noble Lords will remember that, during the passage of the Pensions Act 2014, my department accepted a legal duty to make regulations requiring that transaction costs would be given to members of occupational pension schemes and be published. The Financial Conduct Authority took similar duties with regard to workplace personal pensions at the same time. Again, I acknowledge and thank my noble friend Lord Lawson for his input into the process of developing that part of the Act. I appreciate that some Peers may be disappointed that we have not yet discharged that duty, but in mitigation I should explain that there has never been a single agreed definition of transaction costs nor a way of calculating them. We have made progress in defining transaction costs, but until recently we made less progress on a way of calculating them. This is because many transaction costs are not explicit costs which appear on a scheme’s balance sheet but implicit “frictional” costs from trading, which need to be calculated. The wide variety of approaches to calculating transaction costs are not simply disputes about the odd one-hundredth of a percent but quite significant differences in methodology, which can result in transaction costs differing by a factor of five.
We clearly need to ensure that trustees of occupational schemes and the independent governance committees of workplace personal pension providers have complete, consistent and standardised cost and charges information before they can report it to members; at this point, they do not. The key stepping stone to putting this information into the hands of trustees and independent governance committees was laid down when the Financial Conduct Authority published in October of this year a consultation on proposals requiring asset managers to disclose information about transaction costs to trustees, and a detailed methodology for calculating those costs. Following the outcome of the FCA’s consultation, we currently plan to consult on the publication and onward disclosure of costs and charges to members in 2017. In conclusion on this point, I can assure Peers that we remain wholly committed to discharging this duty in the course of this Parliament. We want pension scheme members to have sight of all costs and charges, regardless of how they are incurred, and to give members the confidence that there are no other hidden costs and charges.
The noble Baroness, Lady Drake, made us aware of the interim findings of the FCA’s Asset Management Market Study, published last month, which found weak competition in the market and proposed remedies through the introduction of an all-in charge and standardised disclosures to all investors. These are timely findings, because noble Lords may also be aware that the Government announced this month that they would be examining the level of the 0.75% charge cap on administration charges in the default funds of schemes used for automatic enrolment and whether some or all transaction costs should be covered by the cap. This work will be undertaken in 2017 as part of the review of automatic enrolment. It will involve comprehensive engagement with a wide range of stakeholders, including asset managers, which will be important given the potentially complex nature of transaction costs. The outcome of the 2017 exercise will help to determine whether there is a need to amend the definition of administration charges in Schedule 18 to the Pensions Act 2014, and at that point we will consider whether we should also cover transaction costs in the master trust legislation.
I reassure noble Lords that in practice we do not believe that transaction costs are a loophole that will be exploited to drive up charges to the detriment of members. Noble Lords will be aware that the vast majority of defined contribution pension schemes, including master trusts, are invested via investment platforms in pooled funds in which the trustees of the scheme will be just one among many investors. Given this pooled and intermediated nature of pension fund investments, it is highly unlikely that a triggering event experienced by just one of the investors in the fund would drive up the ongoing transaction costs from remaining invested in the fund. Taking these points into account, it does not appear necessary to bring transaction costs into the charge prohibition measure in the Bill.
Before I conclude, I ought to acknowledge that this is the last time I will stand before your Lordships on a Bill as a DWP Minister, although it is not quite my last appearance in the role, because we will have some fun on Wednesday discussing universal credit—I hope we will. On Third Reading in the new year, and when the Bill potentially returns to the House for further consideration after it has been looked at by the Commons, I will be leaving your Lordships in the very capable hands of my noble friend Lord Young—the junior member of the Freud/“Jung” combo. I thank him for all the support and time he has given me, and I am sure that noble Lords will continue to afford him the same courtesy and patience that has been displayed thus far.
Lord McKenzie of Luton
My Lords, perhaps I may take the opportunity from these Benches to place on record our thanks to the noble Lord, Lord Freud, for the engagement that we have had on pensions Bills and other Bills over many years. That engagement has always focused on data and evidence. We might have disagreed about their interpretation from time to time but the debates have always been robust. The noble Lord has been assiduous in engaging with Members across the piece, making sure that their points and concerns have been addressed and not just brushed aside.
We will have the chance to say something to the Bill team on another occasion—I hope some of us will still be here at Third Reading—and we will have another debate on Wednesday. However, we wish the noble Lord well in his retirement. I am not sure whether it will be his retirement, as I am sure he will go off to do something intellectual. We look forward to working with the noble Lord, Lord Young, in the future, but from the Labour Benches we express our best wishes to the noble Lord, Lord Freud.
Baroness Bakewell of Hardington Mandeville
My Lords, I wish to associate myself and our Benches with the comments that have already been made. We have always found the noble Lord, Lord Freud, extremely accommodating towards us as far as he has able to be so, and I will have something further to say when we come to universal credit. I have taken over this role only fairly recently but I thank the noble Lord for all the help he has given us during the passage of this Bill.
Baroness Drake
I thank the Minister for his reply. It is helpful to have his wider statement on the record because this issue of transaction costs is still very controversial. I hope that the FCA’s report increases the Government’s sense of urgency regarding the need to address this issue and to introduce regulation—notwithstanding problems with definition—with master trust regulation benefiting from that as well.
Perhaps I, too, may take the opportunity to make a personal comment because I think this is the last time that I will be talking to the Minister in his current role, although he may not be talking to me at all following the vote. When he was at the Dispatch Box, I always felt that if I had a good argument, argued it well and had a good evidential base, I had a fighting chance that, first, he would listen and, secondly, that he would see whether it was possible to accommodate my concerns. He often made me do my homework and made me work hard on occasions, but that was a fair exchange. However, if I had a good point and good evidence, I knew I would get a fair hearing. That is important in this House. It incentivises one to pursue the argument and the case because one knows that one will get a fair hearing. The Minister is a wonderful example of someone who will listen and consider the arguments.
He has always been friendly, courteous and considerate in giving access to his civil servants and information—very often so that I can improve my knowledge base and not ask awkward questions; on other occasions to fuel my knowledge base to allow me to ask awkward questions. Either way, I was grateful for that.
I hope he takes some rest and has fun—he has worked very hard and deserves some fun—and that we see him back soon, bringing his intellectual skills to the House. I thank him for the statement on charges. I shall still push on transaction charges because millions of people get a rough deal but do not know they are getting a rough deal, which is even worse. I beg leave to withdraw my amendment.