Video: Regulatory changes for pension schemes | Insight Investment

Good morning.

My name is Joanna Harley. I tend to look after our pooled fund offering at Insight, but today I've been asked to give an update on regulations in the pension sphere.

I would like to start my presentation with a slide showing how there is no universal answer to how to invest pension assets.

On the left hand side, we demonstrate the allocation of private sector DB schemes. These are closed, quite mature, well-funded, and obviously the pension promises made are guaranteed in nature. Hence, we see a fairly low risk investment approach adopted. It's also a fairly liquid investment strategy to keep the door open for DB schemes to potentially liquidate and transfer to an insurer.

If we move along to the right, we see how insurers invest both private and bulk annuity assets. Again, a pretty low risk approach, but you'll see the greater allocation to alternative illiquid type investments reflecting the fact that insurers are comfortable that the liabilities they've adopted are fairly long-term in nature and they can make long-term investments to back them. They don't have any interim liquidity needs.

To the right of that, we've got public sector DB schemes, which tend to still be opened new accruals and hence the upside of taking investment risk has obvious, uh, meaningful benefits as future contributions may be able to be scaled back if the investment risk, uh, uh, proves positive.

Finally, on the right hand side, we have DB schemes, both workplace and individuals such as SIPS and, and private pensions where investment risk is adopted because the upside of such risk has a direct positive benefit to individuals.

So the way in which different types of pension schemes are invested reflects regulations and the nature of the pension promises made it's worth keeping an eye on regulations and, and changes being introduced in the UK pension bill is therefore what I'll be covering over the next 15 minutes or so.

Before I go there, I thought it might be worth just taking one minute to highlight changes in the Dutch market, which might give us a different reference point from which to consider changes in the uk.

So in Holland, DB schemes are currently being unwound members and assets are being moved into DC structures similar to a big kind of transfer out, but done at a, at a national level. Um, this is due to take place, uh, between January, 2026 and January, 2028. So it's a quite a live issue ahead of that change. Uh, there is even more pressure on DB schemes to maintain their current funding levels, uh, and therefore, uh, hedge e even more of their risks.

However, once that transfer into DC takes place, there is an expectation that assets will be reorganized to reflect the new pressures and incentives Dominant in, in a DC framework, and we'll generally see a re risking of assets, um, effectively moving from the left hand side of this slide to the right hand side.

So that's a huge change in pensions in the Dutch market. Uh, we don't expect such, uh, big changes in the uk, um, but the pensions bill will have significant impact.

So looking at the UK pensions bill, um, it covers, uh, three main areas. Uh, the first looks at local government pension schemes, LGPS, um, and also more widely, uh, across all DB schemes, the power to pay surplus.

The second part relates to DC pensions and the third to super funds motivations common, uh, across all parts of the bill are fewer schemes IE consolidation, increased investment in the uk where possible and better outcomes for savers.

We thought it might be a very useful to give a very brief summary of each element of the pension bill, uh, just so that, uh, you are have an understanding of the changes coming, uh, to the UK over the next few years.

Firstly, local government pension schemes. LGPS. There are currently 86 LGPS in England with about 7 million members, 400 billion of assets over the last decade. There's been a government push towards pooling of those, uh, schemes, and there are currently eight pools that manage about 75% of the LGPS assets.

However, the government has kind of run outta patients and and now wants a hundred percent of assets managed by the pools by March next year. It also wants less pools, um, I consolidation. And so from the current eight pools going forward, there will only be six. Two of them are closing access and Brunell, which used to manage about a billion of assets. So, so those assets are being redistributed. Uh, amongst the other pools, uh, the main beneficiaries of that being border to Coast Central and LPPI, so from March, 2026, all LGBS schemes must take their principal investment advice from the pools.

They must delegate to the pools, the implementation of their investment strategy and transfer all assets to the management of those pools. Those pools can either then use third party, uh, managers, or in fact they will be FCA registered investment managers themselves. And so they may increasingly over time take on more, uh, asset management in-house.

The other element of the pension bill, uh, with respect to LGPS reflects the view, um, of the government that these are quasi kind of mini sovereign wealth funds, um, which can be directed, uh, to certain types of investments, uh, and particular supporting uk.

So the second element of the LGBS part of the pension bill is to mandate the requirement for LGBS to set out an approach to local investment and work to identify suitable opportunities such as clean energy infrastructure, affordable housing, SME financing, et cetera.

Finally, on this slide I've put the future and I've mentioned reform. This isn't a party political broadcast. Um, this, uh, simply reflects current polling where current expectation for the next government suggests either a Hong Parliament or a majority reform government, um, which would be the new, kind of the first time a non-conservative or non-labor LED party had been in charge in over a hundred years, and therefore we can expect greater changes than, than with previous, um, general elections.

So it's worth keeping an eye on what they're saying. And with respect to LGPS, um, two themes really. One is, is less, uh, support of of ESG type investments. They call them ESG obsessed investments, um, and support of further consolidation and centralization that, that last word centralization. Uh, possibly leaning more to, uh, that view, uh, that LGPS schemes can be seen as quasi, um, sovereign wealth funds.

So quite a lot of change going on, uh, in the LGPS sector, particularly ahead of March, 2026.

Moving on, uh, still within part one of the pension bills still within DB schemes, um, but turning more generally to DB schemes. Um, the main change, uh, within the pension bill is the ability to release surplus whilst running on at the moment.

If your pension scheme was to generate a surplus versus a long-term valuation basis, let's say of gilts plus a half, the majority of schemes would currently consider transferring that surplus to insurers, in effect, paying the premium necessary necessary to meet a buyout price.

Um, and the payment of that surplus to insurers is effectively in exchange for the insurer taking on the responsibility and the underwriting of those pensions.

Spending surplus in this way also transfers the opportunity for further surplus generation to the insurers 'cause they are the ones that will then end up with the asset base, uh, which can then be invested in a productive manner.

Changing the pensions bill introduces the option for schemes to instead choose to share the surplus, uh, to the benefit of both sponsor and members and critically continue to retain the assets and hence the opportunity for further future surplus generation and distribution to sponsor and potentially members.

It's almost a rinse and repeat cycle where any further, uh, surplus generation would then be distributed again to the benefit of sponsor and members. Uh, and that can be, uh, repeated several times.

Uh, this is in my opinion exactly as it should be. Uh, the benefits should be shared with the sponsor who effectively has spent years underwriting pension promises with no real upside. Um, and also the benefits should be shared with members so that trustees can aim for pension improvements such as discretionary inflation uplifts where they are not already baked into the promises.

So hopefully this will change a pension scheme, um, to no longer just be seen as a potential liability to be seen as an asset from which both sponsors and members can benefit. Um, with prudent risk taking.

I say prudent risk taking on the investment strategy rise. Um, if you are running on, uh, what's most likely there, well, risks that are still seen as unrewarded risks should continue to be hedged. Um, but risks that people or trustees think are worth running can then be run in a prudent manner to gently generate surplus through time.

If we consider one option for your pension scheme, uh, opting for buyout, effectively buying out those pensions on a gilts flat basis versus the other option of choosing to run on for let's say 10 years, applying a gilts plus one Strat type of investment strategy at 1% with very crude maths over a 10 year period, that would generate a 10% surplus.

Now this is 10% on the total scheme assets. That is a really significant number, and it's that number that can then be shared between the sponsor and members and potentially, as you mentioned, follow that rinse and repeat cycle.

We don't necessarily mean running on forever if, if trustees opt for a run on, um, but similar to the example given it means just not opting for buyout immediately or as soon as possible, uh, maybe opting for a run on period for another five or 10 years and then reviewing once again, uh, this kind of outcome.

Um, if it has the intended, uh, effect would support the UK government's aims that any surplus release immediately that surplus that's released back to the sponsor company, um, would, uh, primarily feedback into UK companies for immediate investment, uh, in further growth.

Um, and any sharing of the surplus with members would meet that other, um, aim of, uh, the government to improve member benefits, potentially, as I said, giving some inflation protection where that is not already the case.

Turning to part two of the pensions bill and DC investments, DC assets now amount to about A trillion, um, of assets split equally between individual or retail savings through SIPS and, and personal pensions and workplace savings.

DC is well supported by auto enrollment, which has been in place in the UK since 2012, um, and continues to support DC savings as 8% of qualifying earnings are auto automatically moved on behalf of employees into their pension DC pots.

Notably at retirement. As shown on the right hand side of this slide, the split of assets is quite interesting. There's still a large amount held in annuities, um, because before 2014 and before pension freedoms, all retirement assets had to be invested in annuities.

Since then, you may have expected a more even split of assets between kind of retail drawdown and a workplace, uh, in scheme drawdown, but that is not the case at the moment at retirement. Almost all assets move outta the workplace schemes into private frameworks.

An interesting global comparison here is, is a reference to Australia. Australia is about 20 years ahead of us in, in their DC frameworks. They, they started auto enrollment in 1992. They started auto enrollment with a contribution rate of about 3%, but in April this year, finally, um, they have achieved their long-term target.

Those contribution rates have been slowly increasing and they have now reached the long-term target of 12% of all earnings. So something to, um, uh, compare the the UK to.

The other interesting thing about Australia pension environment is that the state pension is means tested and hence support of DC savings mean that more and more pensioners, uh, when they reach, uh, pension age are to mean tested basis, no longer need full state pension support because they've got their DC savings in place.

And actually by 2035, Australia is forecast to have one of the lowest, uh, spend rates on public pensions in any of the 38 OECD countries. And that's because of the means testing, but also because they have been supporting effectively individual savings for pensions and hence less reliance on the state.

I don't think any of the UK political parties are quite ready to move to means tested pensions given that, uh, means tested. Uh, winter fuel allowances, uh, kind of didn't go down that well, but it's something that cannot go unnoticed by European politicians trying To balance their budgets. Um, the, the situation, the very positive situation that Australia finds itself in.

So we may not be in a position to replicate everything, uh, of the Australian model, but there are continued elements of it that, that we adopt. And in the pensions bill, one of those, um, is a focus on value IE performance, not just fees paid, but the overall performance generated by any DC provider.

The aim is to review underperformance and potentially use that to drive, uh, consolidation as assets move from underperforming providers to higher performing providers, um, and also provide obviously, a better outcome for savers.

So that focus on, on performance is one thing. However, further to that more, more subtle approach, there is also mandated consolidation for multi-employer schemes. IE master trusts. They must be 25 billion in size by 2030 or have plans in place to get there.

The other element of consolidation is the requirement for workplace DC schemes to offer default retirement pathways, and that will prevent what I previously mentioned where most assets shift out of, um, into the retail universe. Um, whereas this change, uh, is hoped that more assets will stay managed in scheme, uh, even in retirement, um, and in scheme managed on a consolidated basis.

There's also an increased commitment from DC uh, funds to invest in UK assets where you can discuss over launch are varying views on, on how much the government should get involved in, uh, asset allocation. Uh, but that is, is factual at the moment in terms of the future.

On the DC side, it's an area of continued evolution. Uh, the pensions bill is not the end of changes on the DC side, there's an adequacy review coming up, um, as to whether eight 8% is, is enough, um, potentially a political issue there given, uh, changes to minimum wages and national insurance as in yet another increase to employers, uh, will probably not, uh, go down. Well.

Um, further to that reviews on CDC. So CDC is collective defined contribution. It's not db, um, because the pensions are not guaranteed. So the outcomes are a bit more variable, but it is not variable to the extent based purely on your own individual experience.

It's variable with some of the risks involved, shared amongst a wider membership, um, for example, uh, investment risk, uh, but also longevity risk.

Finally, on super funds, uh, part three of the pensions bill. Um, these are vehicles that allow employees, employers to transfer pension liabilities and break the legal link link to the parent company a bit like, uh, buyout, but they tend to be cheaper than buyouts.

Um, and in exchange for the underwriting, uh, of the pensions being provided by the super fund, the super fund then retains the benefits of any surplus generation.

Clara is the only active fund at the moment with four schemes transferred into it since 2023. Uh, about 1.4 billion of assets, but there's a pipeline there of another 5 billion.

Clara operates as a bridge to buyout model. Um, so buying out as soon as it's affordable to do so, um, regulation that needn't necessarily be the case for, for other super funds. But regulations of super funds are, are still in their infancy, um, and the pensions bill aims to provide more clarity and as such, encourage new entrants into the market.

We understand this is working, um, and there are four potential new providers, uh, two in the late stages of authorization.

So there's a lot going on, uh, in the pension sphere. Um, we welcome discussing any of this, uh, with you as it may prove helpful.

Um, historically, K db schemes have looked to buyout as soon as possible. The surplus versus technical provisions effectively being directed to the insurer in return for that insurer providing the underwriting, uh, to the pensions.

Changes in the pensions bill may mean the pension schemes are no longer seen purely as a liability. They may be seen more than an asset and they may choose to run on such that surplus can be extracted on an ongoing basis for the benefit of sponsors and members.

Another alternative to buyout would be the Superfund model, where the surplus is effectively paid to the capital backers of the super fund, in effect for them underwriting the pensions that they've taken on.

Finally, as the pension bill goes through, parliament and other reviews are kicked off. Fundamentally, we expect to continue to see regulations supportive of the consolidation and the desire for uk uh, for increased UK investment as these appear to be goals common to all political parties.

Thank you. I hope something in the last 15 minutes has given you pause for thought, um, and welcome any questions.