Defined contribution reforms incoming, promises UK government

Jeremy Hunt makes the pilgrimage to the City, promising to ‘unlock’ pension cash to battle cost-of-living and reinvest in the UK.

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Jeremy Hunt's visit to Mansion House has received mixed reaction from financial services commentators.

Jeremy Hunt, the UK's Chancellor of the Exchequer, said in his speech to a group of assorted senior figures in finance at his Mansion House speech last night that he will reform pensions.

Hunt’s speech is an annual tradition by the UK government’s financial head to the City of London that aims to outline concerns and plans in the financial services industry at Mansion House, the Lord Mayor’s residence.

The reforms promised by Hunt were to “unlock up to £75 billion of additional investment from defined contribution (DC) and local government pensions”, and would support the Prime Minister’s priority of growing the economy and “delivering benefits to pensions savers”.

Issues commonly impacting DC scheme investment strategies have long been a target for regulatory reform.

“The UK has the largest pension market in Europe, worth over £2.5 trillion,” said Hunt, whose government under PM Rishi Sunak has been keen to exorcise any remnants of Liz Truss and Kwasi Kwarteng’s infamous mini-budget last September and keep the City close. “[The pension market] plays a critical role in providing safe retirement income as part of the social contract between generations,” said Hunt.

“More effective investments by DC pension schemes will
also increase savers’ pension pots by up to 12%."

Hunt’s promised reforms included an agreement between nine of the UK’s largest DC pension providers, which included a commitment to allocating 5% of assets in their default funds to unlisted equities by 2030. “These providers represent over £400 billion in assets and the majority of the UK’s DC workplace pensions market,” the government’s press release on Hunt’s speech said.

The release added that this measure could reveal up to £50 billion of investment in high growth companies by 2030 if all UK DC pension schemes follow suit. “More effective investments by DC pension schemes will also increase savers’ pension pots by up to 12%, or as much as £16,000 for an average earner,” it said.

A consultation will also be launched with the Local Government Pension Schemes on setting an ambition to double existing investments in private equity to 10%, which could provide £25 billion by 2030. “A new call for evidence will also launch tomorrow on the possible role of the Pension Protection Fund and the part Defined Benefit schemes could play in productive investment whilst securing members’ interests and protecting the sound functioning and effectiveness of the gilt market," said the release.

Market reaction

The investment community had a largely positive reaction to the speech.

"[We welcome] the increasing focus on the importance of getting investment right in the UK pension system, whether that be through DB schemes, DC, or variations of the two," said Chris Cummings, Chief Executive of the Investment Association (IA). “For DC, an important first step is to reframe the value discussion to focus on long-term returns for savers. The new Long-Term Asset Fund (LTAF) is designed in part to facilitate this, by providing both DC pension savers and retail investors with wider access to private market.”

The IA also said that these reforms would improve the gilt market, ensuring UK government debt remains attractive to domestic and international investors.  

However, other areas had more mixed views.

“UK pension funds have been winding down allocations to UK companies for years, if not decades, turning away from risky equity bets in favour of reliable government bonds that can be matched up with future pension payments,” said Nicholas Hyett, Investment Analyst at retail investment consultancy Wealth Club. “There are lots of perfectly sensible reasons for that. Firstly, most defined benefit pension funds are now shut to new members, and their remaining members are either in retirement or soon will be.”

Hyett added that with more short-term liabilities and fewer liabilities out in the distant future, funds would not be able to afford to take the same level of risk. “Secondly there’s the move towards 'liability driven investment', where a pension fund's liabilities are matched specifically to future government bond payments,” he said.

“What will be the liquidity, valuation, cost differences and
implications to pension fund members?"

“This was meant to reduce risk, and while the panic after the mini-budget last autumn proved that nothing in investments is a sure bet, there is some genuine logic to matching liabilities where you can. Forcing pension funds to abandon bond investments in favour of substantially increased risk would be a mistake, in our view,” he added.

Chris Smith, Investment Manager, UK Equities, Jupiter Asset Management said it was unrealistic to expect the reforms announced to make a meaningful difference to growth or investment in the UK in the short term and there is still a lot of questions to answer. “How are ‘UK growth assets’ defined?" he asked. "What does a ‘voluntary expression of intent’ mean? What will be the liquidity, valuation, cost differences and implications to pension fund members being asked to invest in unlisted assets? Is there enough in the way of high quality, unlisted investment opportunities in the UK for an additional £75 billion of investment?”

Inflation still a priority

Hunt also addressed the cost-of-living crisis that is affecting the UK and said regulatory and government controls were being used effectively to ease pressures for working households. “With the levers of fiscal and monetary policy, wholesale food and energy prices falling and a government that has made the battle against inflation its number one priority, there is nothing insurmountable in the current situation,” he continued.

"There can be no sustainable growth without eliminating the
inflation that deters investment and erodes consumer confidence."

“Working with the [Bank of England], we will do what is necessary for as long as necessary to tackle inflation persistence and bring it back to the 2% target,” he said, a comment that could fuel tensions between certain sectors that believe capping inflation would send the UK into a recession.

“Delivering sound money is our number one focus. That means taking responsible decisions on public finances. It means recognising that bringing down inflation puts more money into people’s pockets than any tax cut,” Hunt added. This point was further complicated by the UK seeing the joint highest wage growth since modern records began in 2001. “And it means recognising that there can be no sustainable growth without eliminating the inflation that deters investment and erodes consumer confidence,” he also said.

The cost-of-living crisis – rising energy prices, slower real wage growth, and the proportion of wages set by collective bargaining – and the protest intensity in 2022, as well as the first quarter of 2023, were fuelling “political turmoil” and propelling it to the country's number one concern, according to the July Political Risk Index report released by broker WTW.

WTW’s report said that, in 2023, intense cost-of-living protests struck hardest in developed and wealthier emerging markets.

The continued pressure between governments and central banks has been felt worldwide over the course of the high inflation period that began in the wake of the post-pandemic reopening. US Federal Reserve Chair, Jerome Powell, has also had several battles to convince US business and government to accept the Fed's medicine.

What does this all mean for insurers and their investment teams?

There are two key takeaways for insurers.

The first is the government’s use of the ‘unlocked capital’ for widespread investment back into the country – possibly aimed at its levelling up fund and other equity projects to tackle social cohesion and the lack of productivity in certain areas of the country.

In their view of the reforms, law firm Linklaters, said that “numerous commentators and press articles have recently pointed out the gradual shift of DB pension fund portfolios out of equities and into bonds over the past decades, and the resulting loss of potential investment capital.” This issue, it said, could be tackled by the new reforms.

Others also saw issues with the proposed reforms in terms of the government's own longevity and its commitment to following through. "With the economic environment becoming more challenging, the need for UK schemes to pursue greater diversification is pressing," said Melville Rodrigues, Head of Advisory – Real Assets, Apex Group. "UK pension schemes are lagging behind other developed economies in the context of investing in alternatives – that is, longer-term, less liquid assets such as real estate, infrastructure, private equity and venture capital."

This means the government could continue to tinker with the reforms until it feels it gets the results it wants.

"Savvy investors can get ahead by recognising
the secular trend in yields is upward."

The second key takeaway is that, come hell or high water, the central bank – backed by the government – will for now continue on its path to curb inflation. Depending on the kind of investments an insurer makes this is of varying concern, but it does show what the UK’s overall economic picture will look like for at least the next year or two.

"Looking beyond the current government [that] have been so involved in the deterioration of the UK supply-side, one might become more optimistic that the fiscal re-direction might begin to play out," said Freya Beamish, Chief Economist at TS Lombard, a member of Global Data.

"Markets are never going to vote for that as it implies higher yields and the death of passive investing, but savvy investors can get ahead of that by recognising the secular trend in yields is upward and gaining exposure to the real economy, tangibles and capital good – just not right now."