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UK Pension Reforms: A New Horizon Awaits
Jul 26, 2024
Landmark review can unlock billions of pounds of capital to support economic reforms.
- Proposals could accelerate consolidation in the fragmented pensions sector
- Resulting investing giants will enjoy lower costs, greater investment capacity
- Allocations to alternative assets could drive investments into growth sectors
Planned UK pension reforms have the potential to transform the fragmented landscape of its £2 trillion ($2.5 trillion) pension fund sector and enable billions of pounds of capital to boost growth in the struggling economy.
Pension reform was outlined as part of Prime Minister Keir Starmer’s legislative agenda during the King’s Speech last week, and Chancellor Rachel Reeves has kicked off a landmark pensions review as part of the Government’s mission to “boost growth and make every part of Britain better off.”1
Pension reforms are widely seen as key to revitalise the country’s sluggish capital markets. The UK pension industry is the third biggest in the world, after the United States and Japan, according to a 2024 study by the Thinking Ahead Institute.2
A key objective of the Pension Schemes Bill is to drive consolidation within the corporate Defined Benefit (DB) sector, through the use of Superfunds. Defined Benefit schemes currently hold around £1.4 trillion in assets across around 5,000 pension schemes.3
The pensions review will initially focus on the Local Government Pension Scheme (LGPS) and defined contribution (DC) schemes. While the 87 funds within the LGPS have made progress in merging their investment operations into 8 pools in recent years, the Government is keen on further consolidation. In aggregate, the £360 billion scheme is the seventh largest pension fund in the world, but fragmentation means that the £2 billion that it incurs in fees annually could be reduced.
For DC schemes, member outcomes are the primary focus within the Bill – it will include a value for money framework and insist on DC schemes providing members with retirement income options. The Chancellor plans to unlock billions of pounds of investment in the UK economy from DC schemes, and believes that pension pots for savers in DC schemes could in this way be boosted by over £11,000.3
The next phase of the review starting later this year will consider further steps to improve pension outcomes, increase investment in UK markets, and assess retirement adequacy.
The resulting consolidation - where £148 billion is held across 1,080 DC trusts, according to government data - will hope to mirror Australia’s 2021 introduction of a value for money test within its ‘Your Future, Your Super’ reform package, a move which has helped drive consolidation in its superannuation sector.
Pension industry consolidation is broadly in line with trends seen in other major developed markets. Official data shows that the number of Swiss Pension Plans has declined by 40% over the past decade. Similarly, the number of Dutch Pension funds have declined over 80% since 1997, according to industry data.
A shift in allocations
Equity allocations shift from public to private markets as plans increase in size
Source: PPF Purple Book 2023, figures 3.12 and 7.9. PGIM IAS Calculations.
Economies of Scale
The resulting bigger pools of investment capital have the capabilities to invest beyond traditional asset classes such as publicly listed stocks and debt. Bigger investment pools benefit from economies of scale as they spread fixed costs across a wider base and exert greater bargaining power, but this is only part of the story.
Larger investors can afford more sophisticated governance arrangements. These provide the capacity to invest in private markets and to engage with market participants to structure transactions that meet their investing objectives. Scale opens the door to investing in asset classes that can provide differentiated sources of return, such as direct lending or infrastructure projects.
In recent years, media headlines have focused on the diminishing footprint of UK pension funds in the public markets. Allocations to UK public equities by domestic defined benefit plans has fallen to 23% of plan assets by 2023 compared to 81% in 1993, according to official data.
But a likely welcome development from policymakers’ perspective is that larger pension pools will lead to greater participation in private markets. Institutional investments into private assets can help the government’s objectives of attracting longer-term capital into the broader economy to fund some key economic projects, such as the green energy transition, for example.
The Universities Superannuation Scheme (USS) - the UK’s largest private sector pension plan – reports that it invests £28 billion in private UK markets, representing 46% of the plan’s private market sleeve.4
Potential increased demand for UK assets and projects needs to be matched with adequate supply of suitably structured projects. Measures have already been announced to fix the planning system and to create of a new National Wealth Fund.
Incentivising the creation of large superfunds in the pension industry could also boost overall returns net of fees, despite the potential for these large pools to pivot towards allocations which typically involve higher costs than public markets.
One thing is for sure, the review represents a major opportunity to provide a starring role for the UK pensions sector in the country’s economic growth over the next few decades.
Stuart Jarvis
Managing Director, Institutional Advisory & Solutions, PGIM
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- https://www.gov.uk/government/news/chancellor-vows-big-bang-on-growth-to-boost-investment-and-savings
- Global Pension Assets Study, 2024. Thinking Ahead Institute.
- FINAL - 17/07/24 King's Speech 2024 background briefing final GOV.uk.docx (publishing.service.gov.uk)
- https://www.uss.co.uk/how-we-invest/where-we-invest/private-market-investments
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