If you read nothing else, read this … Defined contribution schemes may face claims from disgruntled members. Be wary of lifestyle funds, they will not fit all. Employers should regularly review not only the performance of existing funds, but the range available and any omissions. Income levels on conversion to an annuity must be realistic when shown in promotional material.
Article in full Employee litigation is increasing, especially in cases that involve multiple plaintiffs. Nowhere is an employer’s potential liability more difficult to predict than in the pensions arena, where hardship giving rise to a complaint, will usually emerge long after the decision that originally caused it. At its simplest, an employer might set up a defined contribution (DC) scheme with a life company whose managed fund boasts a solid record. But a fund’s performance may deteriorate quickly for a variety of reasons. Problems could arise when an employee subsequently discovers their pension has been invested in a dud, and becomes aware of the enormous disparity between top funds and laggards. One of the biggest problems will be default options that subsequently prove inappropriate for a member. Many default options are lifestyle funds, which automatically rebalance the asset allocation from a high proportion in equities at younger ages into bonds as members approach retirement. The purpose of this is to lock in any earlier gains. But, either through poor health or redundancy, most members will not make it to 65, and may retire when their fund is still heavily invested in equities. If at that time stock markets are bearish, their fund will be liquidated at a low value. Bob Scott, partner at actuarial firm Lane Clark & Peacock, says: “[Some] 90% of members will be in default options which are promoted as being safe. But they may not adequately cover the risks they set out to protect, while the member is giving up a chance to share in any equity outperformance.” While offering a multitude of fund choices could easily confuse members, employers might be at risk if they fail to offer a specific fund based on a certain asset class which then goes on to be a winning sector. The other thorny area is the conversion of the fund into an annuity. As mortality increases, many employees will be disappointed with their level of income in retirement. An employer’s best defence is to constantly monitor the situation, reviewing the pension provider on a quarterly basis, switching to a new provider if needs be, and ensuring that all literature is realistic about expectations. Terminating the original provider once a fund has nosedived is not always the best solution. While this might appear the most responsible action, it leaves members switching out of funds at their lowest ebb and buying into others at their peak. Wholesale switching would also place undue emphasis on short-term gains, encouraging the uptake of higher risk funds. Ken Murphy, director at IFA firm Bestinvest, points out that the adoption of DC will grow and cases will spread from the US: “Even where there is no case to answer, such claims take up management time, legal costs and there is a reputational risk, which spins out into other areas.”