Political parties of all persuasions are convinced that defined contribution (DC) workplace pension schemes are often poor value for money and are run with insufficient thought about members’ needs.
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- Pension providers will have to set up independent committees to monitor their investment and administration activities from April 2015.
- This is an imperfect solution because the committees will not be able to take account of every employer’s scheme.
- There is also scepticism about what changes can be forced through in practice.
Last year, an Office of Fair Trading (OFT) investigation confirmed these weaknesses and called for an immediate improvement in governance, particularly as more employees are now joining DC schemes through auto-enrolment.
The Association of British Insurers (ABI) responded by promising that its members would set up independent governance committees (IGCs) by July 2014, and the Department for Work and Pensions (DWP) announced in March that it would make this a legal requirement from April 2015.
The DWP’s command paper Better workplace pensions: Further measures for savers sets out the initial framework for IGCs, which will be responsible for ongoing monitoring of schemes’ investment structure, value for money and administration, with the power to recommend changes to providers.
A key feature of governance committees is their independence, because they must contain at least seven directors, at least half of whom must be independent. Any recommendation they make must be looked at by the pension provider, which will have a comply-or-explain duty to take action. If that fails, the committees will be able to take any issues to the regulator and go public with their concerns.
However, only one committee will convene for each provider pension arrangement, but each provider’s pension arrangement can cover thousands of subsidiary employer schemes, so decisions will have to be made at the most general level.
Different impacts on different employers
Roger Breeden, partner at Mercer, says: “Decisions will have different impacts on different employers because the schemes will be configured differently. For example, some will be bundled and some standard, and they will have different charging structures. The committees will therefore have to look at it from a macro level and agree how to segment the portfolio.”
Default funds are a particular concern. Paul Black, head of DC investment at Lane, Clark and Peacock, says: “We think it will be very difficult for provider-led committees to look after the interests of all schemes. Most providers have a small range of in-house default investment strategies, so we expect that provider-led committees are likely to focus their attention primarily on these strategies.
“However, many employers have set up alternative default strategies that generally use a wider range of funds, often more externally managed funds. We anticipate that these employers will continue to monitor them using their own governance committees.”
Also, although some schemes are structured so that the default funds can be changed unilaterally by the employer or trustees, others are structured so that any switch in default arrangements requires individual members’ permission. Ian McQuade, client director at governance and administration consultancy Muse Advisory, says: “The IGC will look at old funds closed to new money which have underperformed the market for years and will have to work out what to do if they have no power to make changes without members’ permission. This is a big issue that needs to be addressed.”
Budget brings new dilemma
The 2014 Budget also introduced a new dilemma because many pension scheme members will opt to take their entire pots in cash instead of an annuity or drawdown, which calls for a different style of investment than the currently prevalent lifestyle funds, which progressively move to 75% bonds and 25% cash at the point of retirement.
Will Aitken, senior consultant at Towers Watson, says: “We know that, by and large, members will not choose new funds themselves, so the committee will need to do it for them. For example, members with funds under £30,000 will probably want to take it all in cash and will therefore need to be in a fund that moves fully to cash. The committee will need to agree some scientific basis on how to handle this, but it would be untenable for no decision to be taken.”
There is also scepticism about how independent the IGCs will really be because they will be paid for by the provider and will recommend their findings to managers who are bound to act in shareholders’ interests. In fact, the OFT’s original report was sceptical of governance committees run by providers.
In practice, if a scheme is failing to perform in investment or administrative terms, it is hard to imagine that it would be switched to another provider. However, experts generally think that visible and public reporting will provide some protection, along with peer pressure between the independent board members.
Best value for members
Rona Train, senior investment consultant at Hymans Robertson, says: “The committees will be independent and have a real responsibility to provide best value for members and part of that is looking at the funds available to see whether they offer best value, with an implicit requirement to look across all funds.
“However, it will remain good practice for employers to set up their own governance committees, because the provider-sponsored committees will focus on the product, rather than the wider employee benefits brief, such as contribution rates, benefit adequacy, and what kind of outcomes members can expect.
“A good pension governance strategy should set clear objectives. Some employers may want to work through The Pensions Regulator’s 31 quality features and embed these into the scheme. There also needs to be a good working relationship with the employer to ensure it understands the implications of its policies, such as the impact of contribution rates on the level of benefits.”
The introduction of IGCs will be just the first step in a long journey to minimise member disappointment with DC scheme benefits, which, since the advent of auto-enrolment, may be seen as government-mandated. If pension scheme outcomes fall short of members’ expectations, many employees will not be able to afford to retire when they had planned, which will have implications for their employers.
What will independent governance committees look like and what will they cover?
The Department for Work and Pensions proposes that IGCs should consider:
- The value for money of schemes on an ongoing basis, including whether the default investment strategies are designed in the interests of members, with a clear statement of aims, objectives and structure and how these are appropriate for members.
- Whether core scheme financial transactions are processed promptly and accurately.
- The level of charges borne by members and the costs incurred through investing assets.
If a problem is identified, a proposed action will be reported to the pension provider’s board. If it fails to act in a way that satisfies the committee, the committee has the power to make the matter public, inform employees and the employer, and escalate the matter to the relevant regulator.
IGCs will be made compulsory under Financial Conduct Authority (FCA) rules. Later in the year, the FCA will consult on issues such as whether smaller employers may instead be allowed to employ an independent governing person or organisation, and whether an explicit FCA rule is required to ensure providers can show evidence that they have given due consideration at an appropriate level of seniority to any recommendations made.
Where there are reasonable barriers, for example additional costs such as switching fees, the provider will have to explain why it is not feasible to implement the recommendations.
Case study: Finmeccanica takes charge of governance
Defence organisation Finmeccanica’s FuturePlanner pension scheme, which was set up in 2007, has 2,500 members, with administration provided by Aon Hewitt and investment services provided by P-Solve on a fiduciary basis through Skandia as the investment platform.
The scheme currently has five trustees, two of whom are nominated by members through Finmeccanica’s pension consultative committees. The trustees meet at least quarterly, receive regular administration and management reports and check the scheme’s progress against an annual business plan.
Mike Nixon, head of pensions at Finmeccanica, says: “We support The Pensions Regulator’s efforts because we believe good governance can make a positive difference to outcomes, particularly for members in default options.
“We have found it helpful to share ideas and experiences across all our schemes and apply a consistent standard of governance for both defined contribution (DC) and defined benefit (DB) assets.
“However, I am a little concerned at the volume of current governance initiatives and the risk of overwhelmed fiduciaries reverting to box-ticking rather than considered responses.”
Finmeccanica is also the ultimate sponsor of the Selex and AgustaWestland pension schemes which, last year, launched a series of four blended funds as part of an overhaul of their additional voluntary contribution (AVC) investment options, to smooth out volatility for members. “We are giving them the kind of skillset that has also been deployed for the main assets,” says Nixon.
Although a governance committee will become a requirement for pension providers under the Association of British Insurers’ code, Nixon believes there are good reasons for employers to run the committee. “Pensions are an expensive and important employee benefit,” he says. “It makes sense to me for employers to make the most of their investment by ensuring the scheme is well governed and properly appreciated by the members.”
Viewpoint: Spotlight on pensions governance
Every employer will be making an important decision when it chooses a pension provider. Many scheme members are not engaged in looking after their pension savings, which increases the pressure on employers to make sure employees are protected properly. How can employers be sure they are doing the right thing?
There are 10 top signs of a good pension provider.
First, it has a clear governance policy and independent oversight. This could be an independent trustee or a governance committee that includes individuals who are not employed by the provider.
Second, it can explain how it will ensure that workers’ interests are taken into consideration when it makes commercial decisions.
Third, its charging structure is clear and transparent so there are no hidden costs, and it can be compared to those of other providers. From April 2015, the government plans to introduce a charges cap of 0.75% and a ban on charging employees consultancy and commission costs.
Fourth, it offers value for money or, in other words, the costs and charges taken from members’ savings are competitive when considered against the benefits and services that members receive.
Fifth, it offers an appropriate default investment strategy, because it is likely that a large proportion of members will end up using it.
Sixth, the investment options offered to members qualify for protection and compensation arrangements, for example under the Financial Services Compensation Scheme, and the provider holds enough money in reserve to ensure it can survive as a business even if it encounters severe problems.
Seventh, it keeps the pension scheme’s records accurate and up to date, so members can be contacted and receive the right information to monitor their savings.
Eighth, it writes regular letters to members explaining how much they have saved, how their investments are being invested and how they have performed, what their projected savings will be at retirement, how much of their contributions will be taken in charges, and whether the desired retirement income can be achieved at their current rate of contributions.
In addition, the provider will be signed up to the Association of British Insurers’ (ABI) code of conduct on retirement choices, and can provide employers with examples of typical scheme communications sent as members approach retirement.
Finally, it has good and efficient administration, invests contributions quickly and has a track record of low numbers of complaints.
But what else can employers do?
The decision to use a particular provider must be kept under regular review so the scheme continues to be appropriate for workers. If an employer has an independent financial adviser or employee benefits consultant, they may monitor the scheme depending on the terms agreed when they were appointed. Employers should speak with their adviser to establish what, if any, monitoring they can carry out.
Some employers set up their own management committee to monitor their pension arrangements. See The Pensions Regulator’s guidance Monitoring your pension scheme – management committees for employers , published in July 2013, for further help.
A key point for employers to consider is whether they will offer to protect the committee and its members against any liabilities they may incur when carrying out their role, otherwise it may be difficult to find volunteers to sit on the committee.
Be aware that the rules covering the governance of workplace pensions are expected to change in April 2015. The government has announced that higher standards will be expected of the organisations that are responsible for running such arrangements. This includes new annual reporting requirements, which should, once they come into force, simplify the monitoring process from an employer’s perspective.
Helen Ball is head of defined contribution team at Sacker and Partners
OFT report’s findings
The Office of Fair Trading’s report on pensions was critical of employers as well as providers. It said that while scheme members carry the risks of a DC pension, responsibility for choosing the product lies with employers, which often lack the necessary understanding.
The OFT said: “Those employers without the resources to fund the use of capable trustees, internal governance panels or high-quality advice to improve decision-making and monitoring may not get the best value for money for their employees.
“Many employers do not always prioritise all the elements we consider key to assessing value for money when they select a scheme… There is little evidence that many employers prioritise the key elements of scheme quality, such as investment design and performance, or scheme governance.
“Instead, many employers that are automatically enrolling employees into pensions for the first time are likely to prioritise minimising the costs to themselves of setting up and administering the scheme. Employers may also seek to prioritise the interests of current employees over former employees.”