• Executive summary
  • The Pensions Regulator has issued a further statement on the governance of Defined Contribution pension plans affecting trust and contact based arrangements.  
  • Squire Sanders anticipates that there will be significant governance ‘gaps’ in many contract based pension plans.  
  • This article examines the impact of the Regulator’s pronouncements and expectations.  


Last year the Pensions Regulator entered into discussions with the pensions industry on how best to enable good outcomes for members of DC pension plans. This built on the separate work of the Investment Governance Group, which, although sponsored by the Regulator, had produced its own principles in November 2010. From this base, six principles for design and good governance of DC pension plans have emerged. In June 2012 the Regulator issued a further statement linking these principles and some draft “key features” of the principles in advance of the now imminent introduction of the automatic enrolment (AE) régime. The final piece of this particular jigsaw is a useful online flowchart tool to guide employers through the intricacies of how to determine if a pension plan is a qualifying scheme for AE.  

The Principles

The six principles summarise the Regulator’s earlier work in this area and are as follows:

  1. Essential characteristics: pension plans should be designed to be durable, fair and deliver good outcomes for members.
  2. Establishing governance: a comprehensive governance framework should be established at set-up, with clear accountabilities and responsibilities agreed and made transparent.
  3. People: those who are accountable for pensions decisions and activity should understand their duties and be fit and proper to carry them out.
  4. Governance and monitoring: pension plans benefit from effective governance and monitoring through their full lifecycle.
  5. Administration: pension plans should be well administered with timely, accurate and comprehensive processes and records.
  6. Communication to members: member communication should be designed and delivered to members to encourage engagement and enable members to make informed decisions about their retirement savings.  

Few people would object to anything stated above. The Regulator’s suggested “key features” (which will be the subject of formal consultation later this year) suggest how each principle can be achieved in practice. Some of the 36 key features are unarguable points of good governance (eg “members are regularly informed of the importance of reviewing the suitability of their investment choices”); others largely reflect existing legal requirements (eg “member data across all membership categories is complete and accurate and is subject to regular data evaluation”); and others stem from fiduciary duties that will be familiar to trustees of trust based pension plans (eg “those running schemes act in the best interests of all beneficiaries”).

However, the devil is, as always, in the detail.

Draft Key Features

We anticipate that many existing trust based arrangements will already comply with the six principles to a large extent. However, governance ‘gaps’ will be clearly apparent in many contract based arrangements, which have not traditionally benefitted from the same level of attention as trust based plans. In that sense the Regulator is to be applauded for trying to raise the game for employers who may, in the past, have been content simply to pay over DC contributions (or arrange stakeholder access) and then sit back.  

Astute readers will recognise some familiar but seemingly intractable themes of the DC governance debate in some of the key features. We consider a few of these below.  

Active Member Discounts

Under the over-arching first principle, the Regulator has referred obliquely to the debate over active member discounts by stating that “all beneficiaries… are treated impartially and receive value for money” and that “all costs and charges… are transparent and communicated clearly at point of selection to the employer to enable value for money comparisons to be made and to assess the fairness to members of the charges”. This stops short of banning the practice of imposing higher charges on deferred members (which, outside of stakeholder pensions, the Regulator has no legal power to do anyway) but clearly flags that it is the employer’s duty to take an interest in how charges are set.  

Internal Controls and Business Risks

Principle 1 also contains the feature that “those running schemes [should] understand and put arrangements in place to mitigate the impact to members of business and/or commercial risks”. This theme is repeated under one of the features of Principle 2: “those running schemes establish adequate internal controls which mitigate significant operational, financial, regulatory and compliance risks”. Presumably these suggestions are aimed primarily at providers of both contact and trust based plans, although the second articulation is a nod to the existing duty of trustees under section 249A of the Pensions Act 2004. On a practical level, how would these exhortations work? Providers are already required by FSA rules to stress test their businesses against a number of measures which could impact on their solvency. Apart from ensuring that contributions are paid on time and benefit queries are addressed promptly, trustees can do little by way of “arrangements” to mitigate business or commercial risks, other than by monitoring the provider.  

At the moment we doubt that many trustees would actively seek information on anything more than performance and administration, so if the Regulator is suggesting financial solvency monitoring then they will have more to do. All this means more cost for the members, which might reduce the value of their pensions unless the sponsoring employer picks up the cost.  

Suitability of Fund Options

One other feature under Principle 1 that addresses a fundamental issue – how many funds to offer – is dealt with as follows: “the number and risk profile of investment options offered must reflect the financial literacy of the membership. Different ranges of investment options could be offered to different membership groups”.  

At first sight, this is common sense, but this raises the age old conundrum of how trustees or employers can know what is suitable for their members/employees, without straying into the territory of giving investment advice. How can the “financial literacy” of their members be assessed? Equally, providers of contract-based arrangements can only really be expected to approximate member understanding of and appetite for risk. Very few employers have followed the example of British Telecom, which recently announced a programme of mandatory financial education for its workforce, which would address this issue in part at least.  

Joined up Thinking

The Pensions Regulator is not the only body to issue guidance on the operation of DC plans. There is some overlap between the new material issued by the Regulator, the investment principles issued by the Investment Governance Group, and the guidance on DC default investment choices issued by the DWP. None of these materials have the status of legislation. Compliance is or will be voluntary, except to the extent that there are overlaps with existing legislation and Regulator’s Codes of Practice. This, of course, is part of the problem with the latest pronouncement; employers, trustees and providers are bound to wonder why the opportunity to rationalise all of the various sources of guidance and legal obligations on DC governance has not been taken.

Comment and Action

Most employers will satisfy their automatic enrolment duties by enrolling employees into a DC plan. Some plans will be trust based, others contract based, and the jockeying for business among new and established providers has begun with gusto. The success of DC provision is integral to the success of AE as a whole, but the Regulator’s latest statement on DC governance is of wider significance. The real political danger with auto enrolment – “dumbing down” DC plans to offer the bare minimum – is perhaps the main catalyst behind the Regulator’s keenness to improve member outcomes, but all those responsible for DC plans should be aware of its recommendations.  

Employers with contract based arrangements may be concerned about developments from across the Atlantic. In the USA, in the first law suit of its type, a company has recently been fined over $35m when a court ruled that it had breached its fiduciary duties to participants in the company’s 401(k) pension plan in relation to costs. The court ruled that the company had failed to monitor record-keeping costs, had failed to negotiate rebates for the plan from investment providers, had kept more costly classes of investments on the investment platform (when less expensive classes of the same investments were available), and had agreed to pay an investment manager more than the market cost for services (in order to subsidise another service provided to the company). The Pensions Regulator’s attention to costs and employer duties in DC plans may lead towards similar claims featuring in UK courts in the future.  

The timing of the Regulator’s pronouncements is interesting for another reason. We are expecting details of the Government’s proposals for ‘defined aspiration’ pension arrangements later this year. Pensions Minister, Steve Webb, promised that this type of pension arrangement would “sit within a less burdensome regulatory regime”. It is difficult to see how this promise will be achieved in practice when there is clearly an increased focus on good practice/compliance in the DC arena combined with an overabundance of legislation in the DB arena.  

Pensions lawyers at Squire Sanders are assessing the future shape of UK pension provision. How does the desire for simplicity and good member outcomes fit with the increased regulatory burdens and the frail economy? How will this be further impacted by the introduction of new European requirements on solvency, governance and disclosures (known as Solvency II)? Our findings will be shared with readers in the coming months. Trustees and employers are encouraged to consider the Regulator’s material and to discuss compliance aspects with their administrators and pension providers.