The Pensions Regulator has been paying increased levels of attention to how defined contribution (DC) schemes are governed. This, together with the trend for employers to provide DC vehicles (whether trust-based or contract-based) for future service, means that the spotlight is now, firmly, on DC governance. Challenges lie ahead (for instance, in relation to default funds and lifestyling) but much can be done by employers and trustees to address the issues with enough honesty about the time, effort and cost of effective DC governance.
Why is DC looking so attractive?
Although there are many employers sticking with defined benefit (DB) provision for plenty of good reasons, there are also lots of reasons for going DC. One key factor relates to certainty of cost, from the employer's perspective at least. For employees, the uncertainty of not knowing what they will end up with at retirement means that they will have to make plans from a more informed position than they might previously have assumed. Employers seeing their competitors moving towards DC are likely to feel more comfortable about making the same move. Plus, of course, the advent of personal accounts provides another opportunity for rethinking pension provision. Scheme design is creeping up the agenda now for many schemes. For those employers who do decide to go down the DC path, it's in their best interests to see their scheme working well. A workforce including staff who cannot afford to retire is likely to be less effective than one with a healthy level of staff turnover.
What's the latest state of play?
Personal accounts are receiving daily press attention and increasing numbers of employers are looking at how best to prepare for this. For some pointers, see our alerts Personal accounts - a pensions revolution and Personal accounts and auto-enrolment - what does this mean for you?
The Pensions Regulator is focusing on DC in the knowledge that its growing attraction demands greater focus on the regulatory side. The pressures aren't just domestic. The Organisation for Economic Co-operation and Development  has called on national regulators to look at the risks presented by default funds. Should those funds limit investment in equities, for instance? We know from numerous surveys that DC schemes often receive less attention than their DB cousins, with a greater focus on administration than on the strategic decisions (such as investment and genuine member engagement).
What the Pensions Regulator has been doing
It's clear from the Regulator's statement about higher standards in DC pensions (issued in July of this year) that its desire to increase confidence in pensions is closely connected with the forthcoming launch of personal accounts. The Regulator wants standards in DC schemes to rise, to enable members to make informed choices at retirement and improve the quality of employer engagement. The Regulator believes that part of the solution lies in education: in relation to trustees, knowledge and understanding, while employers are encouraged to look at the Regulator's Pensionwise online information service.
But a softly-softly approach isn't the only one being employed. The July 2009 statement also said that where the Regulator found shortcomings as part of its investigation into pre-retirement processes and literature it would use its enforcement powers, if necessary. That investigation (based on DC pre-retirement literature offered by 97 DC trust-based schemes) found that 57% of those schemes had scope for improvement. More worryingly, 30% appeared to be in breach of the disclosure legislation. But there were some positives. For example, more than half the schemes offered members access to advice and/or support in the form of a specialist annuity broker or financial adviser.
One of the examples identified by the Regulator as indicative of poor practice centred around poor record-keeping. The Regulator issued its record-keeping guidance last December, looking at trust and contract-based schemes. The risks presented by DC processing (for instance, making sure that contributions are allocated to the correct funds and that members' choice of funds are implemented correctly) mean that clear audit trails are particularly important if data is to be complete and accurate. In that sense, poor record-keeping in a DC scheme is far more likely to come to light than in a DB scheme, with the consequent knock to members' confidence in their employer's pension provision.
What other bodies are doing
Other pensions bodies are working with the Regulator to help achieve higher standards. One body keen to maintain its involvement in the DC arena is the National Association of Pension Funds (NAPF). In September of this year the NAPF launched its Pension Quality Mark for DC schemes. To date, 13 schemes have been awarded the Quality Mark. Schemes seeking this must have contributions of at least 10%, with a minimum employer contribution of 6%. For the 'Plus' version, overall contribution rates must be 15%, including an employer contribution of at least 10%. Schemes must also provide clear and simple information to members when they join the scheme and throughout their membership. Of equal importance is the NAPF's insistence that governance arrangements are in place, such as trust boards, management committees or annual scheme reviews.
The NAPF also identified in one of its recent surveys high levels of concern among employers worried about whether they can speak frankly to their staff about pensions. In response, the Regulator has said that it will work with industry bodies, like the NAPF and the Confederation of British Industry, to "develop clarity of information for employers". In the meantime, the Regulator and the Financial Services Authority have jointly published a guide for employers about discussing pensions with employees. Although the issues involved are not limited to DC arrangements, it's clear that the implications of poor communication for DC members are likely to be more acute, those members taking on a greater share of the risk than their DB counterparts.
What about contract-based arrangements?
Where employers choose the contract-based route, are the risks to members greater without the presence of a trustee board to oversee arrangements? It would be fair to assume that the scheme administrator would spot a basic problem (for example, not passing employee contributions across to the provider) and tell the trustees about it as soon as possible. The Regulator is keen to encourage employers with contract-based arrangements to work closely with their provider and adviser, perhaps establishing a governance committee. Its own research revealed that about half of employers have some kind of governance arrangement in place, over and above that required for their contract-based schemes. There's some helpful guidance on voluntary employer engagement in contract-based schemes (published by the Regulator in January 2008). The guidance sets out some of the benefits of having a governance arrangement, such as:
- spotting administrative problems
- monitoring contract charges/competitiveness
- improving member understanding (by, say, providing access to advice) and
- minimising member complaints (for example, by spotting investment under-performance early on).
For some employers this will be a case of preaching to the converted. For others, however, it may well be the case that these advantages have not yet actually made it onto their radars, in which case they will be less prepared to deal with the challenges ahead.
Read about the challenges faced by DC schemes in our alert Spotlight on DC governance - the challenges ahead.