Recent years have seen many employers manage the risks associated with their defined benefit (“DB”) pension schemes by closing them to future accrual and establishing replacement defined contribution (“DC”) schemes. In general, those DC schemes are ticking along quietly and most finance directors believe pension risks have now been largely contained.
However, DC schemes carry with them an array of different and often latent risks which trustees and employers may not be aware of until years after problems begin. Specifically, these risks cover issues such as investment, administration and retirement.
1. The advice gap
It is clear from legislation and related Pensions Authority guidance that trustees are expected to “make arrangements for the payment of benefits as” they fall due and provide benefit option statements to members when they reach retirement. However, trustees are not subject to very prescriptive obligations in terms of preparing members for retirement. At a regulatory level, the focus seems to be more on tasking trustees with administrative functions associated with paying benefits.
While trustees can, and should, provide members with basic information on their retirement options, they cannot stray into providing financial advice to members. This seems to be recognised in the Pensions Authority’s Trustee Handbook which recommends that trustees “encourage members to seek advice when considering their retirement options”.
The reality is that members will require financial advice, not only at point of retirement but also in the five to ten years leading up to that date. There is a debate brewing within the industry about who has the responsibility for filling this advice gap.
At one level, DC schemes are about individuals taking responsibility for their own retirement savings so it is for them to seek, and pay, for any associated financial advice they may need. The difficulty employers and trustees have in getting DC members to take ownership of their retirement planning in DC schemes often stems from the fact that a DC scheme is a benefit provided through the employment relationship. Therefore, many members assume that the trustees or employer are taking responsibility for ensuring they get an adequate pension and are often very ill-equipped for the difficult decisions they face when it comes to retirement.
This is why communication and engagement with members is so critical in a DC context. If the employer expects members to use the DC scheme to take control of their own retirement savings then that message needs to be clear from the outset and communicated to members consistently.
Where it is not clear whether an employer is adopting a paternalistic or individualistic approach in helping members prepare for retirement, trustees should engage with the employer to get an understanding of what the employer’s perspective is on that issue.
If the employer wishes to adopt a paternalistic approach, then arrangements and processes should be put in place to ensure that members are well prepared when the time comes to make those important financial decisions. What those arrangements should look like will vary from organisation to organisation. It may simply involve employers paying for or subsidising financial advice for employees at point of retirement. At another level, it could involve organising retirement clinics on site where DC members can meet with financial advisers periodically as they get closer to retirement.
As DC trustees generally will not be in a position to pay for the advice members will require, they will need to engage with employers on this issue. While there would be a cost to employers in putting such arrangements in place, those costs need to be viewed in the context of potential claim costs which employers may be exposed to if retirement risks are not properly managed.
2. Age Discrimination
It is generally acknowledged that the current average level of contributions to DC schemes are not going to be sufficient to provide members with adequate pensions in retirement. As a result, there is a risk that there will be a growing trend in the years ahead of employees not being able to afford to retire.
This trend emerges against a changed legislative landscape where mandatory retirement ages must be objectively justified. Where employers now seek to enforce contractual retirement ages and employees find that they cannot afford to retire, this is likely to prompt discrimination claims against employers.
The Employment Equality (Abolition of Mandatory Retirement Age) Bill 2016 was debated in the Dáil on 23 February 2017. This opposition sponsored Bill proposes that, save in the case of employment in An Garda Siochána, the Defence Forces and other specified emergency services, it shall not be lawful to set or contract an age for the compulsory retirement of an employee. While this Bill is unlikely to become law in its present form, it is indicative of increased opposition to employees having to leave a job simply because they have reached an age set by their employer.
We are already beginning to see a growing number of age discrimination claims relating to retirement ages. A variety of defences have been used by employers to objectively justify mandatory retirement ages, including health and safety and promoting workforce cohesion. However, the case law makes it clear that the sort of defences which will succeed are very case specific, not only to the employer but also to the particular role in question.
For these reasons, employers are best advised to put in place appropriate arrangements which will assist in raising awareness of employees’ intended retirement plans. Some employers might also consider extending retirement ages to align them with increases in the State pension age. However, doing so throws up a number of legal and other issues which will need to be carefully managed.
3. Investment – lifestyle transitioning and market risk
The importance of implementing best investment practices are never more required than when members move close to retirement and are involved in a once in a lifetime transition of their retirement funds from group DC schemes into post-retirement retail products.
If members’ investment switches are made late or not made at all then any loss in value associated with such errors is much more difficult to recover from. Members may naturally look to the trustees to make good such losses, with potential consequences for employers who indemnify those trustees.
Also, once members have decided how they wish their DC pot to be applied at retirement there is likely to be a gap between disinvestment from the scheme and reinvestment into an ARF product, for instance. Again, any significant movement in asset values, or any change in investment strategy, while that transition from one investment to another is taking place may cause members to suffer losses, or not to achieve the desired outcome. Those losses could be avoided if that out of market risk had been minimised.
It is vitally important, therefore, for trustees to ensure that they have robust procedures in place with their administrators and investment managers to minimise the risk of any such errors or delays.
A more difficult decision for trustees is whether they stray into the retail and post-retirement market to try to secure discounted charges for members with a preferred provider. The scale and purchasing power a large DC scheme brings with it may enable trustees to secure such preferential rates for members.
Some argue that trustees’ duties to safeguard trust assets extend to ensuring members get value for money when it comes to accessing their DC pots on retirement. Unless the terms of the particular trust deed create such an obligation, in our view, it is not correct to extend that duty into the post-retirement world. At that point, members are drawing down their benefits so those assets cease to be trust assets which trustees have a legal duty to safeguard.
That said, if trustees go down the road of offering members access to a preferred provider, they need to be very careful in how that option is communicated. Members need to understand that it is their decision how to apply their DC pot on retirement, with the support of appropriate financial advice.
It is likely that the whole area of financial advice at retirement will become subject to much more scrutiny in the years ahead, particularly in light of the Pensions Council’s report last year on ARF charges. Whether this report prompts any legislative reforms remains to be seen.
In the meantime, what trustees and employers can strive for is that members are well educated on the options available to them at retirement, and are able to ask the right questions in understanding the retail products on offer.