New initiatives from the Pensions Regulator to tackle defined contribution risk
by Andrew Riley of Ash Shaw LLP on 2 January 2007
The Pensions Regulator has issued a 56-page consultation document on work-based defined contribution funds urging far better risk management in relation to pension administration, member awareness and fund investments as part of its aim to fulfill its Medium Term Strategy for pension schemes. At the same time a learning module dedicated to DC schemes has been added to the free online learning programme www.trusteetoolkit.com.
The Regulator invites interested parties to respond by 2 February 2007 to this consultation (www.thepensionsregulator.gov.uk/pdf/DcRisksConDoc.pdf).
"Our first and top priority therefore is to promote the raising of standards, clarifying what is expected of those running and providing DC schemes and backing this up with action where necessary."
For both trust and contract-based DC schemes the regulator states the standards it expects trustees, providers, employers, administrators and payroll providers to achieve in mitigating five key risks it has identified in the consultation document. No new legislation is proposed but the regulator's intended approach includes intervention and 'naming and shaming' where encouragement and education fails to work.
The five key risks requiring action are:
- poor administrative practices;
- poor investment practices;
- unduly high charges impacting members;
- poor decisions on retirement choices by members; and
- lack of member understanding.
The regulator believes that DC risks pose a threat to the well-being of significant numbers of people. The current size of the DC market for occupational and personal pensions/stakeholder is estimated to be over 5 million members, and will increase in importance with the arrival of auto-enrolment and personal accounts. By 2012 occupational DC active members are predicted to broadly equal the number of defined benefit active members.
Size of DC market (trust-based and contract-based arrangements)
| Scheme type |
Number of live schemes |
Number of members of live schemes |
| Trust-based DC Occupational Pensions (1) |
72,000 |
2,700,000 |
| Group Personal Pensions (2) |
100,000 |
1,900,000 |
| Group Stakeholder Pensions (2) |
34,000 |
680,000 |
| Totals |
206,000 |
5,280,000 |
The statistics given for the 72,000 occupational DC schemes reveal that the vast majority have fewer than 100 members.
Size and number of occupational DC schemes
| Size of scheme (number of members) |
Number of DC schemes |
| 2 - 11 |
64,275 |
| 12 - 99 |
6,356 |
| 100 - 999 |
1,783 |
| 1000 - 4999 |
231 |
| 5000 - 9999 |
33 |
| 10000 + |
22 |
| Total |
72,700 |
The regulator believes the deficiencies in the knowledge and understanding of those running DC schemes are due to:
- the focus of the industry on occupational DB schemes (until relatively recently); and
- the small size of the almost all DC schemes which has left the majority of trustees and managers with insufficient help and support to engage experienced advisers.
The regulator's recent governance survey found that over 75 per cent of schemes of the 71,000 trust-based schemes with less than 100 members did not have a formal process in place to identify risks; and 25 per cent of all trust-based schemes surveyed either had no pension administration service level agreement (SLA) in place with their service provider or were not aware of any such agreement.
Better education and training for trustees is highlighted as a key requirement with the regulator concluding that induction and ongoing training is not standard practice for the majority of trust-based schemes, but where training is provided there is a marked increase in the confidence of trustees in their own performance and in the standard of corporate governance.
Trustees 'strongly agreeing' that the board performs in four selected areas
| |
All schemes: column percentages |
| All schemes |
Advanced training in the last 12 months |
No formal training in the last 12 months |
Difference in percentage points |
| Regularly reviews its investment strategy |
62 |
84 |
41 |
+43 |
| Reviews the scheme rules at regular intervals and updates these as required |
55 |
72 |
42 |
+30 |
| Takes steps to ensure it follows good practice in governance |
67 |
81 |
52 |
+29 |
| Ensures a high standard of member communications |
36 |
49 |
22 |
+27 |
Addressing DC specific risks: the regulator's three-pronged approach
The consultation document advocates a three-pronged approach of promoting education and guidance, partnering and intervening to tackle the risks of poor administrative practices, poor investment practices, unduly high charges impacting members, poor decisions on retirement choices by members and lack of member understanding.
- Promoting education and guidance
- Develop educational tools with good practice tailored guidance, delivered over the web for the five key risk areas, using examples of:
- good practice within the industry (such as internal control, risk management and effective data transfer processes);
- templates of SLAs for pension administrators and payroll providers; and
- communication programmes for those running DC schemes and communication products and surveys for scheme members.
- Enhance the regulator website (www.thepensionsregulator.gov.uk) linking initiatives for industry professionals and scheme members (such as the FSA's cost comparison tables and the FSA's annuity comparison tables).
- Partnering
- Work with government and other regulatory and industry partners through appropriate channels (for example working group forums), to identify ways in which the Pension Regulator can either support the activities already taking place or provide additional help to ensure consistent messages and support.
- Intervening
- Intervene, where appropriate, on those DC schemes that pose most risk to the regulator's objectives of protecting members' benefits and ensuring good administration of pension schemes by:
- public reporting ('naming and shaming') of persistently poor performers (such as pension administrators and payroll providers);
- reporting of poor providers to the relevant professional trade bodies and institutes;
- encouragement of whistleblowing reports;
- issuing third party notices and improvement notices where poor practice results in a breach of pensions legislation.
Expecting better performance
"As a risk-based regulator we have focused not only on risks that may already exist but also on those that may materialise in the future. Our aim will be to influence behaviours so as to reduce the likelihood that risks will materialise and to act decisively where they do."
The regulator is demanding improvements to the current level of knowledge and practice shown by employers and trustees with work-based DC schemes. Its expectations are:
Better administration
- all pension schemes should have an effective SLA in place which is regularly maintained and reviewed;
- in-house administration to have appropriate performance levels and internal controls in place; and
- accurate, timely and relevant communications between parties (including members) to be in place to support good record keeping and timely reconciliations.
Better investment practices
- rigorous processes to be in place for selection of investment manager(s) and for the review of investment manager(s) and fund performance;
- an appropriate fund or range of funds should be provided;
- members should be able to make appropriate investment decisions.
No unduly high charges
- trustees, managers, providers and employers to consider charges at scheme setup and at regular periods thereafter to ensure the scheme continues to provide value for money; and
- providers, trustees and managers to issue relevant, clear and timely information to members, so that they can be clear on the impact the charges might have on the value of their pension fund and help them make informed choices.
Informed decisions on retirement choices
- trustees, providers and advisers to ensure that members are made aware of:
- their right to exercise the open market option;
- how annuities work and the different types available; and
- other alternative retirement options open to them.
Member understanding
- trustees, providers and employers to provide clear, balanced and timely information to members to help raise understanding of their pension scheme; and
- engagement between relevant parties so that they understand what needs to be communicated, and when, in order to protect members' benefits.
Sending in your consultation response
The regulator has provided a pro-forma which includes a list of the consultation questions available from www.thepensionsregulator.gov.uk/pdf/dcRisksResponse.doc
Author: Andrew Riley of Ash Shaw LLP
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