Risk and responsibility

The demise of final salary schemes continues apace. There are now just three FTSE100 companies that have open defined benefit schemes following the move by BP to close its scheme to new employees.

As the number of blue chip companies moving to DC arrangements, and ultimately to contract-based ones grows, so the focus on default governance will grow. The shift will have significant implications for the DC arena, particularly with contract-based schemes. For starters, as the shift from trust-based occupational schemes to contract-based arrangements continues, employers may assume that their responsibility diminishes. Whether employees share that view is a different matter.

In practice, the shift also raises questions for advisers about their role in helping workers make the most out of their pension.

“With a large transition from DB to GPPs and occupational DC, mainly to reduce cost for sponsoring employers, the risk is also shifting from the employer to the employee, with retirement benefits ultimately dependant on the performance of the invested fund,” says Lee Smythe at Killik. “With little or no governance, members of such schemes could find that their money remains in underperforming or inappropriate funds for their risk appetite for considerable periods of time. This will ultimately reduce the benefits available to them at retirement.”

The current financial and economic turmoil and market volatility have heightened the need to review investments, funds and asset allocation. Yet according to the Pensions Regulator many smaller schemes are unlikely to have formal structured training in place for trustees. A survey by Hewitts showed that only 7 per cent of contract-based schemes have a formal governance process, while one in four schemes have no form of governance at all.

But it is the FSA and not TPR who are responsible for the investments within contract-based arrangements. Failing to consider governance goes against the treating customers fairly principles laid down by the FSA.

AKG, the actuary and consultants describes the way that corporate intermediaries provide investment advice to their clients as “a process which implicitly brings with it a duty of care…where necessary the process should also encompass ongoing reviews to ensure the advice remains appropriate”.

But the reality is that many advisers do not have the time or the inclination to service the governance of the schemes that they have helped set up. It is of little surprise that many fail to monitor their DC offerings. According to the latest PensionDCisions survey at least 10 per cent of plans had not reviewed their schemes for two years – flagrantly ignoring the guidelines laid down by the regulator in October.

Governance is a problematic area for contract-based schemes because the responsibility of the plan is less than clear-cut. In a trustee-based scheme most pension experts agree that the buck stops with the trustee, but with contract GPP that is not the case. You could argue that the provider, the adviser, the employer and the employee all have a responsibility in some shape or form.

Martin Palmer, head of pensions marketing at Friends Provident, says scheme members as well as employers need clarity. “Who is responsible for making sure the right fund choice is there and that members are communicated with? There needs to be clarity. Some kind of pseudo-trustee may be put in place to advise members but whatever happens, it must be installed in a formal way,” he says.

Many providers are moving towards a pseudo-trustee model, some would argue that it is a model they have been operating for some time. The question is whether advisers and employers can be confident that providers are doing enough when they assume the role of the trustee and take care of governance.

Scottish Life is currently making a noise about its “market leading” investment proposition to help advisers and employers with governance.

In a nutshell, its new Governed range offers a number of risk-profiled portfolios, which can operate on “autopilot”, the flexibility to allow advisers to tailor solutions for specific client needs and ongoing governance at no extra cost.

This governance means that there is a formal review process, which includes an investment advisory committee to review investments and the use of analysis from risk management experts Barrie & Hibbert.

Nick Leitch, head of investment marketing at Scottish Life, said at the time of the launch: “The recent FSA letter, ‘Pension Switching Advice’, gives some classic examples of this real world. For example, to quote from the letter ‘Where an asset allocation approach has been recommended, the scheme needs to be reviewed periodically, and rebalanced where necessary, to ensure it continues to be suitable.’

“The demands on advisers today are clearly significant. Our new investment proposition has been designed to help advisers comply with regulatory requirements; to provide a leading-edge product for their clients; and to achieve greater commercial success within their own business.”

Leitch’s marketing claims appear to have hit a nerve with some rivals, many of whom wonder what all the fuss is about.

Rivals do not believe that Scottish Life is breaking new ground and argue that governance has always been a requirement and that reviews and the use of an independent committee are not new habits.

Julian Webb, head of DC pensions at Fidelity, says: “Scottish Life’s new range is not new news at all and I also question whether it goes far enough.”

Adam Potter, head of sales corporate pensions at Aegon, reckons that all providers have governance in place and investment committees to review funds.

He says that Aegon has investment committees for its Universal Lifestyle Collection and they have moved to replace managers when they haven’t been doing what they said they would be doing.

He added: “It [the Scottish Life Governance plan] is well marketed and they are publishing committee minutes on a website for all to see, while most committees don’t publicise the fact, but it does not mean that they don’t review.”

Scottish Widows is also less than impressed with Scottish Life’s offering. Ann Flynn, sales & marketing manager at Scottish Widows, says: “We regularly review and have an independent committee [also Barrie & Hibbert] to ensure the funds are doing the right thing at the right time. We have been doing that since 2006.”

Even AKG in a review of the Scottish Life plan admitted that its “approach is not the only facility of its type” although its proposition “does tick all the boxes”.

Scottish Life claims otherwise and admits that its rivals have elements of governance in place. It argues its governance offering, with its risk assessment tools, use of Barrie & Hibbert and a range of seven portfolios with different risk profiles is integrated to the same extent.

“We have enhanced our portfolios and it is something we have been planning for six years. We offer governance across the spectrum from the sophisticated investor to those who need a guiding hand,” says Alasdair Buchanan, group head of communications at Scottish Life.

Scottish Life’s move has stirred debate on what is the ideal governance solution.

For starters, if governance has been in place for years, why are so many default funds bog-standard balanced managed funds that are far from balanced (because they have a significant weighting in equities)? Or why are so many default funds UK-only trackers with no hint of overseas exposure or fixed interest element – or even lifestyling?

Scottish Life has banged the drum about unbalanced balanced managed funds for a while and it is why it began to revamp its pension range six years ago and enlisted the help of Barrie & Hibbert for its Managed Strategies plan.

With Governed, Scottish Life has taken the review process further, with meetings scheduled for one, three, six and 12 months. The committee will realign asset weighting and has the ability to make bold tactical calls.

Yet are monthly or three monthly meetings too frequent, leading to a case of too much meddling? Knee-jerk reactions to market movements could have devastating consequences should the committee make the wrong call.

Potter says he is ambivalent about regular reviews, pointing to Aegon’s most consistent GPP, Universal Life, which is 75 per cent a global passive fund from Blackrock. “There is only so much you can do because you can’t just move assets without members consent within a contract scheme.”

Scottish Widows believes that once a year is more than adequate to review an investment product with a long-term horizon rather than more frequent meetings.

“Making investment calls on a quarterly basis in markets which are as fluid as they are today is extremely difficult. You get volatile periods but an annual review is adequate.”

Martin Ralph, pension & retirement benefits director for Willis Employee Benefits, questions whether the insurer is merely offering sophisticated managed funds, which, for example, reduce risk by simply reducing the equity content. But he does reckon that Scottish Life’s scheme will make it easier for employers and advisers and certainly in today’s environment advisers in particular will not want to flout regulatory guidelines.

Advisers, trustees and employers are caught between compliance with regulation, a desire to educate, concerns about their own responsibilities and liabilities and commercial and financial pressures. Many employers don’t want to advise in any way simply because they feel that this puts a huge liability on them. But it’s certainly arguable that an employer (or indeed a trustee or an adviser) is being irresponsible if they offer or recommend a default fund without the proper governance around it.

Rivals may be concerned that Scottish Life has stolen a march on the governance question because of the way the scheme has been packaged. After all, many insurers already offer a degree of governance such as investment reviews and risk assessment tools.

Despite their criticisms, Aegon and Scottish Widows are in the process of revamping their GPP ranges so they take a more hands-on approach to asset allocation by rebasing funds should market movements bring benchmark weightings off kilter.

They recognise that governance cannot be underestimated particularly now that it is on the radar of the Pensions Regulator and the FSA. Ultimately, however, it will be the decisions made by the investment committees and the performance of the pension pot that will be the judge, rather than any marketing gumpf.

THE Experts’ Verdict

“I think in the current climate and with the general lack of trust in the pension market, governed strategies make sense. As more and more final salary schemes close GPPs will become more important for the employee. Responsibility for investment decisions has been passed to the employee rather than the employer. Scottish Life is helping to ease this transition by providing a strategy for employees that includes monthly rebalancing and an investment advisory committee for little extra cost. This should improve pension performance and importantly volatility when compared to trackers.”

Jason Walker, AWD Chase de Vere

“The new option being added to the Scottish Life GPP must be at a very general level rather than being specific either to the needs of the employer or employee. So how will the Royal London investment committee determine what is a good fund? And will the member understand that whilst it may be a “good fund”, it may not be suitable for the member? I suppose I believe that there is no such thing as a bad fund (in general) but there is the wrong fund where the fund does not meet the needs of the member.”

Michelle Cracknell, Skandia

“Any additional governance of the investment process is welcome in the mass marketplace of group pensions where there is often no scope for members to receive specific individual advice in relation to their scheme (unless this was costed in to the scheme or they pay an adviser for such advice separately) and so the new funds from Scottish Life go some way to providing an element of consideration to investments held by scheme members.”

Lee Smythe, Killik & Co