The Investment Governance Group wants employers to comply with its proposed new guidelines or explain why they are not. Gill Wadsworth
finds advisers and providers less than impressed
Defined contribution schemes have long been burdened with an inferiority complex; their position as the poor relation to the mighty defined benefit plans has seen them sit in the shadows for years.
But as the world gradually recognises that DC is the future, a process emphasised by auto-enrolment and pensions reform, these much maligned retirement propositions are having to shake off any negative connotations they may have been saddled with in the past and prove their worth as a viable
Yet numerous challenges face advocates of DC provision, many of which stem from the individual as sole bearer of investment and annuity rate risk. And while the employer may go so far as to put the scheme in place and provide a valuable contribution, they are under no obligation – at least in the case
of the contract-based plans – to provide much in the way of support or communication to help employees make the best decisions.
Consequently, The Pensions Regulator (TPR) has been working to improve the lot of the DC member by
raising standards, improving governance and generally attempting to encourage employers to do more than the bare minimum. Most recently, TPR established the Investment Governance Group, made up of industry and government representatives, tasked with creating an ’ideal’ framework for how DC schemes should be run.
Influenced by the earlier Myners principles on institutional investment, the IGG produced a set of six initial best practice principles for DC contract and trust based schemes covering clear roles and responsibilities over a long list of matters including investment decision making and governance, effective decision making, appropriate investment options, appropriate default strategy, effective performance assessment, and clear and relevant communication with members.
The IGG consulted with the industry from February until the start of May this year and, in spite of widespread agreement that the aims were laudable, there has also been anxiety the guidelines might impose a trust-based framework onto contract-based schemes.
John Lawson, head of pensions policy at Standard Life, says: “The thrust of [the IGG guidance] seems to force the trust-based and paternalistic
approach on to all schemes. That has to be avoided because not all employers want to go down that route, particularly smaller employers without the time or resource to get involved in running governance committees.”
He adds: “There should be separate guidance for trust and contract-based schemes; the two things are completely different.”
These concerns are compounded by the IGG’s decision to use the Myners’ ’comply or explain’ terminology. The paper suggests employers voluntarily report on where they adhere to the guidelines and make clear the reasons where they don’t. Commentators find this language particularly inflammatory arguing that for most employers it is simply unrealistic.
Lawson says: “To have to comply or explain is nonsense. It was originally invented for large companies looking at corporate governance. The regulator needs to get real.”
Trust-based schemes, while far from all the same, tend to be more consistent in their approach since they are governed by a clear set of legal obligations. Contract-based, on the other hand, run the entire spectrum from putting a provider in place and doing the bare minimum, right up to having investment and governance committees complemented by specialist communications programmes. Consequently, the IGG is facing a not inconsiderable challenge in attempting to build a framework under which all these schemes can happily operate.
Rachel Vahey, head of pensions development at Aegon, says: “It is difficult to have one best practice model, which is what [the IGG] has been trying to achieve and I am not sure that works. Perhaps it needs to look again and bear in mind different sizes of employer and the particular position of contract-based schemes. It might be that you can’t have just one best practice model.”
The IGG, however, justifies its decision to build a single governance structure for the entire DC universe on two points. First, the group argues that irrespective of whether a member is in a contract or trust-based arrangement they should be entitled to the same standard of care and oversight.
Victoria Nye, chair of the IGG, says: “From a member’s perspective it shouldn’t matter about the structure of the scheme; they should still get a good deal. The whole aim of putting [contract and trust-based] together under a DC banner was to find a level playing field across the piece no matter what kind of scheme.”
Secondly, Nye points out that all trust-based schemes aren’t the same and they don’t necessarily offer equivalent governance standards.
She adds: “Even in trust-based schemes there are a wide range of investment governance outcomes; trust is not always a perfect rrangement.”
Further criticism of the direction in which workplace scheme governance is headed comes from advisers and providers who feel the IGG has
underplayed their role in the process. In the case of contract-based arrangements, the deal is between the employee and the provider, with the employer simply responsible for putting the plan in place. However, the IGG paper places the employer as central decision-maker and therefore accountable for monitoring the investment performance, reviewing the default fund and communicating investment choices to members.
Rachel Brougham, Mercer’s head of governance consulting, says the current legislative and regulatory regime makes it difficult for employers to take on this larger role within their schemes.
She adds: “The principles will encourage best practice for trust-based schemes, whereas contract-based arrangements will continue to rely on
providers’ goodwill and ability to make their products more flexible. Bringing contract-based schemes up to the same governance standards as trust-based pensions would require potentially impractical changes to pensions legislation or providers taking on higher costs to deliver more bespoke workplace products.”
The IGG guidelines note that employers will take advice or guidance from providers or advisers when making decisions on a contract-based scheme, but providers argue that more should be made of the professionals’ role in shaping a plan.
In its response to the IGG consultation, Standard Life suggests the employer retains accountability for the decision making but that best practice guidelines make clear where and when they would pass responsibility to a third party.
Lawson says: “There is a bigger role for the provider than [the IGG] acknowledges. As a provider we are quite happy to step up to the plate and say that we are responsible for a particular situation and we would expect advisers to do the same.”
Bringing contract-based schemes up to the same governance standards as trust-basedpensions would require potentially impractical changes to pensions legislation
Lawson adds that the adviser is central to the entire contract-based arrangement since they will guide the employer towards a certain provider, help select and shape the default fund and, in some cases, liaise with employees and provide both tailored and generic advice.
He says “The IGG’s table of accountability has a footnote on employers seeking advice but the adviser is actually key and they are taking money for doing that advisory job so it ought to be clear that they are responsible.”
Feedback to the consultation also criticises the principles for failing to highlight the role of the employee as a decision-maker in a contract-based DC scheme. For example in most of these kinds of arrangement the member is in charge of where they end up, be it default or active fund selection, and they are also responsible for ongoing reviews of whether their selected funds are still suitable. However, nowhere in the IGG best practice is the individual clearly made responsible for decisionmaking. Responding to the criticism, Nye says the IGG does not underestimate the role of third-parties in governing DC schemes.
“It was very strongly felt that advisers and providers have a fantastically important role; we couldn’t do without them. But because [running a DC scheme] is a team effort, the whole structure is built on sand unless someone can be called to account that things are working. There needs to be some recourse for members who know who to go to when it isn’t working,” says Nye.
Central to much of the regulator’s efforts to improve DC standards is member communication. Under principle 6 of the IGG best practice guidelines, employers are responsible for providing “clear information on the investment options and their characteristics that will allow members to make informed choices.”
However, Kevin Shilling, managing director of pensions communications firm Shilling, says principle 6 misses the point and fails to appreciate the difference between simply providing members with information and engaging with them on a more intrinsic level.
“The regulator still has a problem understanding the difference between issuing information to employees and effective communication with scheme members. Is it any wonder that employers need guidance from communication specialists to help them engage with members?”
He adds: “Principle 6 does little to encourage employers who are not committed to effective member communication; the communication gap will just get wider.”
For some commentators the direction of the regulator’s stance on DC governance will ultimately drive employers to level down their existing arrangements and simply offer the National Employment Savings Trust (Nest). Fears of ’getting it wrong’ or being forced to spend vast swathes of already stretched resources will, some say, be the final straw for employers grappling with workplace provision.
Sackers’ partner Andrew Bradshaw says: “Employers might say that at the moment they can do their best but [governing a pension fund] is not their main business and they are not going to spend a fortune on it. As soon as regulators start saying companies have to have governance and educate members, then the costs and the potential liability go up and actually employers will think they can’t be bothered and will just go to Nest.”
Similarly, Mark Futcher, associate at Barnett Waddingham, argues that while good employers already offer high levels of governance, there is a danger that many firms will feel weighed down by the guidance and resent the additional demands.
“There is a danger of burdening employers. The good employers want to look after members and ensure they are doing their best, but certainly some companies are going to say they chose a GPP or stakeholder because governance wasn’t required and now this is extra money they have to spend,” Futcher says.
Given the strength of feeling from industry commentators that the direction of DC scheme governance will force employers to ditch existing plans, the IGG is at pains to point out that the guidelines are merely that; guidelines. Nye says the group is not in the business of scaring schemes away from providing pensions and argues that their intention is to offer support.
“If there is an impression out there, which I fear there is, that employers are being bullied and that this is another example of employers being put upon, then that is a shame because the principles are not meant like that. It’s meant to be a handholding encouragement exercise; it’s not something that employers have got to do right now and if they don’t do it then they’ve failed,” Nye says. However, Bradshaw points out that although the guidelines are not legally binding, after a set period of time they become more deeply enshrined in members’ expectations, potentially leading to awkward legal encounters.
He says: “Guidance is not like legislation, the IGG is not saying employers should do this or that, but over time it goes from best practice to standard practice and then in five years time, people start waving these kinds of principles around in court.
“They are ratcheting up what needs to be done but there isn’t any protection for employers; a halfway house [between best practice and legislation] could be dangerous.”
The regulator still has a problem understanding the difference between issuing information to employees and effective communication with scheme members. Is it any wonder that employers need guidance from communication specialists to help them engage with members?
It is early days for the DC governance guidelines and the IGG is clear that nothing is final. There is a chance the ’comply or explain’ requirement will yet be removed and the group remains open to the industry’s responses. However, there can be no doubt that the regulator, and wider government, is taking DC governance seriously; the regulator has a separate project looking at DC risk while the Department for Work & Pensions is exploring guidance for pooled DC funds.
Efforts to improve governance are laudable and undoubtedly members stand to benefit from a more robust framework, but unless providers and advisers are able to share the burden with employers, such attempts may lead to levelling down. Best practice must be formulated with a sound understanding of the diversity among DC schemes and it may be that one set of guidance simply won’t fit all.