Is DC governance fit for purpose?

Published in Professional Pensions 7th April 2015

DC governance will need to evolve rapidly in the coming months if it is to remain fit for purpose.

At a recent event that I chaired, organised by the Pensions Management Institute London Group, only 8% of the attendees believed that DC governance would be fit for purpose within the next 12 months.

There was an overwhelming view that auto enrolment and the new DC flexibility regime had really raised the DC governance stakes, but there didn't appear to be a parallel push from the market to ensure that member outcomes were being adequately addressed.

Of the 19 million eligible employees under auto enrolment legislation, nine million were already members of qualifying schemes. However, by the end of 2015, we will have auto enrolled a further eight million employees. These employees have become members of pension schemes, not by their own volition, but through inertia. They could potentially coast along through several schemes, reaching retirement, not fully understanding what they have actually been signed up for.

Would they be wrong to expect that the contribution rates and investment strategies chosen for them by their employers (or trustees) would be adequate for a comfortable retirement?

At retirement, they will face a frightening amount of choice. According to The Pension Regulator, 70% of members of current pension schemes remain in the default fund strategy within the scheme. Furthermore, nine out of ten members do not shop around for annuities, potentially missing out on opportunities to maximise their income.

The government initiative, Pension wise will be available to help them understand their options but how much confidence do we have that members will be able to wisely manage the choices around their broader choices at retirement?

Experience in Australia indicates that 44% of their membership takes a lump sum at retirement to pay down loans and a further 28% use the lump sum for a holiday or a car. A recent research report from Prudential, of those planning to retire in 2014 showed that women owe £20,700 on average while men will retire with an average debt of £28,400. It is likely therefore that we will see a similar pattern in the UK, especially for those retiring with a CETV or DC pot of less than £30,000. Is that necessarily a bad thing?

Who ensures good governance?

So who within the industry is responsible for ensuring good governance of our DC schemes?

The introduction of the Independent Governance Committees (IGCs) is a good start, but looks at schemes at a high level only. A number of advisers have developed high quality DC governance tools to help sponsors and trustees evaluate and track the governance of their schemes.

However, the implementation of that governance will finally reside with the employers, DC trustees and pension providers of contract-based arrangements. They will need to ensure that they are focused, not merely on the structure of the product, but the member outcomes as well. These stakeholders will then be overseen by two bodies, the FCA and The Pension Regulator.

The nub of the issue is that the 92% of the audience at the pension event I mentioned earlier did not believe that these stakeholders were necessarily aligned with the very granular issues that the member needs to grapple with to ensure the retirement outcomes that are required.

Much of the issue raised were around legal issues (where does guidance stop and advice begin), some being driven by the financial implications (increased contributions, cost of education, etc.) and a lot by pure member apathy (interest and / or capability of understanding the complexities of long term savings for retirement).

How can we as an industry deal with these issues in a manner that is fair to all stakeholders?

• Ensure that contribution levels rise up to reasonable levels. The NAPF Pensions Quality Mark will help.
• Educate members around the asset allocation model, dollar averaging and the joys of compounding. On the 80/20 rule we just need a small percentage of members to make that leap toward being educated investors. For many, a high enough contribution level combined with a good default may be all that is required.
• Support the member with the highest quality of support around their decumulation options. Information on tax, longevity, risk, asset growth and possibly a panel of approved IFAs.
• Finally, to have a strong governance mechanism. If a trust-based scheme is too much, a strong representative governance board set up by the employer using a similar structure but without the formal authority and supported by quality advisers will go a long way to ensure that your pension scheme will deliver the outcomes your member desires. 

Professional Pensions: http://www.professionalpensions.com/professional-pensions/feature/2403027/is-dc-governance-fit-for-purpose