It seems that barely a day goes by without a story or anecdote about the struggles associated with DB schemes. In contrast, DC schemes seem to sail serenely on through calm waters without any of the risks or problems that DB schemes face.
There may, however, be monsters lurking just below the surface for many of these DC schemes. The nuts and bolts of a DC scheme are complex, involving investment options, communications and infrastructure that make a DB scheme quite straightforward. Underpinning this is a high level of member expectation as to how the scheme will perform and no automatic safety net of an employer to top up the money if things don’t go according to plan.
With this complexity comes greater scope for things to potentially go wrong and, if they do, for the consequences to be severe.
In 2010, approximately 1.5 million people were members of trust-based DC arrangements in the UK. By 2020, this had increased to 35 million members.
So, while we have not yet had a generation of retirees relying solely on DC benefits to fund their retirement, that is the direction in which we are heading. And for many of these members, engagement with their retirement arrangements will have been limited until they are very close to retirement. In 2019, TPR noted that 95 per cent of members are in default funds, and studies show that 85 per cent of members don’t respond to pension scheme communications.
The effect of this is that many members will approach the latter stages of their working life with an expectation that their pension savings will sustain them in retirement. They have paid contributions and they expect these to have grown significantly over the years to provide a substantial pot for a long and happy retirement. Their experience of pensions will have been to see many DB members retire with valuable benefits with which to enjoy their retirement.
If this member expectation is not met, the rise of the compensation culture in the UK could lead many to search for somebody to blame. Claims management companies have grown over the past decade, focusing on issues such as PPI and, in recent times, pension scams. The combination of disappointed members, a DB comparator who is receiving a secure and guaranteed level of income and claims management companies pointing to potentially significant amounts of compensation, could easily lead to a rise in claims in the DC field.
It doesn’t necessarily follow that disappointed members will have valid claims. So, is there anything to be concerned about? Well, yes, because the inner workings of a DC scheme comprise an incredibly complex beast.
The systems and processes involved in a DC arrangement are crucial, intricate and interconnected. Here are just a few examples.
The collection and investment of contributions is key. Given market fluctuations, any delays or failings in such a system may give rise to loss for a significant number of members. Trustees must, with the assistance of investment managers, select from a huge range of investment options for members, including an appropriate default fund for the members who do not self-select.
And the default fund choice and design is itself complex. It must reflect members’ divergent attitudes towards risk, and differing expected time to retirement. It may include “lifestyling” or “target date” funds to transition the investments as members approach their target retirement age. And as members now have a wide range of choice for how they can access their benefits at retirement, and at what age, there is plenty of scope for members to decide, with hindsight, that the default fund was not right for them.
With the increased complexity and member choice comes increased risk for things to go wrong and greater scope for members to challenge the investment offerings. Given the number of DC members, and the rise of claims management companies in the pensions industry, it is credible to think that we will see a rise in DC member claims.
Trustees and employers who are alive to these risks and take steps to mitigate them will be able to better place themselves to withstand such potential challenges if they arise in the future.