Both the Department for Work and Pensions and the Pensions Regulator are setting a great deal of store by scheme governance to ensure standards and good outcomes for members as auto-enrolment begins its gradual but inexorable roll out across the UK workforce.
But how much of a premium will employers and employees put on governance? Will they know what it is when they get it and how much of a difference will it make to their outcomes?
“Scheme governance is more of an issue than it has ever been before,” says the Pensions Management Institute’s technical consultant Tim Middleton. “We are going to be enrolling people into pension schemes without getting their specific consent. We need to be striking the right balance with default funds, a balance between prospects for growth and ensuring stability without paying too much in charges. There is more moral responsibility on trustees and employers than there has ever been before.”
Advisers say that perceptions and awareness of pensions governance vary dramatically among employers.
Hargreaves Lansdown head of pensions research Tom McPhail says: “This is a complex landscape with good and bad all across the piece, and sometimes even within the same scheme.”
On the whole, advisers say that for most employers, ensuring compliance with auto-enrolment itself is the top priority, not governance, and any significant focus on governance will follow later.
Jelf head of benefits strategy Steve Herbert says: “Governance will ultimately be very important to the success of auto-enrolment. However, most employers, particularly those new to the pensions field, are struggling to even find the time and resource to meet their auto-enrolment duties, and governance is probably considered tomorrow’s problem at this stage. Once auto-enrolment is safely put to bed, governance will rise up the agenda, but for many, this is a step too far at this point.”
Unsurprisingly, advisers believe awareness of governance is typically lowest among employers which haven’t offered pensions before.
Herbert says: “Employers who have traditionally supported pensions in the past are more likely to have awareness of and compliance with governance duties. For new entrants to this field, the knowledge bar is much, much, lower, and is a little way down the road for many. I think the media and the political agenda will raise awareness in the coming years here. The pensions industry is likely to focus increasingly on this area post the auto-enrolment and RDR spike as well.”
But some experts say that meeting the basic requirements alone could lead to problems. PTL managing director Richard Butcher says: “The good employers, and the larger-sized employers are getting some governance structures into place. However before the Olympics, I was likening it to the 110m hurdles. Everyone has been thinking about getting over the first hurdle, but no one is thinking about getting over the second, third, fourth, and so on. We are telling employers if you don’t think about this, you fall at the second hurdle and undo all the good work getting over the first.”
Buck consultants head of pension policy Kevin Le Grand says: “There is a big problem with DC schemes and poor member outcomes. One obvious way to address this is to put more money in. The other is to make the best you can of the money that does go in. If you have a scheme you set up and leave alone you can’t ensure the outcome. A lot of schemes were sold on the basis that it was just that. ‘Pay your money and walk away.’ We are starting to see more interest from employers in outcomes, but also there are benefits if you are sticking that money in and being forced to do so, you might as well get good value for it. If you find your employees get to retirement age and won’t leave because they don’t have much money to live on, employers might question the value.”
There are also debates about whether formal governance structures involving trustees will always produce good outcomes or whether more informal but effective arrangements can actually do better in terms of scheme communications.
“Be it trustee or governance committees, the application and understanding of governance by employers is pretty patchy across the UK at present. Different organisations and indeed sectors of the pensions industry have different criteria for what a suitable governance structure is, and how it should be delivered,” says Herbert.
McPhail says: “If you have got a well-informed, well-engaged independent body of trustees looking after members that is the most robust structure, but it is pretty rare. Sometimes you get it on small schemes, sometimes on big schemes but there are no hard and fast rules. It is easy with trust-based schemes to default members in, default them into a fund, default them to a contribution rate. Officially you have a robust structure with trustees negotiating the price, but it is no guarantee that everything is going to be good.”
“You can have contract-based pensions where between the administrator or the scheme adviser and the employer secure low charges and offer good member communications, and they are managing to look after employees very well.”
Traditionally however, the contract-based scheme has often been chosen precisely because the governance is less onerous.
Johnson Fleming senior consultant David Roderick says: “People are beginning to wake up to the fact that money purchase needs governance. We go along with TPR in terms of six key areas. Lots of schemes have done administration, investment and charges, as part of their strategy. But there is a massive gap between the good, the bad and the downright ugly. Many schemes have been sold where there is no governance, and governance is effectively handed over to the provider.”
Lift Financial head of corporate pensions Noel Birchall says many employers have chosen contract schemes in the past precisely because they don’t have trustee responsibility.
Advisers will now have to change tack and ‘sell’ governance to them, he argues.
He says: “From an adviser point of view, governance is a logical extension to the services they provide, especially as services move away from new joiners to on-going support. As far as clients are concerned, many chose contract-based because of the lack of trustee responsibilities so governance services have to be “sold” to them rather than clients demanding them.
“But I think most contract-based schemes can be persuaded to have some form of governance as part of their schemes reaching a more mature phase and having significant assets within them.”
In terms of its direction of travel, TPR head of DC regulation Darran Burton, setting out the regulator’s approach, implies that it hopes the larger employers can lead the way. He says: “All members should be auto-enrolled into schemes capable of delivering good outcomes – we are committed to raising standards of governance and administration in all DC schemes. Our aim is to achieve better performance from those providing pensions and running schemes, while enabling employers and members to make good choices about their type of scheme.
“We want smaller employers to have confidence that, when it is time for them to select a scheme, the market will provide a quality product.”
Butcher suggests the direction of regulation is effectively creating a ‘pseudo-fiduciary’ regime for contract-based schemes.
But he says the final nature of regulation is difficult to identify even with the TPR’s six principles, six elements of good outcomes and 36 key features. Butcher says, for example, under contract-based schemes it is difficult to know who will receive a regulatory slap, the employer or the insurer, or even which regulator will be doing the slapping, TPR or the Financial Conduct Authority.
He says: “I suspect there will be a code of practice at some time that will give the six principles, six outcomes and 36 key features an evidential value, if not quite making them a requirement. That is probably where we will end up in the medium term. We will end up with a framework but I don’t think that will be thrashed out probably for another three, four or five years.”
One question many are asking is whether the halfway house of master trusts can provide the answer. Twelve firms, B&CE, Black rock, BlueSky, Legal & General, National Pension Trust (Xafinity), Now: Pensions, Pensions Umbrella Trust, Salvus, SEI, Standard Life, SuperTrust and The Pensions Trust have set up the Master Trust Association (MTA) to drive up standards and increase public confidence in pensions.
The chief executive of Now: Pensions, Morten Nilsson, says he was surprised at the low barriers for setting up a master trust in the UK, though this led the firm to almost have to reinvent the wheel to get the strong structure he wanted.
The driver for setting up the MTA is that generally poor standards have damaged trust.
“Our research shows that what makes people not save enough is that they don’t trust their providers. We in the NAPF and the MTA and are trying to advocate that the standards of pension providers should increase around cost, governance, investment governance and default funds. We also see too much volatility and risk not being managed and poor record keeping.”
Another driver is managing conflicts of interest, although on this point, Roderick is quite cynical. He says: “Whether it delivers good governance, employers are handing over a lot of control. They provide a solution to certain issues. They can deliver governance, but it is bound to be limited.”
Butcher, whose firm PTL is involved with seven master trusts, says that what will distinguish good master trusts from the also-rans will be issues such as demonstrating competence with investments, offering good investment tools, the ability to communicate with the end user, and showing how all individuals can achieve good member outcomes.
But the issue that will concentrate minds in the industry is whether regulators and politicians eventually envisage trusts and governance structures being involved in switching fund managers and pushing down on charges.
Le Grand says: “I think that is where they would like to get to. There are two approaches. One is you take the view you can educate members to take decisions and give access to information. The other is you take the view that the vast majority of the population will never get to where they will be able and confident to take investment and annuity decisions. The DWP are at the second place. So they think people are ill-equipped and you have to rely on someone running the scheme for them to get the best outcome. That means you’ve got to have some professional involvement and review and updating of investment.”
Le Grand says there are many routes to achieving this.
“On the investment side, you could give the investment manager greater responsibility, a managed approach, or you could have the consultant doing it through managed consulting. You have the usual issues of the adviser making sure they are not conflicted with firewalls or use different advisers and consultants. I don’t see why the consultant can’t be involved in the mechanics of scheme as well as given the advice. I don’t see a fundamental conflict. In many ways, it is putting DB-type controls and overrides into a DC environment.”
Most advisers and consultants remain unconvinced about how the charges issue should be treated. Butcher says: “Low charges are important but what is more important is the value you get for the charges you pay. Twenty basis points on a bog standard contract where you get nothing, is that better than 30 bps where you get support and are likely to get a good outcome?”
Roderick says: “Is it about charges? In terms of charges being low, they are pretty low. For the right solution, the top end of schemes, we are seeing charges as low as 0.2 per cent, if the benchmark is 0.5 per cent, a lot are sitting around that charge rate.
“I don’t think it should be about switching fund managers and making investments because you are almost moving into unbundled trusts. Certainly for the average members it is not going to achieve much in member outcomes. It is about ensuring the default strategy and the primary funds are appropriate, and there is a role for consultants in achieving that. The true role of governance is not working out whether it is 0.4 per cent or 0.5 per cent. Or if it is a 60/40 global or 40/60 global fund. The true role is how we make members understand the role they have to play, if they are enrolled in a one and one contribution scheme.”
However, it is clear that governance comes at a price. Roderick says: “Where does the money come from for governance? It is a cost on employers. To deliver governance is not cheap, and certainly not to the level the TPR thinks is good practice.”
He says one client has had a quote from a big consultancy to provide governance to TPR-required standards for 1,000 lives at £200,000 a year.
“As with all things, employers can pay for it directly or incorporate it in the costs of the scheme. It depends on their appetite. The higher end will pay fees. As you move downscale it becomes more challenging,” concludes Roderick. n