The advent of 2012, auto-enrolment and personal accounts is highlighting the significance of the difference between trust- and contract-based pensions as never before. Two different regulators, different tax treatment and the potential for regulatory arbitrage between the two mean choosing which route to go down will become increasingly complex.
Add in the fact that the government is effectively endorsing trust-based by setting up its own version under occupational rules, and it is clear corporate intermediaries will in future be spending more time deciding which way to send their clients.
Delegates at the Corporate Adviser/Axa round table, DC pension investments: a time for change felt the reform process may tip workplace pensions back towards trust arrangements, and predicted that further changes would be needed if the regulatory environment is to remain coherent in the new world.
As the pensions reform bandwagon trundles its way towards 2012 it might seem as if there is little to be done to halt it. But there is still precious time left to influence the regulatory structure before then. There has already been much jockeying for position between contract-based and trust-based schemes in recent years, with contract-based becoming the principal growth area, not least because of the cheap, hands-off solution that it offers employers. But experts are predicting that there could be some sort of reverse back in favour of trust-based schemes, something many advisers see as no bad thing.
Auto-enrolment has been largely welcomed by the pensions industry but what remains to be seen is just how enthusiastically employers embrace the responsibilities bestowed upon them when it comes to pension provision.
In its first review of the defined contribution landscape, ‘DC Trust: A presentation of scheme return data’, The Pensions Regulator reported there are 1.5m members of trust-based schemes, of which 532,000 are active members, spread across 54,000 schemes, while there are 3.2m members of contract-based schemes, 8.8m members of defined benefit schemes and 14m personal pension plan holders.
How these figures look in three or five years time will depend to a large extent on how the regulatory structure is constructed in the next 12 months.
The option to return of member contributions if they leave within two years is one controversial factor that could persuade employers to go down the trust-based route, particularly where they have lots of staff attrition in the early years.
Andy Cheseldine, consultant at Hewitt Associates thinks the two-year refund rule for trust-based schemes should remain but questions whether it can actually be done. “Can you remain a qualifying scheme with a two-year refund rule – does that not effectively abolish it?” he asked, “You could offer the people the choice of personal accounts or another scheme that does do a refund.”
Cheseldine says the appeal will be strong to some employers with high staff turnover.
“If the client is prepared to pay a fee to Hewitt, Mercer or Watsons for advice they are not going to change their spots overnight, they are going to remain committed to offering their employers decent retirement options. But a high street retailer with very high turnover, then they may take a different approach. The CIPD reckons that 75 per cent of leavers leave within the first two years. You might probably put people into personal accounts for two years and then if they are still with you move them up into “the proper scheme”. The question mark then will be whether you leave them in personal accounts and put the extra into the proper scheme or whether you move them completely into the proper scheme.”
Meanwhile, Katharine Photiou, principal at Mercer is concerned at the migration toward contract-based pension schemes for small and medium-sized employers. “That risk transference to employees has gone too far, to the point where there isn’t any fiduciary role,” she said, “We need something with a fiduciary role, pensions regulator obligations and governance committees that actually have teeth.”
She also suggested the industry could migrate over towards some form of hybrid style trust-based scheme with an element of risk sharing between the employer and the employee and some corporate body looking at the trust issues.
Delegates predicted attrition from contract-based schemes into personal accounts. “I don’t think the providers want them and I don’t think the employee benefit consultants want them,” Photiou says.
What employers certainly won’t want is any sort of liability – the scenario where members come back to them if they are dissatisfied with the performance of their pension. The notion that a group stakeholder plan employers can avoid liability may not be one that can be relied upon.
“As soon as we get into a situation where there are a load of small savers that are then suing a large corporate entity, history tells us that courts tend to favour the little guy,” said Will Allport, director product strategy, UK & Ireland at AllianceBernstein.
Cheseldine added: “When you designate a stakeholder scheme there is no liability at all, but as soon as you contribute into it as an employer it ceases to be a designated stakeholder. So although it is perverse, if you set up a stakeholder and then contribute to it you can be sued. There is no exemption.”
It may also be the case that an employer that is feeling defensive will look at the fact that the government has made personal accounts trust-based and think that replicating that structure will protect it from legal come back.
“Personal accounts is the government mandated DC plan that has had all of this research and industry consultation,” Allport reasoned. “So it will be tempting for some employers to say: ‘How can I mitigate all of my risks around my pension provision? Obviously I have got to tick all the boxes of the employer’s duties under the Pensions Act but after that is the structure of my scheme giving me any risk? And if I design my scheme pretty much like the Government one then no one is going to touch me’.”
Whether going the trust-based or the contract-based route, the issue of employee engagement is a key one.
“We have to get the employer engaged in that process otherwise my concern is if providers provide that role to some degree in contract-based then employers can step away from that responsibility,” said Photiou. Some form of framework and governance, that includes a role for the employer, put in place by the Pensions Regulator would be welcome, she argued. “We do need employers engaged in contract based solutions in the workplace,” she said.
Many employers will argue getting involved in investment decisions is certainly a step way too far beyond where they want to be. But Gary Smith, senior investment consultant at Watson Wyatt said employers may be missing a trick in gaining employees’ appreciation, in that taking responsibility and doing it are two different things.
The Pensions Regulator has called for informed member choices at retirement and greater employer engagement for defined contribution pension schemes. It has called on trustees to do their best to help members who are retiring make the right choices about their savings and focus on improving the standards of pre-retirement processes and member communications and also wants to encourage employers to engage responsibly with employees about pension arrangements.
Tony Hobman, chief executive of The Pensions Regulator has said: “It is more important than ever in these challenging economic times for members to make the right decisions to maximise value for money at retirement. We know that our work on DC will enable trustees, employers, advisers and providers to improve the outcomes for DC scheme members. In the run-up to 2012 we are focusing on providing more education to assist employers with their pension provision and are looking at the standards in key processes for DC pensions. We are willing to enforce better practice, if we need to.”
Industry experts see two challenges to employers and pension providers in addressing these educational and communication issues. One is that there is a huge mistrust over savings pensions or otherwise among the population. But also that those doing the pensions communicating have to re-think just where the focus needs to be.
“The borrowing culture’s bubble has been pricked,” said Robert Booth, investment strategy manager at Axa Corporate Benefits. “Give it another five years and I think as a nation we will be much more one of savers rather than borrowers. Then if people are saving for the long term, does it matter much whether they are saving into a pension or into an ISA?”
This will certainly help pensions practitioners whose efforts to promote pension savings has been dogged by the credit culture and a commonly held view among the populace that you don’t have to save to afford something.
Whether they do so within the contract-based or trust-based framework will depend on who lobbies for what in the coming months.