Different ways of managing workplace pensions

Most Defined Contribution (DC) workplace pensions are set up so that there is minimal need for employers and staff to intervene in their management. This is in sharp contrast to defined benefit plans, where constant attention is need to the funding of the plan to make sure there is enough money to pay pension promises.

However, DC workplace pensions are far from simple to run and the cost of bad management is felt in retirement in a lower standard of living for former workers.

A small number of employers will want to take direct responsibility for the management of the DC scheme. Usually this means setting up a board of trustees, creating unique “scheme rules” and taking responsibility for each aspect of the scheme’s management. We’ll refer to this approach as trust-based. Not surprisingly, it is thought too demanding by most employers who prefer to outsource this management function to an insurance company. In this case, the insurance com­pany will take who takes full responsibility for the management of the scheme, usually set up as a series of individual contracts with members. This approach is known as “contract-based”, a term covering both group personal pensions and group stake­holder pensions. Currently, contract-based plans have internal governance commit­tees. However, their providers have recently agreed to make these committees inde­pendent of the providers by forming “Independent Governance Committees” (IGCs).

A more extreme form of outsourcing involves requiring members to take full responsibility for the investment of the monies contributed. This is known as “self-investment”, and the type of workplace pension is known as a group self-invested personal pension (GSIPP). We won’t talk much about self-investment in this document, as workplace pensions qualifying to be used for auto-enrolment have to provide a default investment option which members use unless they choose to self-select. Under a strict definition, GSIPPs are not suitable for auto-enrolment.

There is one further variation we should mention at outset: the master trust. A master trust is a trust-based pension where the responsibility for managing the pension is outsourced to a board of trustees rather than directly to the organisation providing the service. Theoretically, the board is entirely disconnected from the providers of investment and administration services, but often the distinctions are blurred.

Some insurers run master trusts, and most master trusts contract with a service provider which manages the various services on offer. Most people know of one master trust, NEST, which was set up by the DWP. Similar master trusts are run by NOW:Pensions and The People’s Pension. The advantage of master trust, in terms of “governance”, is that it offers the formal trust-based structure but without the obligations of the individual employer. Master trusts are set up on a multi-employer basis, so what is lost by the employer in terms of control is made up for in the reduction in risk and cost.

Communicating governance

If you were to ask most people to spontaneously associate a word with “governance”, the word would most likely be “boring”. Governance (or management) of a pension should involve minute scrutiny of data and should be uncompromising in its approach. In this regard it should be boring. Attempts by those being managed to treat governance lightly have often been a smokescreen for their incompetence, negligence or downright fraud.

However, we should not confuse this serious business of scrutiny with the communication of the governance process to those sponsoring the scheme. This communication should be engaging and should be a pleasure to read. Too many governance reports are never read because they are as dry as a ship’s biscuit.

To be relevant to the sponsors and beneficiaries of schemes, communications should be relevant, well-written and brief.

Governance – what matters

There is a lot of guidance for trust-based plans from the Pension Regulator. The Regulator’s website gives guidance to companies setting up their own DC trust, which is intelligible and comprehensive. You can access all this information here (http://goo.gl/jyTNH7). There is a lot here and you may prefer to read the simplified version produced by solicitors Squire Saunders which is linked here (http://goo.gl/Oi0TtV).

Here we’ll concentrate on the simplest of the Pension Regulator’s papers which explores, ”what makes for Good DC outcomes”? Our view at Pension PlayPen is that employers selecting a good workplace pension should concentrate on just six factors.

1. Price – are the services offered competitively sourced? How competitive is the price charged to the member and employer?
2. Durability – is the provider of investment and administration services committed to the market and do they have a sustainable business model?
3. Support – what is the quality and extent of the support offered to employers at outset and on an ongoing basis?
4. Engagement – how successful is the provider in engaging members on their responsibilities to make the pension work?
5. Investment – how likely are the investments of the plan to provide better returns and what are the risks being taken?
6. At and beyond retirement – what does the provider offers to help members get the most from their retirement savings?

Some of these factors are easier to assess than others. Unfortunately this leads to a bias in assessment towards what is most obvious. Take price as an example. A cynical inter­pretation of providers might suggest that they are “as bad as each other” and can only be differentiated by the price of the services they offer. This is an obvious error and is a result of laziness. Unfortunately, many governance specialists dismissive of DC pensions have adopted this shortcut to ongoing governance as well as assessment. This leads to a dumbing down of factors 2-6 by providers happy to cut corners.

Unless there is a holistic approach to selection and governance, employers and their staff are likely to end up with a cheap but not very cheerful experience. The key to good selection and good governance is to adopt a balanced approach and not to take any shortcuts in scrutinising each factor.

What do we mean by Price?

It is the members who usually pick up the investment costs of their workplace pension plan. These costs include the costs of investing and recording contributions, and the ongoing costs of managing the money. Sometimes members are expected to pick up other costs, such as the compliance costs to the employer and the cost of selling par­ticipation (paid as commission).

We are opposed to passing compliance and sales costs to staff, and support initiatives to ban them from workplace pensions. Where legacy commissions are still payable within the plan, these costs are easy to identify and to strip out, employers can easily check whether these toxic charges exist in a plan by asking their provider or adviser. No new workplace pension should use commissions to pay for sales commissions or em­ployer compliance.

More difficult to spot, but just as damaging to a member’s fund, are the recurring bills to members, funds presented by those providing services to the fund managers. These bills can be for buying and selling shares, bonds and properties, for research, for exchanging foreign currency, and for the legal and custody services that fund managers buy-in. We have a simple attitude to what needs to be included in the price. This is assessed as “what the member pays” – we call it “total billed” – and the price covers everything for which there can be an invoice.

What do we mean by Durability?

The list of insurance companies we have entrusted with our savings that are no longer offering workplace pensions is long, and includes some household names like the Prudential and Royal Sun Alliance. When a provider stops selling itself to its public, standards tend to fall, research and development falls away and member service and investment returns often suffer.

Trustees and even Independent Governance Committees can assess the durability of a provider in a number of ways.

One means is to refer to the credit ratings of the company providing the service.

Clearly this limits this technique to providers who are big enough to choose to apply for a rating, and the rating only refers to the financial strength of the organisation, not to its commitment to UK workplace pensions.

A second means is to refer to ratings provided by AKG, a UK-based specialist rating agency that examines in detail the returns to the FCA of each contract-based provider and assesses their financial capacity to continue trading. AKG also makes a subjective assessment of the commitment of the provider’s management to workplace pensions. However, by far the most effective form of assessment is through interaction with the management of the provider itself. Clearly this is difficult where the provider has estab­lished the trust (a master trust), or where the Independent Governance Committee is populated mainly by representatives of the provider that set it up. Such conflicts of interests persist but are diminishing as good DC governance improves.

What do we mean by Support?

For a workplace pension to run successfully, it must properly integrate with the employer’s HR -and payroll functions, so that money can be invested in a timely and accurate way, and employees get communications that are intelligible and useful.

While there is a benefit to staff, it is principally of benefit to employers who have to conform to the rigorous auto-enrolment regulations. Failure to comply can be expensive to employers with a swingeing fine awaiting those employers who do not properly invest deductions and communicate options to staff.

Strictly speaking, the remit of trustees and governance committees is to protect the interests of staff and not employers, but in practice we consider that the monitoring of provider support is likely to be included in scope. “Support” and “Service” are comple­mentary terms.

What do we mean by Engagement?

There is general acceptance that contributions to DC pensions are too low to properly replace income lost at retirement. To make that difference up, investments must perform better (aided by good governance!) and employees must contribute more.

Encouraging members to join, stay in and properly use the workplace pension is a key task for providers, and one that can be easily monitored by IGCs and trustees. One simple measure to monitor the effectiveness of a plan’s engagement strategy, is to look at the level of voluntary contributions and the levels of opt-out from the plan.

Historically, other metrics relating to investment choice were used. It was thought that schemes where a wide variety of funds were selected and a large number of fund switches transacted were seen as “good”. This presumed that individual engagement in taking fund choices was in their interests. Now the concept of making “everyone their own Chief Investment Officer” has become less fashionable.

The means by which a provider can work with employers include worksite meetings, the judicious use of social media and web-based tools, as well as more traditional, paper-based communications.

What do we mean by Investment Governance?

This Is easily the most developed area of governance. For a full investment checklist you may want to access the Pension Regulator’s Investment Governance Template here. It is important for trustees and IGCs to be clear about the different layers of governance involved.

At the core of the investment process is the selection of assets and their management within a fund. Scrutiny has to be applied, not just to the investment choices but also to the execution of those choices. There should be a clear strategy that drives these deci­sions, based on the investment philosophy of those that manage the fund. This strategy should be aligned with the strategy of the provider as outlined in a Statement of Invest­ment Principles.

Governance is much more about outlining what an investor can expect and delivering to expectations than in deciding whether the strategy is good in itself. It is possible to have two pension schemes with widely different strategies both of which can be excel­lently governed. They will deliver different outcomes and ultimately the strategy not the governance will most determine outcomes. However, we are clear that funds that follow a consistent well-executed strategy consistently outperform funds that don’t.

Increasingly there is consensus on fund management strategies that are likely to deliver better returns than others. The work of Professor John Kay, on long-term investing, sug­gests that where fund managers exert pressure on the management of companies in which their funds invest, those companies produce better returns. Similarly, where funds insist companies in which they invest pay heed to socially responsible behaviours, sustainable out-performance against companies that don’t - can be achieved.

Pension PlayPen works with Share Action, a pressure group that lobbies for high stand­ards of investment governance in fund managers, to ensure members get the dividend from investing in companies that exercise these (good) practices.

As well as scrutinising the work of the underlying fund manager’s investment decision - making, trustees should also study the impact of the trades entered into. A well-executed trade can cost a fund a fraction of a poorly executed trade. While scrutiny of the trading impact within funds is difficult, it is not impossible and should not be beyond the capacity of an IGC or a properly constituted trustee board.

We should point out that the impact of poor trading is different from the costs of that trading. Costs are scrutinised as part of the price, impact as part of investment govern­ance.

So far we have concentrated on the activities of underlying fund managers. However, trustees and IGCs also need to be concerned with the behaviour of those that buy and sell funds on behalf of members. These we can call the fund platform managers rather than the managers themselves.

Units of funds are constantly being bought and sold as a result of manual switches, transfers in and out of the pension itself, and because of automated trades (typically resulting from lifestyle trades). The internal controls exerted to ensure this work is carried out to the best standards can often be lax (especially when a provider is no longer marketing itself to the public).

There is considerable work to be done to properly scrutinise this area of investment management. This includes the setting of “best practice benchmarks” to ensure stand­ards are available to trustees and IGCs. But, most importantly, providers must develop the reporting mechanisms necessary to deliver the management information to trustees and IGCs, to ensure that these procedures are properly monitored and audited. Since there are so many participants in the investment management process, the opportunities for things to go wrong are at their greatest, and the need for good govern­ance most critical, in this area. In our view the majority of trust-based workplace pension plans are simply not resourced to manage the data needed to properly monitor invest­ment performance (even were that information is available).

Finally, a note about fund choice. It’s estimated that 85% of all DC money is invested in defaults, in auto-enrolled schemes the percentage is even higher. 85-90% of trustee attention must be focussed on the default investment strategy, but residual time needs to be devoted to the additional fund choice offered.

Obviously the budget for additional fund choices is limited by the concentration on the default. Additional funds do not get the level of scrutiny of defaults and this should clearly be indicated to members (as off-piste skiing is indicated as riskier than sticking to the main ski areas).

It stands to reason that the smaller the number of funds offered by providers to mem­bers, the greater the governance of each fund. We do not recommend that more than 10 additional funds be promoted on a scheme’s platform. Any funds selected beyond this limit should be considered as “self-invested”, and either form part of an individual contract (a SIPP) or be clearly marked as being funds for which the trustees can take no responsibility.

What do we mean by “At and Beyond Retirement”?

We have got used to thinking about workplace pensions as a means to build up pension savings. We give little thought to what happens at retirement. But recent research shows there’s a huge disparity in the rate at which pension savings are converted to pensions through annuitisation.

Workplace pension pots are now maturing with over 420,000 people buying an annuity in 2012.

Trustees, and in particular IGCs, are in a position to improve things through governance. Insurers are under a partial obligation to follow the ABI’s code of good practice and ensure that members of workplace pension, have access to all annuity options. But there is scope for innovation in this area, and trustees and IGCs wishing to go the extra mile and offer more than the bare minimum are in a position to add considerable value.

Currently we see few workplace providers fully exercising good governance in this area. Much more can and should be done. Relative to mature areas of governance such as “investment and administration”, governance “at retirement” is a Cinderella.

Ten top tips for getting started

1. Make yourself known. If your workplace scheme is contract-based, contact your insurer and find out who is responsible for establishing their IGC. If you are in a master trust, ask who is secretary to the trustees.
2. Ask your point of contact for a statement on the trustees’ policy on each of the six areas raised in this document (you may wish to send them this document).
3. Ask specifically what the trustees’ policy is on corporate governance and what procedures are in place to make sure that it is observed.
4. Ask if the trustees have produced either a statement of investment principles and a statement of investment philosophy.
5. Ask what opportunities there are for you to become a trustee or be part of the Independent Governance Committee.
6. Ask what you can communicate to your staff to demonstrate you are monitoring the management of your scheme.
7. Set up your own governance committee: we’ve attached terms of reference below.
8. Join Share Action’s Greenlight campaign at www.action,shareaction,org/content/greenlightlanding/ Details on the link
9. Read Pension PlayPen “how to” guides, available at www.linkedin.com/company/pension-playpen=top_nav_home
10. Go to www.pensionplaypen.com , rate your pension and, if all else fails, choose a new pension!

Workplace Pension Plan Governance Committee

Terms of reference

Background

The purpose of this document is to provide an overview of the terms of reference for the Governance Committee set up to oversee the operation of the XYZ Stakeholder/GPP Pension Plan (the “Plan”).

It should be noted that the Plan is not a trust-based pension arrangement and so the Governance Committee is not a formal trust body. This means the Governance Commit­tee is not subject to the formal duties and responsibilities imposed by trust law and prac­tice.

Purpose of the Governance Committee

Whilst the ultimate responsibility for the Plan remains with XYZ, XYZ has charged the Governance Committee with overseeing the operation of the Plan on its behalf.

Members of the Governance Committee can also act as a conduit for seeking the views of the Plan members and feeding these back to XYZ, so that it can consider the relevant issues and decide if any action should be taken.

Members of the Governance Committee are not authorised to provide advice to any members of the Plan and they should therefore ensure that only factual information is provided to members in order that committee members do not breach any regulatory provisions.

Composition of the Governance Committee

The membership of the Governance Committee will normally include the following individuals but may, at the sole discretion of XYZ, include other appropriate parties:

• XYZ representatives, including the:
  • Finance Executive
  • Human Resources Director
• Employee representatives, including:
  • One employee who is a member of the Plan nominated or chosen by the Plan members
  • A relevant trade union official

XYZ has complete and sole discretion over the appointment and removal of members of the Governance Committee.

First Actuarial, as pension advisers to XYZ, will provide advice and secretarial support to the Committee.

In addition, a representative of the Plan provider will normally attend meetings of the Governance Committee.

Key duties and tasks of Governance Committee

• Provide feedback and recommendations to XYZ in order that it can make well informed decisions regarding the strategic and operational aspects of running the Plan
• Work with the advisers and Plan provider in order to achieve the e.icient and effective operation of the Plan. This is to be achieved by the operation of an annual governance process which will include:
• Receiving regular reports from the Plan provider on the operation of the Plan, focussing on.
• Price – are the services offered competitively sourced? How competitive is the price charged to the member and employer?
• Durability - is the provider of investment and administration services committed to the market and do they have a sustainable business model?
• Support- what is the quality and extent of the support o.ered to employers at outset and on an ongoing basis?
• Engagement- how successful is the provider in engaging members on their responsibilities to make the pension work?
• Investment- how likely are the investments of the plan to provide better returns and what are the risks being taken?
• At and beyond retirement – what does the provider offers to help members get the most from their retirement savings?
• Acting as a conduit for feedback from the members of the Plan and addressing any issues or complaints raised by members with the Plan provider.
• Making recommendations to XYZ in relation to any actions thought necessary as a result of strategic or operational matters brought to the attention of the Governance Committee, whether by the members of the Plan or the advisers or the Plan Provider.

Change

XYZ reserves the right to change any aspect of the Terms of Reference of the Govern­ance Committee and may, if it should so decide, choose to dispense with the operation of the Governance Committee. Appendix: sample terms of reference for an employer governance committee – kindly provided by First Actuarial.