The DC pensions tightrope
There is undoubtedly a need for regulation within the ever-growing defined contribution pensions market, but while protecting the interests of scheme members is vital, a heavy-handed approach could see employers walk away from pension provision altogether.
Recent years have seen a shift away from final salary or defined benefit pensions towards defined contribution (DC) pensions, where the investment choice – and risk – falls squarely on the members. This trend shows no signs of abating, and conversely, with the proposed introduction of personal accounts by the UK government, it is likely to accelerate.
Some regulation already exists – the Financial Services Authority, for example, controls the sale of contract-based pensions policies. Now The Pensions Regulator (TPR), having recently consulted on the risks to DC members, is moving to issue its own guidance or regulation of DC schemes, and with the Department for Work and Pensions (DWP) equally concerned, the risk of over-regulation is tangible.
“If they go too far, that might just tip the balance,” says Tony Barnard, technical consultant at Gissings. “One of the reasons a lot of employers moved from trust-based to contract-based schemes is to get away from over-regulation.”
Crispin Lace, investment consultant at Watson Wyatt, adds: “The Regulator has to achieve quite a fine balance between trying to protect members of DC schemes and encouraging companies to offer pension provision in the first place. If you make it all too onerous then people will stop offering company schemes, particularly if the NPSS [National Pension Savings Scheme] comes in.”
So how do we avoid a Big Brother approach and find a happy medium between protection and over-regulation?
The key, says Alan Hubbard, chief operating officer at DC Link, is co-ordination between the different regulators to develop a set of best practice guidelines. Additionally, he suggests finding a way of identifying high risk DC schemes.
“Funding rate calculations on DB schemes identify very easily which are the problem schemes,” he notes. “In the DC world, there is no assessment of what is a high risk scheme, so we’re not necessarily asking for regulation, but perhaps some more intense monitoring of high risk DC schemes.”
Barnard of Gissings warns against a “one-size-fits-all” approach to regulation, particularly since the Regulator found 97% of schemes (70,631) have less than 100 members.
“With a lot of larger companies moving to money purchase and DC, those larger schemes will be the schemes with the greater risk purely by number of members,” he says. “The fear is that they will come up with guidance and try to apply it equally to a scheme of 100 lives as a scheme of 10,000 lives and that will make life very difficult, especially for the small to medium sized employers.”
TPR is in the process of sifting through responses to its consultation How the Regulator will Regulate Defined Contribution Schemes in Relation to Risks to Members, and a spokesperson says it is too early to say what approach will be adopted.
However, she says the Regulator will not be producing joint-regulation: “We do work with other bodies but we wouldn’t produce regulations with them because our regulations relate to our remit and the FSA’s is different, so that’s for them to decide.”
The consultation paper identified five key risks to members: poor administrative practices; poor investment practices; unduly high charges; poor decisions on retirement choices; and lack of member understanding.
Hubbard at DC Link says while some of the problem areas were identified, regulators need to tackle the fact that small schemes should not be trust-based, and that DC schemes should be segregated from DB where hybrid schemes exist.
“Originally, DC schemes were set up as hybrids because employers wanted to keep their governance costs down, but secondly, many years ago a lot of DB schemes had surpluses and sometimes used them to pay for part of the DC section,” he explains. “Now, most schemes are in deficit, so the original reasons for hybrid schemes have dispersed although I do acknowledge that costs are higher having a separate DC scheme.”
Lace of Watson Wyatt says more could be done to bring governance of DC schemes in line with DB schemes.
“If it’s an employer-related benefit then companies should be prepared to exercise some governance over it to monitor the benefits they make available and make sure they remain appropriate,” he adds.
Whatever the approach, it seems clear that a light touch and co-ordinated approach will prove more successful than mounds of prescriptive regulation.
“At the moment everyone seems to have their own agenda,” says Barnard at Gissings. “If that continues then we’ll just have one piece of regulation on top of another. Until we get the various bodies sitting down and co-ordinating what they are doing, my fear is we’ll just get over-regulation and people walking away.”