Key speechesRegulating the changing pensions market - the world beyond DB

Tony Hobman, chief executive, speaking at the Pensions World conference
November 2009 

Good morning and welcome.

It is my pleasure to be here with you for the start of a day of discussions about some of the important issues that we all face in the pensions industry at this time.

I have been asked to talk to you about 'regulating the changing pensions market', so for the next 15 minutes or so I will aim to give you:

• some insight into our regulatory response to the evolving landscape for occupational pensions in the UK
• an update on our current work at the regulator; and
• an idea of the areas we will be focusing on as we move forward into this changed and still changing landscape.

It is certainly the case that much has changed in the relatively short space of time since we opened our door for business in 2005.

There is of course greater economic uncertainty; and the pensions market is increasingly moving towards DC provision, a trend that will undoubtedly continue as we head towards 2012 – when millions more people will be given access to workplace pensions – many for the first time - and over a million employers will be required to offer a pension – again many for the first time.

And as a responsive and risk-based regulator we have always been focused on ensuring that we remain able to regulate effectively across our broad remit to protect the benefits of members of all workplace schemes.

This means recognising and dealing with both the current and emerging risks - in both the DB market and in the growing DC market.

And of course it also means ensuring that we are able to play our part fully in the successful implementation and delivery of the regulatory framework to support auto-enrolment and the 2012 reforms.

Before I talk in a little more detail about our current work - I would first like to take this opportunity to reassure you that while our focus is indeed evolving to reflect the changing landscape - our approach to regulation will remain the same.

We remain committed to our model of education and enablement - focusing on delivering support and education for trustees, employers, and advisers. Continuing to do what we can to help you to fulfil your role in supporting and delivering successful workplace pension schemes to the highest standards.

And we will continue to use our enforcement powers only when necessary.

So we remain absolutely committed to harnessing risk-based regulation in support of our statutory objectives.

Today I want to talk specifically about some of the key areas that we are focusing on in order to enable us to fulfil our mandate.

These can be summarised as:

• Overseeing the prudence of DB scheme funding plans and continuing to monitor de-risking and liability management strategies
• Improving standards and engagement in the growing DC market
• Improving standards of practice in administration and governance across all schemes
• And of course continuing to build the capacity and capability to deliver the auto-enrolment process and monitor compliance.

[DB market]
The changes in the DB market have led to some pretty dire predictions in the media and within the industry about the acceleration of the demise of this form of provision.

However from a regulatory perspective at least, we remain of the view that DB is and will continue to be an important part of the pensions landscape for many years to come.

There are still over 8 million DB scheme members - and there remains a huge volume of assets in DB schemes – over 800 billion – compared with around 500 billion in DC.

And of course members will continue to be entitled to DB benefits - as they reach retirement - for many years to come.

So it should be no surprise that we continue to be focused on supporting those running DB schemes and ensuring that those members' benefits are protected; for as long as they have to be, into the future.

Our aim throughout our work on DB funding has been to help employers and trustees to identify the ways they can work together - within the funding regime – to create recovery plans which are affordable and reasonable for the sponsor - and which enable schemes to fulfil their undertaking to members.

An important part of this has been the flexibility afforded to schemes and sponsors within the funding regime. Throughout the downturn we have emphasised both the robustness of the system - and that trustees have many options for flexibility in setting recovery plans – like back-end loading, the use of contingent assets and allowing for a longer recovery plan period.

We have however also emphasised the importance of prudence in the setting technical provisions.

We encourage employers and trustees not to mask the true size of the liabilities or the deficit. It is not the Technical Provisions that are open to flexing. A scheme's deficit is what it is and the technical provisions cannot be adjusted down just because times are tough.

And this work with schemes and sponsors will of course continue well into the future – bearing in mind that we are only just reaching the end of the first triennial valuation cycle under the post-Minimum Funding Requirement regime.

[De-risking and liability management strategies in DB]
The effect of the economic climate on pension scheme deficits has led many employers to review the form of the pension provision they offer to their employees.

This in turn has fuelled the level of activity in the de-risking and the liability-management markets.

Various products have entered the market aimed at enabling employers to remove their pension liability from the balance sheet – or at least to reduce its size or volatility - and we are now seeing more sponsors than ever looking at the de-risking options available to them.

It is important for me to say now that we do welcome innovation in this market, and that we recognise the use of de-risking strategies as a positive and considered solution for schemes and employers.

However many of these products are new and complex – so it is important that trustees exercise caution – particularly taking into account the potential impact of their actions on member benefits.

In response to the risks that have arisen to members' benefits over the past few years – in June this year we were awarded new powers under the Pensions Act 2008.

This introduced the material detriment test - which is now a part of our anti-avoidance powers.

The test gives us the power to impose liabilities on decision-makers where they take actions that have a materially detrimental effect on the schemes' ability to meet their commitments to their members.

This was an important step – helping us to further ensure that adequate measures are always put in place to protect member benefits.

We know that the existence of our powers has a positive overall effect on behaviour, acting as an appropriate deterrent, and this is why it is so important for us to focus on education and enablement - using our powers only when absolutely necessary.

So - at the same time as the material detriment test came into effect we published guidance outlining the circumstances under which we would be likely to use the new test.

We also published a new module in our Trustee toolkit to enable trustees to increase their understanding in this area.

And of course we have continued to encourage trustees to come and talk to us if they have concerns about their scheme.

Another area of de-risking which has attracted much attention in recent debate has been around transfer incentives.

We already have evidence of poor behaviour in the running of transfer incentive exercises which is in contradiction with our guidance. This concerns us. So over the coming months we will be scrutinising transfer incentive exercises more intently.

As we move forward we will continue to monitor trends and activity within the DB market and where we see evidence of bad practice or unacceptable behaviours we will of course take steps to ensure members' benefits are protected.

[The DC market]
That said, as you will know from our messaging and outputs over recent months – we are also now placing even greater emphasis on addressing the risks facing trustees, employers and members of DC schemes.

And this – as I have said - is a natural step for us as DC provision takes on even greater prominence in the occupational pensions landscape.

There are already almost 2.5 million DC scheme members in the UK in over 54,000 occupational schemes.

And an additional 3.2 million employees have entered personal pension arrangements negotiated by their employers – through group stakeholder pensions, GPPs or Group SIPPs.

[Improving standards and engagement in the growing DC market]
DC scheme members bear significant risk and assume individual responsibility for the outcome of their pension savings.

And this outcome is undeniably influenced by the quality of the choices that they make - or perhaps they don't make - about contribution levels, fund choices, retirement options and so on.

As the DC market grows, more and more individuals will bear these risks and must decide on how to deal with the responsibility. And with this in mind we have been focused on improving standards in DC provision in two areas in particular.

Firstly - improving standards of administration and governance - most particularly in trust-based DC schemes

And secondly - supporting employers in understanding the responsibilities and opportunities they have when they provide DC pensions. And helping them to fulfil that role as effectively as possible.  

The difficult economic climate has inevitably meant that many members of DC schemes are now facing the reality that their savings may not be worth as much as they had hoped - and that they have some difficult decisions to make about their future income.

So, much of our work has been focused on ensuring that members are supported throughout their time in the scheme - for example given the right information in the period immediately before retirement as well as at the time they are deciding whether to join the scheme in the first place.

The pre-retirement phase is a particularly important period for DC members and, as more individuals take on greater personal responsibility for choosing the terms of their retirement income, this will become an ever more prominent feature of good governance.

So, to encourage good practice in the delivery of this information and support to members, we recently published updated information which trustees can give to their members as they approach retirement.

This clearly sets out the options members have when they are making choices about their retirement income – such as choosing the open market option, deferring purchasing an annuity, or taking income drawdown.  

But, as I have said, members can also take important decisions at much earlier stages of the process - and we know that employers can play an important role in helping them to access the information that will enable them to decide what to do.

And so we have also published a guide, jointly with the FSA, called 'Talking to your employees about pensions' which sets out some common questions that employees might ask and offers answers that employers can safely give as well as suggesting other places that employees can go to look for help and advice.

Our hope is that this guidance – which I'm pleased to say has been pretty well received by our stakeholders - will boost employer confidence in talking about pensions in the workplace – and which is particularly vital as we approach 2012 when many more employers will have to play a more involved role.  

Also important for us - in ensuring that contract-based schemes are well run and members get the best value from DC provision – has been to highlight that employers as well as trustees can play a role in improving scheme oversight, through activities like setting up management committees, reviews by human resource departments, or reviews by an IFA.

And in doing so recognising that the needs and capabilities of smaller schemes may not be the same as those with a larger number of members.

And throughout our work on DC we have highlighted the impact of some key governance practices – in both trust and contract-based arrangements - including member communications and record-keeping – which should also help members to get the most value from their scheme.

Moving forward however, as interest rates and asset values continue to be depressed, as more schemes consider the risk of sponsor insolvency, and as many members face important choices about how to maximise their retirement income, we are increasing our focus on the importance of best practice and high standards in governance and administration across both DB and DC schemes.  

[Improving standards of practice in administration and governance across all schemes]
We have of course highlighted the importance of good scheme governance since our inception.

Back in 2006 we published our first internal controls code of conduct and guidance. In October 2008 we published guidance on conflicts of interest. And earlier this year we published guidance on record-keeping, which we will review as part of our current campaign.

Our work now will build on this foundation and will be based on ensuring that trustees responsible for running pension schemes:

• have the right skills to do the job -  and the right people available to help them to run their scheme;
• and have the right processes in place to manage scheme risk.

To launch the campaign last week we published a statement which sets out our overall approach to governance – along with the results of our 2009 governance survey.  

We are very much aware that the vast majority of schemes are run by dedicated and hard-working individuals. And we know that trustees often have a challenging job to do and there is a lot of evidence of good practice.

For example – that there has been an increase in the number of schemes where the trustees have reviewed the sponsoring employer's business plans and who believe that the trustee board is able to conduct effective negotiations with the employer.

There has also been an increase in the proportion of schemes who felt that the trustee board has appropriate processes in place to manage conflicts of interest and are actively monitoring and managing service providers and professional advisers.

But - even though we have seen significant improvement in some areas, there are still many schemes with gaps in key aspects of governance.

For example, only six out of ten trustees describe their boards' collective understanding of how their assets are invested as 'very good', and only the same proportion felt their ability to assess the employer covenant was 'very good'.

Less than half the schemes in the survey felt 'very confident' that they have appropriate internal controls to mitigate the risks of inappropriate investment strategies or errors in the scheme's administration

And fewer than half of schemes are aware of the regulator's guidance on record keeping.

So, over the next few months we will be working to update our guidance and to provide new or additional support in key areas of governance including:

• Internal controls
• Trustee Knowledge and Understanding
• Record-keeping; and
• Wind-ups

Our immediate focus is on internal controls and we will shortly be publishing the consultation document for the latest review of the internal controls guidance.

We have always maintained that internal controls are a fundamental characteristic of a well run scheme and play an important role in securing members' benefits.

And whilst we know that many trustees are familiar with the concept of internal controls, for some schemes, particularly smaller ones, we know that additional help is needed.

So the refreshed guidance has been adapted to take into account the specific needs of small schemes as well as to provide clear guidance for large schemes too.

It explores some of the risks associated with key governance functions and illustrates a number of the issues trustees should address, like trustee knowledge and understanding, conflicts of interest, relations with advisers, record keeping, employer covenant, and investment and retirement processes.

At the same time as publishing the consultation document we will be launching two 'bite-sized' pieces of 'e-learning'.

Located on our website, these modules will provide trustees with the headline learning points about risk and internal controls in less than 3 minutes.

There will also be a longer module – though this will take no more than about 10 minutes – and will provide an overview of the topic – and include case study examples.

We hope these products will encourage trustees to find out more, using the toolkit or the guidance.

We have also recently undertaken a review of the Trustee Knowledge and Understanding code of practice, which will be finalised in early December.

This is the first full review since the code came into practice in 2006 and we were very heartened with the responses we received from a broad cross-section of stakeholders - including trustee boards, lawyers, consultants and professional and trade bodies.

These demonstrated the extent to which the Trustee Knowledge and Understanding regime has become embedded in everyday trustee activity.

Most respondents also acknowledged that an increased level of knowledge and understanding has made a positive difference to their confidence in approaching their duties.

This is encouraging for us. However we will continue to work hard to encourage trustees to complete the Trustee toolkit modules that are appropriate to their scheme - and indeed to seek appropriate training wherever they see fit in order to help them to fulfil their duties.

Looking into early next year we will also be consulting on new proposals for record keeping – which will include standards for the accuracy of data to be secured before the 2012 reforms.

And rounding off the campaign we will be updating our guidance on the winding up of pension schemes.

Early last year we made it clear to trustees that we wanted to see a focus on reducing the time taken to complete the process of wind up - and that schemes entering wind up after June 2008 would be expected to complete the process within 2 years.

Since then we have increased our engagement with all parties - including providers and trustees.

We are seeing some encouraging signs of better practice but we do recognise that there is still work to do.

[IGG]

Our commitment to improving governance practice also extends to our involvement with the Investment Governance Group.

Chaired by the executive director of strategic development at the regulator, Bill Galvin, the IGG is a joint industry and government group working to encourage and support further engagement by the pensions industry with the Myners principles.

These now well-established principles require those involved in investment governance to focus on:

• effective decision-making - with clearly set out roles and responsibilities
• having clear objectives for investment management
• assessing risk and liabilities
• regularly assessing investment performance
• taking responsible ownership of investment products
• and transparency and reporting.

The goal of the IGG is to encourage trustees, employers, advisers and providers to provide greater protection for member interests through sound investment governance and key outputs from the group will include:

• revised principles for investment governance which meet the specific needs of DC employers and trustees - in both trust-based and contract-based schemes;
• tools and templates to support trustees of small schemes in setting up rudimentary, but effective investment governance processes; and
• a 'Guide to Investment Governance Decision Making' – aimed at encouraging further engagement with investment governance in small to medium sized schemes.

These tools and guidance products are planned for delivery via the IGG website in the first part of 2010.

I started by highlighting the extent to which the pensions landscape is evolving and that stressed that we are evolving our regulatory focus to reflect this fact.

But the structure of our working lives is changing too.

Our expectations of retirement are different to previous generations.

We are a much more transient workforce and we expect to live for longer and have a longer retirement.

And that is why we at the regulator have such a key role to play in the 2012 reforms. Current figures show that around 7 million people are under-saving for their retirement – a situation which automatic enrolment can clearly play a part in alleviating.

We are already building up our capacity and capability to provide regulatory oversight for the auto-enrolment process and the employer compliance duties under the 2008 legislation.

[Build the capacity and capability to deliver the auto-enrolment process]

We are aware that the pensions industry and employers are already taking a real interest in the details of the reform. The consultation on the second batch of regulations is now complete and I look forward to working with the outputs from that process as we move forward with our work in developing the auto-enrolment regime.

We fully recognise the impact that the 2012 reforms will have on all employers but most especially on smaller businesses who have not previously chosen to get involved in pension provision, nor have had a relationship with the regulator.

We also know that employers and providers alike will need plenty of time to build the necessary changes into their future business planning.

And we know from the research that we have conducted over the last year or so that when faced with new legislation, employers turn to intermediaries to help them to understand what they have to do.

So next year we will make sure that the widest range of intermediary bodies – for example, accountants, IFAs, employee benefit consultants, trade bodies and providers - have all the information they need to offer that support.

Then towards the end of 2010 we will also start talking directly to large employers, who we know will need time to change their operational processes.

Of course we do also encourage employers of all sizes to start thinking ahead and planning for their own workforce.

But our current plan is to begin writing to all employers individually in mid 2011 - explaining what they have to do to meet the new requirements – and when they have to do it.

This kind of communications campaign will be a significant undertaking for the regulator. However we see this education stage as absolutely fundamental to enabling employers to comply.

Around one million employers will eventually register a qualifying scheme with us, and we know that we must make the process of registering as clear, simple and straightforward as possible.

So we will be designing and testing our processes hand-in-hand with the pensions and business community - working with bodies like the NAPF, EEF and the CBI, and talking directly to key providers, to make sure that we get the detail right.

We believe that the opportunity and challenge of regulating such a significant volume of employers is best achieved through applying a regulatory approach which is consistent with our existing risk-based model.

Key to this approach is a good understanding of our employer customer and the behaviour that is likely to drive non-compliance, as well as an awareness of the risks to compliance that may emerge over time.

So right now we are seeking to develop an understanding of this behaviour - as well as the risks related to the auto-enrolment process, and indeed the DC market as a whole - so that we can respond appropriately once the regime is up and running.

As with our current model of regulation, we will focus on providing education and support at the right time and at the right place for those who need it.

But let there be no doubt that we will have - and will use – both existing and new enforcement powers to ensure that employers ultimately do the right thing.  

So before I open up the floor to any questions I hope that you will take away from this session today that we are a regulator which is fully alive to the changes in the landscape within which we all work.

That we do and will evolve our focus as the environment shifts: identifying and addressing:

• risks to members, trustees and sponsors in DB schemes
• the existing and emerging risks in the DC market; and
• the need for strong and robust governance structures for all schemes.

And that we are committed to maintaining a proportionate and risk-based regulatory approach that focuses on education and enabling trustees, employers and advisers to do fulfil their responsibilities to the highest standard, both now and into the future.

Thank you