The Pensions Regulator

Q&As: DC schemes

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Investment

Why is the regulator interested in improving investment practices?
Will the regulator be issuing guidance on the investment strategy schemes should follow?
Do DC schemes offer members too many fund choices?
What sort of default fund should we offer to the members of our occupational scheme?
What is the regulator's attitude to poor investment performance by DC schemes?

Why is the regulator interested in improving investment practices?

• In a DC scheme, the return a member receives on their pension fund is one of the key factors that will determine the sum available at retirement, which in turn will determine the member's retirement income.
• In general, an employer with a DC scheme is not required to make up any shortfall in funds required to provide expected benefits, as would be the case in a DB scheme, so it's important for the member to make the most of the contributions paid to the scheme.
• Key decisions to be made include the:
  • selection of investment manager(s);
  • selection of range of funds to be made available; and
  • choice of fund(s) by members.
• A lack of familiarity with investments may mean that many members are not well-placed to make investment decisions, without some support.
• This all adds up to the fact that if members' benefits are to be protected, it is particularly important that everyone involved in running DC schemes maintains a high standard of vigilance where investments are concerned.

Will the regulator be issuing guidance on the investment strategy schemes should follow?

• We will not be dictating to trustees or any other party how to fulfil their responsibilities in relation to setting their investment strategy.
• In a contract-based scheme such as a GPP the employer and the scheme provider share some responsibilities for selecting the investment choices to be made available to members.
• Decisions by those running schemes should be appropriate for the membership and due processes should be in place to help ensure that the roles and responsibilities of different parties are properly carried out and that relevant internal controls are in place.

  Key issues for trustees and providers to focus on are their processes for appointing and monitoring investment managers and the range of funds they make available to members.

• We're considering whether it would be beneficial to issue guidance on investment practices such as the selection of investment managers and fund choices.
• In a trust-based scheme, it's for schemes to determine their investment strategy based on their own circumstances, taking into account factors such as the membership profile and the scheme rules.

  This means that although members have the ultimate responsibility to choose from among the funds on offer, trustees have responsibility for determining the overall strategy and the funds to be offered.

• The Trustee toolkit contains a module covering investment issues for DC schemes.
• On GPPs, the FSA rules and principles include the principle that providers must treat customers fairly which includes guidance on product design and communications.
• The regulator is involved in the review of the Myners report on investment practices.

Do DC schemes offer members too many fund choices?

• In practice, most members do not require a large number of funds to choose from. There is evidence that increasing fund choice discourages employees from joining schemes as they are overwhelmed by the choice.

  The Pensions Institute's report 'Dealing with the Reluctant Investor' shows evidence that large numbers of members do not actively consider alternative funds if a default fund is provided.

  However, the regulator is not setting a minimum or maximum number of funds that schemes offer or suggesting whether it is good practice to offer a default fund.

• The number and risk profile of funds on offer should reflect the nature of the membership – especially their level of financial capability.
• Where there is a greater number of funds, this points to a need for greater support for members to make an informed decision due to poor member understanding.
• On GPPs, the FSA rules and principles include the principle that providers must treat customers fairly which includes guidance on product design and communications.

What sort of default fund should we offer to the members of our occupational scheme?

• It is not for the regulator to determine the investment strategy that schemes should adopt and we are not currently planning to provide guidance on the choice of a default fund.
• Schemes other than stakeholder pensions, are not subject to any requirement to offer a default fund. The number and types of funds offered should be matched to the profile of the scheme's membership, especially their financial capability.
• Any default fund should be reviewed regularly as should other funds offered to members.
• Our Trustee toolkit provides help for trustees in the selection of funds.
• Evidence suggests that where a default fund is offered, the majority of members are likely to use that fund to accrue their benefits. This means that the design and monitoring of this fund may be of particular importance to members.

If you want to explore this subject further you could have a look at:

• Recent research by PensionDCisions which demonstrates the wide difference in the returns of default funds; and
• The Pensions Institute report, 'Dealing with the Reluctant Investor' which also highlights some important issues.

What is the regulator's attitude to poor investment performance by DC schemes?

• The rate of return on an investment can be determined by many factors, and our focus is around the processes followed by those running schemes rather than the absolute or relative investment returns in themselves.
• Given that members' benefits in a DC scheme are directly linked to returns on investments, the regulator may take action where it identifies inadequacies in a scheme's processes in relation to investment practices.

  For example, appropriate care is not taken in the selection and review of the appointment of the investment manager.

• In an occupational scheme, trustees are required to follow certain processes, eg take professional advice and appoint an appropriately skilled person to invest contributions.

  In practice, most schemes select investment managers regulated by the FSA. The FSA may act to redress shortcomings in particular where investments are not managed in line with mandates.

• In a GPP the FSA rules and principles include a principle that providers must treat customers fairly which includes guidance on product design and communications.
• In a GPP, employers may wish to put in place arrangements to review investment issues. For example, they may decide to set up a management committee.
• The periodic review of both advisers and investment managers is important and is likely to reduce the potential for member dissatisfaction, as well as helping to ensure that the members' benefits are protected.
• We're considering issuing guidance to help trustees and employers with the process of selecting and reviewing investment managers and choosing an appropriate range of funds.
• Trustees may refer to the relevant module in the Trustee toolkit for information.

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