The Pensions Regulator

Initiatives in DC regulationArticles

Initiatives in DC regulation

Since the creation of the Pensions Regulator in April 2005, our highest-profile work has undoubtedly been in addressing issues associated with defined benefit (DB) schemes.

However, our statutory objectives of protecting members’ benefits and promoting high standards of administration apply equally to defined contribution (DC) provision, and our medium term strategy commits us to ensuring that risks to members of DC schemes are highlighted and addressed in a proactive and proportionate way.

A changing landscape

The closure of many DB schemes to new members, coupled with the associated move towards DC provision, is a familiar story. An estimated 54% of DB schemes closed to new members between the end of 2001 and the end of 2004. By October 2005 only 24% of FTSE 100 companies offered DB schemes to all new employees; 67% of these companies did not offer DB schemes to any of their employees.

Active DB membership, then, is declining. The existence of large numbers of deferred and pensioner members mean that DB schemes still account for the majority of private occupational scheme membership; many DC schemes are relatively new, with their members drawn only from new employees. If current trends continue, however, we anticipate that there will be broadly equal numbers of active members in DB and occupational DC schemes by 2012.

Consultation

Some risks, such as fraud, pose a potential threat to schemes of all types. However, in general the risks facing DC schemes and their members are very different from those to their DB counterparts. This, along with the very large number of schemes involved (many with only a handful of members) means that a different style of regulation is appropriate.

In order to set out our proposals for DC regulation, and to gather feedback from the wider pensions community, we have issued a consultation document, How the Pensions Regulator will regulate defined contribution schemes in relation to risks to members. In this document we highlight five key areas of risk to DC members.

• Poor administrative practices. The administration of DC schemes is complex, requiring high standards of reconciliation, record keeping and communications. Administrative errors can be time-consuming and costly to put right. As regulator, we want to see robust internal controls and effective Service Level Agreements in place between trustees and service providers (such as payroll providers) to ensure that administrative standards can be monitored and maintained.
• Poor investment practices. In DC schemes, unlike DB, individual members bear a direct responsibility for their own investment and longevity risk, and are required to make their own decisions. It is essential that rigorous processes are in place for the selection and review of investment managers and funds. It is also important that the risks associated with investment are understood by trustees, employers, providers, advisers and members alike.
• Unduly high charges. A significant proportion of a member’s final pension income can be eaten up by costs and fees. In a well-run scheme, trustees, managers, providers and employers will consider charges at scheme setup and at regular periods to ensure they continue to provide value for money. Clear information on costs should be provided showing the impact on the scheme and, where appropriate, a member’s return.
• Poor decisions on retirement choices. It is vital that members understand that, as well as bearing the investment risks of their DC pension throughout its lifetime, they also bear the risk of selecting the most appropriate post-retirement product for their personal circumstances. Members need to understand, and trustees and providers should make clear, the options that are available. The regulator expects trustees to ensure that members are aware, for example, of the open market option and the different types of annuity available.
• Lack of member understanding. Good quality, relevant and timely information is vital if individuals are to make the best possible decisions about their DC pension provision. While a good deal of help is already available, lack of member engagement remains an issue, and we expect those involved in providing and running schemes to work towards improving member understanding and involvement. Ensuring the right level of contact between parties should also contribute towards ensuring members receive their correct pension entitlement as it should aid accurate record-keeping and reconciliation.

The regulator’s approach

Our proposed approach to DC regulation, as set out in our consultation document, is three-pronged. Education and guidance are, and will continue to be, our primary means of preventing and tackling risks – for example, through our codes of practice, and specific DC-related guidance aimed at employers, trustees, providers and administrators.

Working in partnership with other organisations is also a key element of our approach; other organisations are involved in the regulation of the DC landscape, including the DWP and FSA, and we propose both to build on our existing relationships with such organisations and to forge deeper relationships with industry bodies to help in the development of good practice guidance, to identify future initiatives and to ensure a consistency of approach.

Finally, we will use our powers to intervene where appropriate. In line with our risk-based approach to regulation, we will focus any intervention on those schemes that pose the highest level of risk. For example, we will be prepared to use our powers by publicly reporting parties where poor practice is carried out on a significant or systemic basis and has a major impact on members’ benefits.

Highlighting the current consultation document, Linda Oliver, policy and guidance specialist with the Pensions Regulator, says: ‘The consultation sets out the regulator’s proposals to addressing the risks to members of work-based DC schemes with either trust-based or contract-based arrangements, and we look forward to receiving responses from the pensions industry.

‘We want to ensure that trustees, employers, providers, advisers, administrators and payroll providers understand the complexities and risks involved in running DC schemes and know how to address them. This will ensure that DC risks are given the attention they require, preventing them from materialising on a large scale and therefore protecting members’ benefits as far as is possible.’

The consultation period started on 13 November 2006 and will continue until 2 February 2007. The consultation document is available on our website, http://www.thepensionsregulator.gov.uk/. The site provides a range of material for those involved in running, providing and advising on pension schemes, including the regulator’s codes of practice, guidance, press releases and news of events.

The ‘Trustee toolkit’

A major element of the regulator’s educational work is the ‘Trustee toolkit’. This is a free online multimedia learning programme designed to enable all trustees of occupational pension schemes, whatever the size and nature of their scheme, to meet the requirements of the 2004 Pensions Act, namely:

• to possess an appropriate level of knowledge and understanding of trusts and pensions law, and the principles of funding and investment; and
• to be conversant with their own scheme’s documents.

The Trustee toolkit allows participants, working at their own pace, to focus on topics relevant to their scheme and their individual circumstances and to ensure that they achieve the levels of knowledge and understanding required by the legislation. It is a modular programme, enabling participants to join a fictitious trustee board and work through a series of authentic scenarios. Detailed tutorials and practical case examples are also provided.

At the same time as publishing our DC consultation document, we launched the latest module of the Trustee toolkit, entitled simply How a DC scheme works. In this module participants learn about, for example:

• the design and management of DC schemes;
• DC contribution structures;
• investment options; and
• the impact on DC schemes of changes in the UK’s tax regime.

Later in the module the trustee board has to deal with some administrative problems that come to light as a result of a member’s complaint about his pension fund. This leads learners to consider how to improve both administration and trustees’ communication with DC members.

Existing modules of the toolkit include subjects such as trust law, pensions law and an introduction to asset classes – all of which are of interest to both DC and DB schemes.

Although the programme has been developed to meet the learning needs of trustees, it is freely available to everyone. We believe that a great many of those involved in pension provision will find it useful, including administrators, advisers, employers and members. Even where training is already available, learners are still likely to find the regulator’s programme useful for induction purposes, and can supplement the programme with more advanced training material where applicable.

Although the programme has been developed to meet the learning needs of trustees, it is freely available to everyone. We believe that a great many of those involved in pension provision will find it useful, including administrators, advisers, employers and members. Indeed, if you are an adviser to pension scheme trustees, you will be expected to be as knowledgeable, if not more so, than your clients, and the trustee toolkit provides an effective means of achieving this. We also believe that even where training is already available, the regulator’s programme may still be useful for induction purposes, or can be supplemented with more advanced training material to develop a blended learning solution.

To enjoy the benefits of the regulator’s e-learning programme, simply register online at http://www.trusteetoolkit.com/.

Published: Financial Adviser, December, 2006