Pensions World

Tony Barnard, Capita Hartshead, examines the Regulator's proposals on how to improve DC provision

With the increasing growth of defined contribution (DC) pension provision, the Pensions Regulator (TPR) is taking the opportunity to update its approach to DC regulation, first outlined in 2007. TPR’s discussion paper issued in January is seeking feedback on a series of questions and TPR will use the responses to develop its strategy. With auto-enrolment due to start next year, the paper is well timed. However, is some of the analysis too black and white and should other factors be considered?

This article will focus on the six elements TPR believes must be present to provide members with the best chance to achieve an adequate income in retirement, together with how it has segmented the DC market to assist its analysis (see Box).

Highlighted elements

For members of a DC scheme, a sufficient pension at retirement is only achieved if adequate contributions are made. While auto-enrolment and Nest will provide an opportunity for those who have not previously saved towards their retirement, the minimum contribution levels surrounding auto-enrolment are unlikely to provide an adequate pension. Auto-enrolment may get members into pension schemes, but it will not get them properly engaged in the level of savings that they need to make to achieve their retirement aims.

While TPR recognises it does not have a statutory remit with regard to the adequacy of contributions, this should not stop it from stressing the importance of long term savings, combined with the level of contributions required to obtain a reasonable pension at retirement. All of the six elements highlighted in the discussion paper have their place in pension provision; however, without encouragement to ensure people save sufficient amounts, the other factors identified will only have a limited effect on an individual’s standard of living in retirement. That said, I accept that the tools to drive really practical encouragement may be in the hands of the Treasury rather than the TPR itself.

Design and selection

With most members investing in their scheme’s default fund, the discussion paper builds on the work of the Investment Governance Group published last year, in particular, the design and selection of the default fund. For TPR, investment options should be appropriate to the profile of the membership. While for larger employers this analysis is possible, unfortunately for many employers this is less of an option. Detailed investigation of scheme membership comes at a cost; for some employers simply paying the agreed contribution is all that is available.

Good outcomes

In conjunction with the work that TPR is undertaking on record keeping, the discussion paper stresses that good administration is integral to delivering good member outcomes. With pension scheme membership expected to increase significantly through auto-enrolment, combined with the complexity of DC administration, TPR stresses that sufficient time and resources should be devoted to administrative matters, to ensure members have confidence that their pension is being correctly administered.

Making the distinction

For any pension scheme it is paramount that members have confidence that sufficient controls and safeguards are in place to protect their pension savings. The discussion paper touches on the importance of strong governance, but is this sufficient? Without strong governance, both in the trust and contract based environment, it is unlikely that any of the six factors examined by TPR will be successful in ensuring members receive an adequate pension at retirement.

Protection of pension assets is vital. However, you have to question why one of the issues raised by TPR relates to regulatory safeguards and how to help people understand the different types of arrangements. If the aim of TPR is to ensure a better outcome for members, explaining the distinction between trust and contract based arrangements is not paramount. More important to members is whether available compensation, should a scheme or insurer encounter financial difficulties, provides a comparable level of support in each situation.

Greater transparency

The penultimate factor identified relates to value for money, with TPR attempting to encourage greater transparency and comparability of cost and charges. Calls for transparency should be applauded, but care needs to be exercised that the analysis is not too simplistic.

Some members may be willing to pay a higher annual management charge with the hope of improved investment returns. It is not a simple case of low charges good and higher charges bad.

Keeping it simple

The final factor examines how a member converts his or her pension savings at retirement. Despite increased coverage highlighting the financial advantages of shopping around to buy an annuity, only around 25% of scheme members are currently using the open market option. Therefore, a significant proportion of members are losing out on potential increases in excess of 15% that can be achieved by shopping around. Others fail to take advantage of enhanced rates for impaired lives. That said, the market has now moved away from standard annuity rates and applies at least basic underwriting to all through postcode ratings. The flip side of underwritten annuities for all is that annuitisation may become less attractive and therefore less relevant for those who have higher than average life expectancy. Continued promotion of effective income conversion decisions is required, by both individual schemes and insurers, to ensure members obtain the best possible pension at retirement.

It is important that TPR encourages scheme members to take advantage of the options available to secure the best pension at retirement. What does not help is using such terms as “decumulation” in the literature they issue. Nest recently issued a phrasebook on plain speaking around pensions. Could we therefore have some joined up thinking in the pensions industry? Keep the language simple if you want more people to save for their retirement.

Split landscape

To assist TPR’s analysis of DC schemes and how they deliver good member outcomes, the landscape is split into seven broad categories. Occupational schemes are split into large, multi-employer, small (bundled) and small (unbundled). In contrast, contract based schemes are distinguished by the employer, the three categories being, “advised and engaged”, “advised but disengaged” and finally “unadvised”.

TPR provides an analysis of each segment of the DC market and whether it is likely to achieve good member outcomes. This analysis is useful; however, TPR must exercise care here. Nest will clearly fill a vacuum for those small/medium sized employers who only wish to have a limited role in pension provision for their staff. However, when TPR considers small schemes and asks whether “there is a merit in encouraging a transition to larger schemes”, is this a step too far? Good governance and good member outcomes can be achieved by any size of scheme. Is the role of TPR to decide whether one type or size of pension arrangement is better than another, rather than protecting benefits for members as a whole? Also with an estimated seven million individuals not covered by pension provision, should the emphasis be on these individuals rather than those who already have pension provision?

When analysing the contract based market, care should be exercised in using any broad brush definitions, for example, “disengaged employer”. Why has disengagement come about? An employer may be “disengaged”, but still be paying a significant level of contributions, when compared to other “engaged” employers. In some cases, disengagement has been a conscious decision by the employer which the regulatory environment has historically allowed; there is still a desire to offer staff a good level of pension provision, but an employer may feel further involvement is unnecessary. Disengagement is clearly an issue, but it does not automatically result in poor pension provision.

Increasing emphasis

In conclusion, the discussion paper is a good starting position for increasing emphasis on the DC pension environment, but TPR needs to tread a careful path between improving governance where this is required while not alienating employers already providing good pension provision, in particular within the contract based sector of the market.

The current DC market will change profoundly following the introduction of auto-enrolment and the establishment of Nest. TPR should ensure there is increased focus on the success of Nest and those currently without pensions, rather than directing its attention too strongly to existing structures.