Pensions World

Jonathan Papier, Hymans Robertson, on the importance of good DC record keeping.

At one level the operation of a defined contribution (DC) pension arrangement is very straightforward.

A member has a level of contribution deducted from their salary, calculated on a basis they have agreed. Together with a contracted level of employer contribution, the combined payment is forwarded to an investment provider who invests it according to the member’s instructions from a choice of funds available. This continues through their employment and, when they are ready to retire, the accumulated funds can be realised to provide them with some cash at retirement, if wanted, and a retirement income, again in the way that they choose. What could be more straightforward? Where are the operational risks?

Updating records

The complications and operational risks arise because DC contributions arrive to an administrator from payroll centres for several members at once. The membership is subject to change as well as the amount of contribution for each member. Aggregated payments for several members may be received from more than one payroll centre for each employer. Every payment receipt must be reconciled to determine the exact composition relating to each member.

Most often, different members will have chosen different proportional splits of their contributions to be invested into the available fund choices – the administrator will need to keep up to date instructions for each member to divide the total contribution receipts into different amounts for the investment provider to invest into the relevant funds, at the same time updating the individual member records to reflect the contribution amounts, prices and therefore the units purchased in each fund type and contribution source for each member as at the transaction date. Then, when the member retires, the correct units have to be sold and care has to be taken not to allocate any more contributions received after that date. And all of this must be done in a timely manner every month to avoid the members being affected (adversely) by a sudden change in market prices.

Usually members can switch their investment choice at any time and there will be “lifestyle” investment changes to be made as members approach their selected retirement date.

Administrators also play a key role in enabling members to make informed decisions about the type of annuities to purchase at retirement and they benefit from any enhanced annuity rates appropriate to their medical condition. The experience of integrating administration practice and communication between the administrator and the independent financial adviser placing the annuity is key to providing a good member experience. Poor integration, at best, will potentially confuse the member and lead to the need for a significant amount of additional explanation. At worst, the member could make an ill informed decision and not get the most appropriate annuity and/or the best rate.

If an administrator, whether a provider of a contract DC arrangement or the administrator of a trust based DC scheme, has tight controls on its processes, with many of them automated to avoid as much risk as possible of human error, there is no reason at all why DC records cannot be maintained in a totally correct way, all of the time. But is this enough?

Discrepancies

Good administration of a DC scheme (and any other pension arrangement for that matter) is not just about creating processes and rigorously testing them to ensure each one works in isolation, It is also about constantly asking the question: “Could anything be wrong and how would you know?”

An administrator’s process for allocating contribution receipts to individual members should include validation to identify any unexpected variation in monthly payments for a member and query this with the payroll area. A good administrator will have a series of validation routines to flag up discrepancies.

The administrator should reconcile frequently the aggregate investment units held in each available fund for each pension scheme against the investment manager’s fund statements. Any discrepancy should be fully investigated.

Data testing

The Regulator has set out some internal control considerations as well as recommending some data tests. Internal controls are designed to manage the risk of error; however, it is regular data testing that provides a complete diagnostic toolkit to identify potential errors at an early stage. Administrators should conduct a complete list of tests, which can be more exhaustive than those recommended and expect to see the results presented, together with details of the potential financial impact and any proposed remedial plan. Administrators should satisfy themselves that the test results do not indicate a lack of control and request an audit of those controls if necessary.

For our clients we have developed a suite of monitoring and reporting tools which are not a part of the operational process for investing DC contributions, but are separately run each quarter to help us to identify if there are any anomalies with our records (or those of the investment manager). Examples of tests include:

• The actual position of investment splits of lifestyle member is what is expected, based on the member’s selected preferred retirement age and the appropriate lifestyling matrix.
• Each member has contribution rates which are consistent with the scheme rules.
• No members hold units in inactive funds.
• An identified transferred out member no longer holds allocated units. This may indicate a failing in the transfer out process.
• All contributions received match the total amounts allocated to members’ investment funds.
• There are no active members with missing contributions in the past three months.
• The period between receipt of contribution and investment exceeds an agreed tolerance.

Fixing the problem

Any DC administrator will tell you that finding a historical problem, such as an incorrect level of contribution being recorded for a member or group of members, or if the contributions have not been invested to the right funds at the right times, presents a nightmare situation to later correct. This can usually only be done fully by replicating every transaction with each investment manager for all contributions paid between the time of an error occurring and the present time, to determine whether individual members have been disadvantaged (or benefited). Such expensive exercises – and the associated serious issues relating to financial compensation and reputational damage for not just the administrator but for the trustees or sponsoring employer who appointed the administrator – can largely be mitigated by the validation checks described (Boxes 1, 2 and 3).

It is also important to stress that “fixing” member records is not the only objective here. It is important to use the information to conduct a full root cause analysis and “fix” the underlying problem.

Administrators should by no means be negligent in designing DC processes to operate correctly, but we consider it prudent to invest DC expertise as well in exploring that question: “Could anything be wrong and how would you know?”