Nearly 2 years ago I bought a new mobile phone. At the time, I was very pleased with the deal that I had signed up to – reasonably priced, a sensible allowance for calls, texts and data, and all the features and apps that I wanted, and it looked good too! However, over time the package has started to lose its lustre, as the mobile phone market has evolved with more flexible contracts, competitive deals, speedier apps, larger data storage and more modern-looking handsets. In addition, many new apps are not compatible with my phone. As well as changes in the marketplace, my own priorities and wish list have moved on as well. What was right for me then isn’t right for me now.
Parallels can be drawn with the defined contribution pension market. Many companies set up DC pension schemes a number of years ago on a “set and forget” basis. Frustrated with the onerous governance responsibilities and volatile costs associated with defined benefit, DC was a breath of fresh air – the sponsor could carry out appropriate due diligence, choose the product that was right for them, then hand over all ongoing management responsibilities to the insurance company or trustees. All they then had to do was write a cheque each month to pay for the contributions. Often, an IFA was in place to give ongoing support in exchange for commission and access to the membership (i.e. for no material employer fee).
However, just like the market for mobile phones, the DC pensions arena has changed massively over recent years:
- The roll-out of auto-enrolment has resulted in a wholesale change to the make-up of pension savers in the UK, with over 6 million more members of DC schemes now than just 4 years ago. So the typical pension saver may now look quite different, and have very different requirements, from that anticipated when the scheme was first put in place.
- Governance requirements for the managers of DC schemes have increased dramatically with the introduction over recent years of the Pensions Regulator’s code of practice and regulatory guidance, The DWP’s Command Paper, the FCA’s rules for independent governance committees not to mention changes in legislation such as the 2014 Pensions Freedoms which will all have implications for the structure of a DC scheme.
- Largely as a result of the above, own-trust DC schemes are now an endangered species, and there has been an explosion of mastertrusts which have been designed to address these governance challenges. This has led to a new set of factors to consider for companies selecting a DC scheme.
- Competitive pressures and legislative drivers have all served to push down the cost of DC schemes. According to OFT research carried out in 2013, average annual management charges of a typical DC scheme had fallen from 0.79% in 2001 to 0.51% in 2012, and these costs have continued to fall. Older schemes also tend to have more opaque and “unfair” charging structures than newer alternatives.
- Thinking continues to evolve on the number and variety of investment choices that a DC scheme should offer. The “right answer” very much depends on the characteristics of the scheme membership (which may have changed – perhaps significantly – since the scheme was set up, see above). However, there is a growing movement to reduce the number of funds on offer to avoid the paralysis of choice that can lead to members making sub-optimal decisions. “Back in the day” it was common for DC schemes to offer a wide variety of investment options. Whilst many (particularly contract-based schemes) still do, there is a groundswell of opinion that members would like scheme managers to make these complex investment decisions for them, and scheme design is evolving to meet this demand. For example, it was recently reported that Whitbread have now removed all investment choice from their DC scheme, and undoubtedly others will follow.
- Technology has moved on apace over recent years, and the tools and interface that DC providers can offer nowadays are vastly superior to those on antiquated platforms.
- The control on commissions paid to advisers has meant many IFAs have disassociated with schemes and that historic control layer has fallen away.
- Those providers who no longer wish to compete have begun to make life difficult for employers in the hope that they will move their business elsewhere. This has included refusing to allow their product to act as a Qualifying Arrangement, restrictions on Pension Freedoms and failure to upgrade technology.
The cumulative impact of all of the above truly represents a seismic shift in the DC marketplace over the last few years, both in terms of what is available and the demands and needs of the users – both employers and members. So what employers may have thought of as a one-off decision might actually be one that is profitable to review. With increasing regularity we are talking to our clientsabout their DC pensions objectives, reviewing their current arrangements and assessing whether they are still fit for purpose and whether there are better, or cheaper (or both!) alternatives available . The financial impetus for reviewing a DC scheme might be less pressing than its DB “big brother”, but with the majority of UK plc employees now belonging to a DC scheme for future benefit build-up, there are hidden costs of delay that might not immediately be apparent.
It is relatively inexpensive to carry out a DC healthcheck, and the exercise could very easily pay for itself in terms of improved governance, cheaper running costs and greater employee satisfaction if any inadequacies of the DC scheme are addressed and the benefit package is made fit for purpose.
Rather like the time I need to invest in searching for a new mobile phone package – it is very easy to put this off but I know that with a small amount of effort now I’ll be enjoying a healthier bank balance and a better mobile experience over the months and years to come.