In the not too distant future, pretty much all private sector employees will exclusively be offered defined contribution (DC) plans for future pension savings. Those schemes will grow quickly to become very large investment funds. Today, the largest individual DC schemes already hold assets of around £1.5 billion. Even small companies will, over time, accumulate sponsor plans that have significant assets. Willis Towers Watson estimates 14 million active members of UK DC schemes by 2018 whilst DC assets could exceed £1.5 trillion by 2030. As the industry matures and plans get larger, so too will DC plans attract higher and more onerous governance requirements. Trust-based UK DC schemes must now follow the six principles for good workplace pensions and the 31 quality features contained in the Code of Practice and Regulatory Guidance. Meanwhile, other initiatives such as automatic enrolment is swelling the number of pension members in company schemes and the innovation does not stop there, ’pot follows member’ and the charge cap – will all add to the complexity and cost of running trust based schemes.
DC pension governance is significantly different from DB plans. In DB plans, governance is founded on the requirement to pay members’ benefits in the most cost effective way for the employer. Any failure in investment strategy affects funding levels, leading to a direct cost and risk for the company as plan sponsor. And so the interest of the company, the trustees and the members were all – to a great extent – aligned. With DC pensions, the company shoulders no such risk, which, of course, is the point of DC from the sponsor’s point of view. In the case of a failure to optimise investment returns, it is the members who suffer with reduced pension benefits at retirement. The members’ and the trustees’ aims are still aligned, but the company’s role is much more removed and they have often excluded themselves from responsibility for member outcomes.
As DC plans evolve, companies’ senior finance managers will, at some point, find themselves asking some questions about the way they provide pension benefits. And the way they answer those questions will have profound implications for the future of trust-based DC plans in the UK, and will have a lot to do with the way that they think about pensions as an element of reward.
These questions for the company include: is the DC plan adding value to my business? Should we consider DC pensions among one of the many non-essential activities that are better outsourced? Is someone else better placed to look after the retirement savings of my employees? Am I prepared to keep investing in the systems and processes that will enable us to continue offering a first rate pension arrangement even as the demands on me from the regulator keep increasing? Do I want to carry on paying the costs for looking after the pension arrangements of my former employees?
The advantages of outsourcing DC pensions are clear: the company removes the operational challenge – and cost – of maintaining plans and ensuring up-to-date governance and compliance with ever more demanding regulatory change. As DC plans grow in size and complexity, pension plan providers will need to invest continually in administration and communications technology and processes. There may also be benefits to the trustees and members from the economies of scale that can be achieved on fees and plan-specific costs (such as on technology) if they can be shared with other companies.
In the UK, the market for Trust-based corporate DC plan outsourcing is still small. In part this reflects the immaturity of the Trust-based DC market in the UK, but as new, better options become available we can expect it to develop. To date, the main option for companies seeking a third party for their DC pension provision was to go to the insurance market for a GPP or stakeholder. However, many companies – and particularly plan trustees – have found this to be an unsatisfactory option. The fundamental misalignment of interest between the plan’s members and trustees, and the insurance company’s responsibility to its own shareholders, has meant that the migration of company DC plans to the insurance market has been slow. It’s hard to transfer the built up assets in existing plans because of the certification requirements that mean that even if future provision is outsourced there is often still a legacy plan to run or wind-up, both of which can be expensive propositions. Members can be mistrustful of any proposed switch of the plan to an insurance company. And company’s senior management – while perhaps keen on an outsourcing strategy, have also been reticent to propose such a conceptually-flawed solution.
New Master Trusts are emerging that offer a better solution to outsourcing. These are entities that can take on all the management and governance of DC pension plans (such as administration, investment and communications) for multiple employers. As a trust-based plan, a Master Trust can replicate the in-house plan’s alignment of interests between those running the plan and those of the plan members. The trustees of the Master Trust run the entity and their only objective is to look after the beneficiaries’ interests. At its best this could offer a much better outsourcing solution and trustees could be agreeable to transfer entire plans to these entities – including the entirety of their legacy arrangements. There’s no reason why pension plan members should not also be much happier to see their workplace pensions outsourced to a Master Trust solution – and with a smooth transition (the individual plans remain as distinct units within the Master Trust) there is little potential for any negative issues. The company can remain associated with the plan through its segmented section and from an individual member’s perspective little has changed. Indeed members may get access to the latest engagement and communication tools allowing them to make much better retirement planning than was available in their current trust based plan. The most significant change is for the sponsoring employer, who no longer has to shoulder the challenges of DC plan governance.