The Government has made it’s agenda plain. Small (that is sub £100m) occupational DC schemes do not offer the governance, do not have the capacity to diversify into private markets and offer poor value to members , relative to larger workplace pensions. They should think long and hard about continuing and later this month they will be introduced to new rules that will demand they prove they are worth keeping. If, after October, they cannot prove their merit, our new tough Pensions Regulator will make it increasingly difficult to operate unilaterally and both trustees and sponsoring employers will have to come up with good reasons for running a workplace pension without scale.
This blog asks what those reasons could be and concludes that in most cases, the reasoning is bad.
Reason one; “nobody knows the workforce like we do”.
This view, often expressed by unions through MNTs is correct. Employers know their workforce well, often too well. Yesterday British Airways announced that they had outsourced their investment management to BlackRock without consulting their staff. That tells you what you need to know about staff relations on pensions. When it comes to DC, the relationship between employer and staff may be more harmonious but the reality is that there is precious little that the employer or trustees can do with that knowledge to improve member outcomes. Attempts by consultants to segment, target, nudge and tailor have proved conspicuously unsuccessful. Most workforces use default options which are homogenous to other, the idea that workforces have special needs when it comes to pensions is fallacious, it has no evidence base. This is a bad reason for keeping a scheme
Reason two; “the scheme is part of the company’s corporate culture”.
The argument used for running a DB scheme was that the company’s HR and Reward teams could use the scheme to recruit and retain good staff and ease into early retirement staff who had become unproductive.
This worked when the pension was “in-house” and the scheme rules were determined by the employer and trustees. There was good reason for a company to have their own arrangement but that reason does not transfer across to DC.
Staff see the quality of a DC scheme by looking at the funding rate and that’s about it. Most staff have no idea whether the workplace pension is a master trust, a GPP or the company’s own trust.
At a recent SG conference, one chair of trustees complained that none of their members seemed to recognize the role of the trustees. We “inside pensions”, massively overestimate people’s interest in the governance of their schemes and arguments about links between employer and scheme are frankly a legacy of a bygone age.
Reason three; “Our occupational scheme offers value for money”
This is usually asserted with reference to the headline annual management charge on the default fund, which may be well below 0.75%. This is a poor measure of value as far as members are concerned. Most members value their pension by the income arising or the size of their pot, not by the money taken out of it by third parties. The total cost of pension management is inflated above the headline AMC in two ways. The first is by the hidden costs of investment management , including the spreads implicit in buying and selling units (the infamous single swinging price). People in lifestyle may or may not be hit by such costs but the likelihood is that smaller schemes , that do not have the capacity to cross trades, are hit harder than large schemes. Most of the management information needed to measure hidden costs is not available to DC trustees, so the use of AMCs to justify VFM is unreliable.
But there is a second more powerful argument for not using the headline AMC and that is the cost of running the scheme. Although the cost of the scheme is not passed on to members, it is accounted for as a staff expense and set against the overall cost of employment. If it were not there, as would be the case if the employer participated in a master trust, then the money saved could be reallocated to higher wages or to higher pension contributions. Staff pay for their scheme one way or another and including the scheme costs in a value for members calculation would show a very different VFM picture.
The costs of running a scheme include trustee expenses, consultancy fees, legal and audit fees as well as any subsidy of administration and fund management costs. In many cases , occupational pension schemes aren’t offering value for members and this can be assessed not by looking at top down metrics but by looking at the Internal rates of return achieved by members and comparing them to those of larger schemes. A further calculation could be made by re-running the numbers using a contribution rate that could have been afforded without the employer paying scheme costs.
What happens to the savings when an employer moves from own trust to master trust is a matter of governance. I would look to remuneration committees and unions to ensure that the savings are passed on to staff and not distributed to management and shareholders.
Reason four; “we have our own advisers”.
The reliance of small schemes on their advisers is not necessarily healthy. The bonds between senior management and their consultants have been cemented over the years with all kinds of perks which are questionable under today’s bribery act. Pensions being a specialist area, advisers are often considered indispensable. Which creates the potential for conflicts.
The pension consultant is not going to give up the value of the relationship with the client easily. It is not in the interest of the consultant or his/her firm to lose the client to a non-remunerative participation in a multi-employer scheme. Even when the master trust is one of the consultant’s options, it now has to be offered alongside other options, typically through a competitive tender run by another consultant.
The pension consultant is faced with the option of losing a client or of losing the relationship with the client (when it moves to a master trust). Many consultants will do their level best to keep an own occupation DC scheme in place for personal reasons that are not necessarily in the interests of sponsor or (more importantly) the members. This is not good for member outcomes.
Reason five; peer group pressure
The majority of trustees of DC occupational schemes are drawn from the company’s hierarchy and corporate trusteeship is linked to certain positions. Pensioner trustees are usually former officers of the company and professional trustees have usually been corporate trustees.
The trustee club is effectively an extension of the portfolio career which will include non-executive directorships and places on charitable boards. This club is very male dominated and heavily biased to older executives. It has its club-houses, the conferences of the PLSA and other trade bodies , where the club can network and be entertained. The club is sponsored by consultants who pass on their expenses to employers through fees.
This club is self-perpetuating and will be very hard to disband, it is the final obstacle to better member outcomes. It is an unhealthy rump which has “sat too long for all the good it does”. It may claim to be looking after member interests but it needs to prove it through publicizing better outcomes, rather than producing vague unread trustee statements about the scheme producing value for members.
The one good argument to avoid consolidation
The amount that people get from a workplace pension depends on the amount paid in, the quality of the management of the money while its in and the way the money is returned to the saver. All of this is quantifiable and measurable through member data- specifically through an analysis of money-in and money-out.
This analysis is being done but it is not (as yet) being published. Instead ,workplace pensions are being analyzed using “net performance” methodology which tells only part of the picture and is too easy to fiddle by those with an interest in showing a scheme in a good light.
I am hoping that small schemes with a really good story to tell , will show that they are worth keeping by demonstrating they have delivered good outcomes to members and have the capacity to do so in future. This means publishing the internal rates of return achieved by individual savers and benchmarking those returns against those of larger schemes.
That is truly fair to members and a capital G in ESG.