In my recent blog ” We can;t risk hybrid DC schemes being left behind. I argued that many member’s benefits are being left in a backwater fouled by complexity.
The DWP have chosen to treat small DC schemes that sit within a larger DB scheme as exempt from the draconian value for member assessments. This is based on what I consider a naïve and usually erroneous belief that DB trustees know what they’re doing with regards DC and that they can leverage economies of scale when purchasing DB and DC asset management from the market.
Most hybrid schemes were born out of a dilution of the original DB promises and often contain elements of DB such as an underpin (mixed benefits) or a wish to protect DB benefits from the PPF where a covenant is failing.
DB mindset pervasive in hybrids
There are people who see pensions in terms of corporate risk and these do very well on DB boards. There are people who see pensions as an employee benefit and these do well on DC boards. There are very few people who can do both, but as Hybrid Trust Boards are paid for by DB sponsors , it is unsurprising that most DB boards are dominated by people who see managing corporate risk as their primary job. Put at its simplest, if a DB pension scheme puts its sponsor into administration – everyone loses.
This is why DC issues are lower order in most hybrids than DB issues. It is why joint meetings that deal with DB and DC spend the majority of the trustee’s time on DB and it’s why DC management is usually outsourced to an insurance company and a fully bundled trustee investment plan.
There is a view that DB trustees know best, this needs to be tested when it comes to DC
DB investment strategies differ from DC.
The main job of DB trustees is (for all but a handful of open schemes) , to achieve self-sufficiency for the pension fund enabling it to either buy-out or run-off – with limited reliance on a sponsor. This requires the use of asset managers that can provide reliable returns that match liabilities (typically these look bond-like and are increasingly tapping private markets for sources of gilts + returns).
These types of returns are not what most DC schemes need. These need long-term growth assets that will provide members with protection from inflation and maximise returns over a very long time. If we think of DC as “to and through” retirement and start thinking of replenishing those who ultimately die with fresh retirees, then DC schemes look like providing services in perpetuity.
So while DB trustees are off researching one type of investment solution, DC trustees have another solution in mind. They are not so interested in debt instruments with a fixed duration but with assets set to grow over a longer time horizon, what is known as patient capital.
It is rare that a single investment management agreement (IMA) can source best in class asset management for both strategies.
This severely inhibits the capacity of hybrid trustees to use the bulk purchasing capacity that comes from DB leveraging a better deal for DC. Where the IMA does cover both strategies, the DC asset management being purchased is seldom best in class but usually justified as being value for money based on a discount offered by the asset manager.
In practice, joint DC/DB IMAs are rare as hen’s teeth as the platforms that control DC pricing rarely accommodate bespoke deals negotiated by the trustees. The reality is that 9 times out of 10, the assumed pricing advantages to DC members of being in a hybrid schemes is not realisable or realised.
It is also far from clear whether DB trustees are as effective in fee negotiation as those who have a commercial interest in DC. Recent work by Chris Sier, for our sister company ClearGlass, suggests that DC fees are consistently lower than their DB counterparts.
There is an assumption that DB trustees invest best, this too needs to be tested when it comes to DC.
DC governance is different from DB governance.
Accepted there are elements of pension governance common to DB and DC, there is more that divides DC and DB than unites them.
DB schemes have always had DC sections since almost every DB scheme has “money purchase” AVC plans (the days of purchasing added years are over).
But AVCs have been regarded as a backwater and increasingly superseded by the capacity to invest in a trustee investment plan managed (like AVCs) as a single policy with an insurer. These AVC and TIP plans are increasingly sitting within insurer’s legacy books and they are not getting the level of investment and TLC that headline workplace products such as GPP, GSIPP and the fully bundled master trust. The books of business with these kind of investment plans in them, are traded around the market to the bewilderment of trustee. Take the Winterthur funds platform that was purchased by Axa, sold on to Standard Life and is now managed by Standard Life Phoenix. The fund platform may remain the same, the funds may remain the same but these changes of ownership mean that very little progress is made to improve member outcomes.
For insurers, the “headroom” from these trustee investment plans is limited. Unlike GPPs or master trusts, these plans will not consolidate other schemes to them nor can insurers market services to members without permission from trustees who they do not control. For this reason, the insurance policies sold to trustees are not being accorded the development given to other parts of the insurer’s estate. Witness the lack of retirement options, the lack of member applications and the lack of development of fund options.
In my experience, the trustees of hybrid DB and DC schemes are not getting a great deal from the insurance platforms they use for investment and often record keeping. The insurers give DB trustees what they want, which is no distraction from the main game in town- managing DB liabilities, but these platforms are managing for retention – not best practice.
Since most DB trustees don’t know what best practice looks like in DC provision, these development failures go un-noticed. Trustees soak up insipid reporting by insurers which marks its own homework through easy to beat benchmarks and vague statements that confirm value for money. Hybrid schemes governance of their DC sections can leave a lot to be desired.
There is an assumption that good DB governance crosses over to DC in a hybrid arrangement, this too needs to be tested.
Why this matters.
Little is published on how many hybrids there are and what the numbers of members with DC pots that “bite”. Many DC schemes are infact offering DB underpins that are (with annuity conversion rates being what they are), DB in all but name.
The latest numbers published by TPR as part of its annual landscape reporting on Defined benefit and hybrid schemes (2020) relegates hybrids to a virtual footnote. TPR’s more comprehensive DC trust return scheme data includes this table.
“Mixed benefit” hybrids are those where there is an underpin and “dual section” refers to trusts within a DB scheme. These figures are from 2020-21 and they show 5.5m savers have DC benefits in one or other type of hybrid of whom 1.2m are actively contributing.
These huge numbers are in less than 1000 schemes suggesting that most hybrids are would urge the DWP to get TPR to look at what is going on in such schemes and apply the same tests on a sample of them as they do on standalone DC. I would be very surprised if hybrid DC schemes are generally offering better value for members, in terms of value for members, based on research carried out by AgeWage.
In conclusions is that DB trustees treat DC as a secondary issue. This started with money-purchase AVCs and continues with today’s TIPs. The problems are outsourced to insurers who treat the policies purchased as legacy , often selling books of this business between each other with little regard to the customers. This class of business is referred to as “sticky”, which typically suggests it is unlikely to be reviewed and to come under commercial pressure from competitive tenders.
The numbers of members in these schemes is high and average contributions tend to be high (these DC schemes are typically replacing DB benefits). My suspicion is that many of these DC sections of hybrid schemes are under the scrutiny of DB trustees who are not always best placed to manage DC schemes and invested in contracts that are unlikely to offer progressive investment options.
For all these reasons, hybrid schemes need to be in the scope of phase 2 of the Government’s consolidation work. AgeWage has been quoted in the recent consolidation paper response as saying
The regulations will reduce the long tail of DC schemes who struggle to present data to third parties in a timely way. This is of importance to the delivery of the pensions dashboard. It will also serve to give larger schemes greater scope to invest in patient capital and reduces the numbers stranded in smaller schemes missing out on investment into illiquids.
We repeat this statement with regards to hybrids, that form part of the long-tail of underperforming DC schemes. It is very much up to the trustees of mixed-benefit and dual-purpose hybrids of all sizes to consider their position and whether DC members would be better off being consolidated into a specialist multi-employer DC trust.
In your article today you have put at the end a link to ‘Beware the reasonable Ralfe’ regarding his views on highly-paid NHS staff. In the recent weeks John is quoted elsewhere as being highly critical of one of my pension managers: BT. Because of what they are doing with their Pension fund etc John is reported as saying that their actions ‘drives a coach and horses through clear pensions legislation’. You may have seen this also. Yet again it might show that Regulations have to be stiffened moreso to prevent even more firms from doing a ‘Maxwell’. As that article suggested: if the BT engineering was half as advanced as the financial engineering used on its pension fund, Britain’s broadband shortcomings might easily be solved. Something close to your heart I suggest…! Kind regards, Tim Simpson