Brute force, or a better way?
Although The Pensions Regulator’s Code of Practice has many benefits, I feel it's heavy-handed for some arrangements, such as legacy Additional Voluntary Contributions (AVCs). It is vital that these aren't neglected, but is there a better way to manage them rather than ‘brute force’ governance?
As a pensions professional, I hope that most employers and those in the pensions industry agree that the increased regulatory focus on defined contribution pension arrangements (such as the revised Code of Practice (CoP) introduced in July 2016) is a good thing. Protecting and improving the ability of the UK as a whole to save for retirement is vital for both employees and employers.
However, there are many arrangements out there subject to the regulations, particularly The Pensions Regulator’s Code of Practice 13 where the amount of time needed to comply can take a disproportionate effort in comparison to the level of benefit members may have in the arrangement. Prime examples of this are closed AVC arrangements within final salary schemes.
In many cases, AVCs make up only a few percent of the scheme’s assets but require governance from Trustees. Undertaking a full CoP assessment could take up what seems an unreasonable amount of time at the Trustee’s meetings.
In fact, despite our earlier argument (see previous article ‘Debunking the Governance ‘burden’ myth) that there isn’t really a governance burden for Trustees, it actually does exist in some circumstances and needs to be managed.
So what should be done?
A proportionate approach?
Striking the right balance for the future governance of AVCs is a growing issue for Trustee boards and deciding on the appropriate and “proportionate” response to CoP 13 requirements may not appear so straightforward. At the heart of governance is, again, value for members. We have carried out a number of initial reviews of AVCs with the goal of structuring them for more streamlined governance going forward.
Some of the key conclusions we’ve drawn include:
Many schemes encompass multiple providers/suppliers giving rise to inconsistencies regarding the investment terms and choices offered to members across the various contract platforms. Although it can seem arduous, consolidating providers could improve member outcomes and streamline the governance requirements of Trustee boards in the longer term.
Typical investment options include With-Profits, Cash/Deposit and a range of active and passively managed funds, either within a lifestyle structure or as stand-alone options:
With-Profit funds – increasingly unpopular option for further future contributions due to anticipated investment return and complexity. For many they offer a lower future return expectation due to de-risked investment structures often linked to a requirement to support/protect existing bonus/annuity conversion guarantees
Deposit Investments (perhaps matching Bank of England Base Rate) - these provide security if funding for cash, however for longer term investors the result is likely a return after charges that is less than rising inflation
Inappropriate risk choices – we find many members are exposed to riskier assets quite close to their intended retirement age.
To help resolve these issues we've helped trustees implement a core fund range and develop simple communications to reengage members with their AVCs. This then allows for a more focused governance process to be installed.
Passing on the burden?
An approach that's just beginning to gain some popularity is to consider transferring the governance responsibilities to a third party e.g. a “Master Trust”. This is made easier given the changes to bulk transfers without consent discussed in our previous blog. The process now becomes less burdensome as it no longer requires the ceding actuary to supply a certificate and is easier still where the transfer is being made to an “Authorised” master trust. That said, care still needs to be exercised in order to ensure members’ rights continue to be protected:
Two alternative approaches present themselves: either via a process of “Assignment”, which is designed to retain all existing investments, attaching guarantees and contractual charges, or a transfer via encashment to an alternative range of investments. Under both examples the assets are passed to the new arrangement along with the governance requirements. Typically, there is also an agreement in place that members can repatriate their AVCs at retirement so they can still use these for tax free cash (if the scheme rules allow it).
This solution may not work for everyone, particularly if there are protected tax-free lump sums or retirement ages that may be lost as part of the transfer. However, it can free up more time for trustees to focus on the governance of the main benefits in the scheme.
Is it time to revisit your approach to AVCs?
Download your copy of our Legacy AVC Governance case study here to see how this works in practice...
This is the third article in a series of considerations for trustees and employers.
Please also check out our previous articles on Debunking the trustee governance “burden” myth and Improving Legacy Arrangements for DC pension schemes.