Paradigm shift in the offing for defined contribution pensions
It has been clear for some time that the defined benefit pension model in Ireland is broken and offers pension promises to members that many schemes cannot possibly fulfil. And barely a day goes by when we do not hear of yet another DB scheme telling its members that it will need to reduce benefits, or be wound up and members transferred into a defined contribution arrangement.
I have said repeatedly over the past couple of years that a well-managed and properly-resourced defined contribution scheme is far more beneficial to people than a deficit-laden DB scheme which has little prospect of meeting its liabilities. The fact that as of April 2012, there were more than 16,000 group DC schemes in operation covering more than 190,000 employees is an indication of the shift towards DC. So if we accept this inexorable shift is taking place, pressure will intensify to ensure that DC schemes are well-managed and efficient retirement vehicles. We foresee a paradigm shift and the DC space will look very different in five years’ time compared to what it looks like today.
As the role of DC schemes becomes more prominent, participants in these schemes are increasingly likely to ask the question “Who exactly is looking after my interests?” and employers will need to review the design and management of their DC schemes to ensure that they can demonstrate clearly that members’ investments are being protected.
While DC schemes have been around for quite a while, the level of assets in them is set to grow significantly over the next few years. Solutions to the DB problem may see a portion of their assets shift into DC schemes. In addition, future contributions (including past service deficit repair contributions) may also go into the DC scheme. As their assets burgeon, the question for employers is, do they know how their DC scheme measures up?
Many employers, perhaps fed up with all the time and resources poured into DB, will want to assume that their existing DC scheme is perfectly adequate. However, to protect their reputation and their employees’ interests, before increasing contributions any further, employers need to stop, reflect and:
determine the criteria for assessing the effectiveness of their DC scheme
review their scheme against those criteria and
consider how best to address any weaknesses identified.
It is likely that the vast majority of employers have in the past simply focused on the need to have a DC scheme. The selection of the provider(s) would likely have been based on brand, price and convenience, favouring perhaps a single provider with the ability to take care of everything from administration, through handling member queries, through managing the investments.
The net result, however, has generally led to a situation where a DC scheme compares poorly with a typical DB one in terms of costs being too high,
contributions too low, and a default fund which is poorly managed.
In the future, governance is likely to come under increased scrutiny. This is already happening in the UK where the Pensions Regulator has highlighted that the changing DC environment places
“ . . . an increased emphasis on the strength of governance and stewardship, particularly around the design of investment options, investment management and scheme administration, and the need for better standards in DC.”
The introduction of auto enrolment in the UK has pushed forward thinking on DC in that market and, as such, it is a useful reference point for Irish
employers seeking to get a glimpse of
how DC scheme management might evolve. While the detail here will
probably be different, for employers the high level message is likely to be the same: you need to think more deeply about the management of your DC scheme.
The guidance issued by the UK regulator in January this year includes six “DC principles” regarding the essential characteristics of the schemes, establishing governance, qualifications of personnel, ongoing monitoring, administration, and communication with members to enable them to make informed decisions about retirement savings.
As the focus increasingly shifts to DC in Ireland, companies should consider the type of governance/management model built into their DC scheme. Is there sufficient independence, challenge and innovation in the model to protect members’ interests? Will one service provider be able to advise and manage on all aspects of the scheme, or might conflicts of interest impede that goal?
Our view is that the DC model in Ireland will evolve. There needs to be increased focus on, and ongoing robust management of, the underlying factors that will impact member outcomes. As this covers everything – from costs through to innovation in investment and communications – it will likely lead to unbundling of services and the emergence of new initiatives.
John Tuohy is chief executive of Acuvest, a specialist pensions advisory firm