DC schemes are not risk-free; they involve risk transfer. With Master Trusts becoming mainstream, there is now a much greater choice of DC arrangements to consider and innovation has come on in leaps and bounds. So, as part of a de-risking strategy, the question that should be asked is who is best placed to take the risk, how can it be minimised and, most importantly, how can the best member outcome be achieved.
What are the risks in DC?
Benefit Adequacy – this is the headline risk in DC schemes and rests with the individual member. It is a feature of all DC schemes but it can be minimised by effective management of all other risks:
Investment Risk - where a fund is invested has perhaps the greatest impact on outcomes. The options and strategies made available to members, and how they are monitored, updated and changed, has huge ramifications.
Costs – DC scheme members pay at least some, if not all the charges associated with being a scheme member. Single employer schemes will typically pick up the costs of running the scheme and members the investment charges. The risk here is that member charges are too high and/or the scheme becomes unaffordable for the employer.
Administration - the risk of administration going wrong has huge implications for DC schemes, more so than DB schemes. For example, contributions must be invested on time, fund switches made promptly, and benefits paid in accordance with members instructions.
Governance and legislative risk – the risk of falling foul of the increasing governance and legislative requirements that DC Schemes face can be time consuming, costly and cause reputational damage. Increasingly the workload and skills required to be a trustee means that professional trustees are becoming the norm.
Member understanding - member understanding in DC schemes is crucial. Lack of understanding will have significant consequences on member outcomes and the risk to trustees and sponsors is substantial.
How can the risks be mitigated?
The starting point for risk mitigation is to consider it from the different viewpoints of the member, employer and trustee. All will have different objectives, but the goal of ensuring best outcomes is the same. In many cases the risk mitigation will be the same and ‘win win’ for all parties. Considerations include:
- Whether the risk is in the right place?
- Is the level of risk being undertaken acceptable?
- What are the mitigations?
To help answer these, stakeholders should review:
- If the scheme is well run and meeting all legislative requirements?
- If it has the expertise to run it?
- The opportunity cost of running the scheme – could resources be better used in other areas?
- Are the costs of running the scheme acceptable?
- Does the scheme have sufficient scale to benefit from latest investment thinking and expertise?
- Is there access to the latest communication ideas and technologies?
- What needs to be done to remove/mitigate risk – i.e. increased budget, training, investment in technology etc.?
- What will achieve the best member outcome?
Are Master Trusts the answer?
In many cases, employers and trustees are finding that the risks and costs associated with running schemes are simply too much and are, therefore, moving to a Master Trust. This route can help de-risk DC and achieve better outcomes for members. Indeed, this is what Master Trusts have been designed for. The key features are:
Scale – the Master Trust model is built on scale. This allows Master Trusts to drive down cost and allows them to offer innovative default strategies and investment options, with access to the best investment ideas, for example Environmental, Social and Governance (ESG).
Governance – Master trusts have very strong governance mechanisms in place and are run by experienced, professional Trustees for whom running pension schemes is their full-time job.
Proposition development – Master trusts scale and long-term nature mean they can invest heavily in the proposition; this means better communication tools for members and the use of the latest technology.
Pensions regulator authorisation. Master Trusts must meet strict conditions for authorisation to operate. This provides confidence that they have the systems, processes, knowledge, skills and longevity in place to achieve strong member outcomes.
De-risking DC by using a Master Trust is certainly an attractive option and has many advantages. For any employers or trustees considering this, it is important that any review is done jointly. Unlike DB schemes, there is very little conflict in the aims of both parties and by working together to review and consider de-risking options, the optimum solution can be found, whether that is keeping the status quo, additional investment/resource or changing arrangements.
Too often DC schemes tend to be forgotten when looking at a pension de-risking strategy. However, if pensions de-risking is expanded to look at all aspects of pension provision, then the result is likely to be better outcomes for members, employers and trustees.
This article was featured in Pensions Aspects magazine November/December edition.
Last update: 27 January 2021