Why is size an issue for DC?
There has been a significant drive within the pensions industry to ensure Defined Contribution (DC) schemes are maintained to the same degree of excellence in terms of governance and due diligence as their Defined Benefit (DB) counterparts. Long gone are the days when trustees spent five minutes on DC at the end of a very long day discussing DB issues.
DC has been through various phases, from being the saviour of UK pensions with the introduction of Stakeholder pensions, to the stalled saviour following the lack of real interest in Stakeholder, back to being the saviour once more with the advent of Auto enrolment (AE).
The size of DC contribution flows and membership have overtaken DB arrangements and this interested the Pensions Regulator (TPR). The sheer volume of DC has brought governance requirements sharply into focus, but with a drive for greater security and higher standards comes increased costs.
The Pensions Regulator introduced the DC principles, followed by the first then the second (revised) DC code. DC schemes must prove they are run effectively for the membership. The Chair of Trustees Statement began as a communication to members, informing them that the trustees, on their behalf, have met the requirements of the DC code. However, it has since become a compliance statement, with TPR expecting trustees to have documentation and evidence to back up any statements made.
AE has driven the surge in membership of DC and it has also seen the proliferation of Master Trusts.
Whilst there are a significant number of them, the vast majority of those members going into Master Trusts, is concentrated in a few.
The attraction of Master Trusts is spreading the cost of governance and maintenance.
Yes, Master Trusts have to prove an even higher level of governance with the Master Trust Assurance Framework and the new authorisation process currently being undertaken, but that cost is spread over a larger pool of members and employers.
A recent TPR survey shows size does matter and Master Trusts, larger employers, and over half of medium sized DC arrangements were expected to meet the requirement to demonstrate value for members. Unfortunately only 14% of small DC schemes were expected to meet these higher governance standards.
Can smaller schemes meet governance standards? There are several different sources of assistance for DC schemes, irrespective of size, notably TPR’s website with guidance on governance and the DC code. It also provides a quick guide to the Chair’s statement, all free of charge. The Pensions Administration Standards Authority (PASA), recently published its DC governance guide and is looking to develop it further, specifically for schemes of varying sizes.
Advisors offer seminars, free events, and updates which are useful.
Will we see the demise of small schemes? Probably. Because it is not just the cost of governance that is the issue. General running costs are significantly higher for administration, advice, and investment. Despite providers being able to downscale their products, there will always be a delimitus, but governance costs may finally have pushed that to a level which is no longer acceptable. And, unlike small DB schemes with deficit issue preventing offloading of them, winding up a single small DC scheme and flipping it into a Master Trust has to be an attractive option.
Last update: 21 July 2020