We’ve all been saying for a while that DC is the future, but DC is also now, right now. Auto Enrolment (AE) has been in flow for more than a year, hundreds of thousands of people are now, newly, in a pension scheme, collectively saving billions of pounds toward their future. More, many more, will join them over the coming years. This is huge and it follows that the public are investing huge faith and huge trust in DC being able to deliver and, consequently, the consequences of failure are huge.
This article answers a few common questions about DC governance, be it of a trust based or a contract based scheme and, in particular, why it is so different to DB governance.
Why is good governance important in DC?
It’s estimated that, come 2017, around 20m workers in the UK will be reliant on DC pension provision for all or at least some of their retirement provision.
For many of them this will be a first foray into pension saving. For others, indeed a gradually reducing number, they will also have some sort of defined benefit (DB) legacy benefit. Either way, only a very small core of workers (estimated at around 5-7m) will continue to be able to rely on DB as their major source of pension income. In other words, a lot of people are going to be relying heavily on DC for their pension income.
At the same time, experience shows that DC tends not to provide benefits that are as generous as DB. This is for a couple of reasons: (a), generally, lower contributions are paid and (b) DC has not, historically, been run in an optimal way. It has been allowed to be inefficient.
The contribution levels may not change in the future (although one feature of good DC governance is to ensure that employers and members understand the impact of their contributions) but the efficiency has to improve. As more rely on DC for more of their pension they are going to expect to get best possible value.
Why is good DC governance important to employers?
Much of the talk around DC focuses on Good Member Outcomes (GMOs), but what are the Good Employer Outcomes (GEOs)?
It is, of course, common sense for any business to maximize the positive economic impact of any investment it makes. That, in a sense, is the simplest GEO. Why spend money and not get the best possible positive economic impact?
The economic benefits are wide and include:
- Exit management: poorly governed DC is less likely to produce adequate income in retirement. Inadequate income is a barrier to retirement. Good DC will, therefore, help an employer to manage people out of the business when it suits the employer as opposed to when an employee can afford to go.
- Enhanced reputation as a good employer: helping to attract and retain good quality staff, keeping them happy and so motivated and productive.
- Litigation protection: as more people approach retirement with inadequate DC savings, they will want to blame someone; their current or past employers, trustees, providers, anyone! Good DC means that an employer is better protected against litigation.
- Ethical, Social and Governance (ESG) screening: an increasing amount of investment is subject to ESG screening (more than E1tn in France last year alone). Staff welfare is a key part of ESG. Good DC is consistent with ESG, therefore making companies that provide it more attractive to investors.
- Cost efficiency and control: without a governance framework, it’s impossible to assess and control efficiency. With good DC, employers are in control and can make the most of their investment.
Why is good DC governance important to members?
Good DC is important to members simply because it provides them with the best chance of an adequate income in retirement. Good DC will provide robust and proactive defaults for those who don’t want to be actively involved and an environment to make informed decisions for those who do.
Why is good DC governance important to the policy makers and regulators?
UK state pensions are not generous. They are designed to provide a basic subsistence level of retirement income. The state’s aim is that private pension provision will boost this and in so doing (a) reduce the risk of people falling back on the state and so protecting the tax payer and (b) reduce the risk of an unhappy pensioner population so protecting the policy makers and regulators.
What’s different about DC good governance?
At a basic level DC governance is the same as DB. It is about (a) doing the right things at the right time in the right way and (b) identifying a strategic objective, having a plan to achieve it and executing that plan.
At a detailed level, however, DC is very different. It requires a different focus and a different mindset. It needs a completely different set of governance tools.
Good DC focuses on the member and the outcome they will achieve. It needs to be more granular than DB because it is the member that bears the impact. It is more time sensitive as the scope for extending the accumulation (or funding) period is more limited. For the same reason, but also because of the inherently lower risk tolerance, it also needs to produce a more reliable result.
DC is more about individuals so to be good it needs to take into account the ability and limits of the technology that we use and the members’ ability to learn and absorb information. It also needs to lead the members to do the right things by default.
Good DC is focused on outcomes: the benefits that will emerge, what it will deliver rather than how it will deliver. Investments, contributions and risk management all need to be designed from that end of the process, top down not bottom up.
How are DC governors different?
Again, at a basic level DC governors need to have the same basic traits as a DB trustee. For example, they need to be honest, have integrity and be thorough.
Good DC governors, however, need to have more. They need to be able to focus on the member experience and view all that they do from that perspective: they must be able, mentally, to walk the membership journey.
They must be hungry to learn and willing to adopt new thought and ideas, this because the DC world is in such a state of flux.
They will recognize the importance of truly efficient communication and recognize their own limitations in this respect. Good DC governors need to ensure that members are informed. The tools for informing them are modern and constantly changing. They need to ensure they harness this energy by keeping an open mind and being willing to ask others to help.
A really good DC governor will not be a Luddite about technology or language. If they are they will soon fall behind best practice at a cost to the member.
What’s different about the strategic objective of a DC scheme?
The DB strategic objective focuses on benefit security, timing and risk reduction. The DC strategic objective is to provide robust and proactive defaults and an environment where members can make informed decisions.
Robust defaults, whether for investment, contributions, the payment phase or communications, have to be research based and appropriate for the population of members at hand. They have to be as granular as possible in order to be relevant.
Proactive defaults require regular testing, from the perspective of the member’s outcome, to ensure they remain appropriate.
An environment where members can make informed decisions raises the bar far above where it currently sits. This is a whole new level of engagement unlike anything we do today.
DC is the future and the now. Huge swathes of people are relying on it working well and to meet their best ends. For DC to succeed it requires new skills and new outlooks from practitioners. If we fail to adopt these, this huge social experiment could fail with catastrophic consequences.
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