It is ordinarily most appropriate to think about different types of pensions in terms of defined benefit (DB) and defined contribution (DC). Working papers being published by the TUC today, by Hilary Salt on DB and Bryn Davies on DC, demonstrate that these forms of pensions provision are indeed very different, and face quite different challenges in the current political and economic climate.
Yet there is another way to categorise types of pensions, in terms of the differences between trust-based or occupational pensions, and contract-based or personal pensions. It is a little known, but hugely important, fact that not all forms of employer-sponsored pensions qualify as ‘occupational pensions’, which is why the strange term ‘workplace pensions’ has entered the pensions lexicon.
The essential difference is that trust-based schemes – which may be DB or DC – are governed by a trustee board, which will typically be composed of representatives of the relevant employer, member-nominated trustees and professional scheme trustees (although board memberships take many different forms, especially in multi-employer schemes). Contract-based schemes are governed simply by a contract between the individual saver and the provider. They have no formal governance arrangements beyond this, meaning that consumers themselves are solely responsible for ensuring that their interests are being served.
The TUC favours the trust-based model, in that in means there exists within the scheme’s governance arrangements a group whose sole responsibility is to protect member benefits. Our annual conference for pension scheme trustees will be held at Congress House on 27th November. The conference is a valuable opportunity to meet fellow trustees, trade unionists and pensions and investment experts to share information and experience (click here for more information).
We know, however, that contract-based schemes becoming more dominant. Among employees enrolled in defined contribution schemes, 65 per cent are in a contract-based pension scheme (either stakeholder or group personal pension), and 35 per cent are in trust-based schemes. 2011 saw membership of group personal pensions overtake trust-based defined contribution pensions for the first time. Despite the presence of NEST (a large trust-based scheme set up by the government – as a de facto default provider) it is likely the majority of people automatically enrolled into a workplace pension in the next few years will end up in contract-based schemes.
Trust-based schemes are not preferable simply because of the role of trustees. There is also a more appropriate regulatory framework in place for occupational pension schemes, in that they are regulated by the Pensions Regulator – whereas personal pensions largely fall under the remit of the Financial Services Authority (FSA). A recent National Audit Office (NAO) report found that:
In contract‑based schemes, where responsibilities are shared with the Financial Services Authority, The Pensions Regulator has fewer options to intervene directly compared to trust-based schemes. It has no powers regarding the providers of contract-based schemes, but it has the statutory objective to protect members’ benefits in these schemes.
Because contract-based pensions, once in operation, are simply saving vehicles offered by financial institutions directly to individuals, it is perhaps right that a watchdog like the FSA governs the behaviour of providers. Also, contract-based pensions have the advantage of operating, rather obviously, under the firm hand of contract law. In practice, however, the NAO’s inquiry gives us reason to question whether the FSA is appropriately geared towards regulating workplace pension schemes. And while the contract signed at point of purchase is regulated and legally enforceable, consumers may not know enough to ensure the contract they are signing is in their long-term interests.
The discrepancy between trust-based and contract-based schemes was also highlighted by recent proposals by the Takeover Panel to give trustees greater power in the event of company takeovers. The principle behind the proposals, which the TUC broadly welcome, is that employee representatives should be made aware of the plans for the company pension scheme of any firm looking to take over another firm. The only mechanism for delivering this in practice, of course, is to give scheme trustees the right to this information. We are left with a situation whereby the role of trustees will, rightly, be strengthened – but the governance deficit suffered by members of defined contribution schemes will increase as a result.
None of this is to suggest that there are no problems within trust-based provision. Often schemes are de jure trust-based, but owned by providers such as insurance companies, and therefore in practice trustee independence is questionable. Furthermore, some trustees in DC schemes, particularly small schemes, often lack the expertise on issues like charges to fully protect members’ interests – as documented in the Pensions Regulator’s Occupational Pension Scheme Governance Survey report. Both trust-based and contract-based pensions are here to stay – and there is scope to improve both forms of provision.
The trustee conference is an opportunity for trustees, and other professionals in the pensions industry, to discuss these issues. The conference will feature keynote addresses by pensions minister Steve Webb, Kay Carberry and John Kay – author of the Kay Review of Equity Markets and Long-Term Decision-Making – as well as contributions from Jeannie Drake, Paul Todd, Hugh Wheelan, Margaret Snowdon, Christopher Sier and Alan Woods. Hilary Salt, author of the working paper on DB pensions, will lead a workshop on scheme closures, and the Pensions Regulator will be presenting on the impact of quantitative easing on scheme funding. One of the conference’s overarching themes will be how pension fund trustees can ensure their investments generate secure retirement benefits for scheme members, in the context of encouraging UK companies to eschew short-termism and focus on ways of boosting long-term, organic growth. Click here to register for the event.