There are two main approaches to designing a ‘defined contribution’ (DC) workplace pension scheme. All DC schemes involve the individualisation of risk, but within this, schemes can be either trust-based or contract-based. The impact on members of this difference is the subject of the TUC’s forthcoming pensions seminar, The Governance Gap, which features shadow pensions minister Gregg McClymont.
New data published by the ONS on pension contributions last week appears to compound these differences – with members of contract-based schemes tending to receive lower employer contributions into their pension pot.
Trust-based or ‘occupational’ DC schemes are governed by a board of trustees, whose sole duty is to protect scheme members’ interests. Incontrast, contract-based DC schemes – which can be either ‘stakeholder’ or ‘group personal pensions’ – have no formal governance arrangements at scheme level. Members have a contract that the provider must respect, but given the complexity and long-term nature of pensions saving, and the fact that it is their employer that actually negotiates the contract, the effect of this in practice is limited. Although trust-based governance is not trouble-free, as I argue here, the absence of trustees in contract-based provision means that, when it comes to decisions on issues such as investment and charges, the members’ perspective is not adequately voiced.
Data published last week by the Office for National Statistics underlined another aspect of the divide. No matter how they are governed or regulated, the most important determinant of outcomes from DC pension will be the contributions put into schemes. We now have strong evidence that contract-based pensions are found wanting here too.
Employee contributions into trust-based and contract-based schemes are roughly equivalent. 53 per cent of trust-based scheme members pay less than 4 per cent of their salary into their pension pot, compared to 62 per cent of contract-based scheme members. The figures for contributions below 2 per cent are 25 and 30 per cent, respectively. We should be under no illusions that parity between trust and contract provision means there is no problem – employee contributions need to rise, but at a time of wage stagnation that is much easier said than done.
Employer contributions are the bigger concern when it comes to understanding the differences between trust and contract DC pensions. On this issue, the divide between the two approaches is actually worsening. For trust-based schemes, in 2011, 47 per cent of members had employer contributions of 8 per cent or under. This fell to 42 per cent in 2012. For contract-based schemes, 69 per cent now have employer contributions of 8 per cent or under, a fall of only two percentage points from 2011.
And within this, there is now a higher concentration of workers in schemes with very low contributions. In 2011, 27 per cent of contract-based scheme members had employer contributions below 4 per cent – this proportion had actually increased by 2012 to 29 per cent.
Of course, contribution rates are not determined by the type of DC scheme selected by employer for their staff. Neither contract-based providers nor their regulators are therefore at fault in any direct sense. Instead, what this trend seems to indicates is a ‘race to the bottom’ whereby employers discharge their duty to provide a workplace pension scheme with as little cost as possible, in terms of both contribution levels and scheme management. There is already evidence that contract-based provision is increasingly more popular than trust-based provision.
The new data refers to contribution rates in place before auto-enrolment got underway. But if such trends are evident among those employers voluntarily providing a workplace pension, then it is unlikely the new compulsory regime will lead to significant improvements in the short term.
To register for The Governance Gap, which also features Bridget Micklem (DWP), Mark Hyde Harrison (NAPF), Debbie Harrison (FSA Consumer Panel) and the TUC’s own Nigel Stanley, click here.