Defined contribution pension schemes: the Government's drive for "quality"

This article was produced by Olswang LLP, which joined with CMS on 1 May 2017.

Hot on the heels of the Government's recent call for evidence on quality standards relating to defined contribution (DC) pension schemes, follows a draft code of practice from the Pensions Regulator. We look at the implications of both for employers and trustees.

The general trend towards providing DC benefits has caused an increased, if somewhat gradual, focus on the quality of DC arrangements. The focus on quality appears to have been given more impetus by the introduction of auto-enrolment and the proposed automatic transfer regime, with both the Department for Work and Pensions (DWP) and Pensions Regulator (Regulator) looking more closely at quality checks for DC schemes. Clearly, any improvement to the quality of DC schemes will be good news for members, but there is a rather large amount of information for employers and trustees to digest.

DWP proposals and call for evidence

The DWP's call for evidence relates to both occupational and personal DC pension schemes and seeks views on introducing minimum statutory standards. The Pensions Act 2013 provides for regulations to be made about quality requirements of automatic transfer pension schemes - namely, those schemes in which a member's pension savings account will follow them when they change employment. The views sought by the DWP relate primarily to scheme governance, standards for investment and default options, and the administration of schemes. The proposals can be found here.

Requirement for a 'governance body': An alignment of the interests of those running the scheme and the interests of members (so that decisions taken are in the members' interests) and ensuring that those running the scheme have sufficient skills and knowledge, are the two underlying qualities that the DWP considers to be the cornerstone of effective governance. So as to achieve this, and as a minimum, the DWP would like all schemes to be overseen by a governance body that has a duty to act in the members' interests. We are already seeing this in practice, having advised some of our clients who have established, or are considering establishing, a governance body. The governance body should be able to explain the way in which conflicts of interests are dealt with, should meet at least every 6 months and at least 25% of the body should have appropriate professional qualifications. Clearly, this will not be without challenges for DC schemes, not least regarding how to align members' interests with the commercial interests of third party pension providers, although it is likely to be easier in trust based schemes.

Minimum legislative standard for default investment options: The DWP suggests default investment options should have a clear statement of aims, objectives and structure, designed to be both appropriate for the membership, and in their interests. The performance and characteristics of default options should be regularly reviewed to ensure they remain aligned with the interests of members and appropriate for the membership.

Standards of administration: In light of the proposal to have automatic transfers, the question of scheme administration, particularly record keeping, will clearly be very important. The DWP therefore wants views on which elements of administration are important enough to set out in legislation and it suggests a number of practical steps to ensure appropriate administration. The Regulator has also been very active to ensure that schemes understand what it considers to be appropriate as regards proper administration and record keeping.

The Regulator's draft code of practice

This is also intended, broadly, to improve the quality of DC pension arrangements, and consequently it does not apply to schemes providing defined benefits only, or defined benefits in hybrid schemes, work-based personal pensions, stakeholder schemes or other contract-based schemes. The code is intended to apply to trustees of all occupational DC trust-based pension schemes with two or more members (whether active, deferred or pensioner members) which offer:

• money purchase benefits, including additional voluntary contributions under occupational defined benefit trust-based pension schemes and the DC element of hybrid schemes; and
• money purchase benefits with a defined benefit underpin (for example, where the benefits under a DC scheme include a guaranteed minimum level of pension).

The Regulator's draft code (now in final form here) is expected to come into force later in the year and is divided into 5 key sections dealing with knowledge of the scheme, risk management, investments, governance as regards conflicts of interest, and administration. There is considerable detail and on a first reading, it appears complex and rather prescriptive. Nevertheless, when the code becomes effective, it will be helpful for trustees who wish to benchmark the governance of their own schemes against what the Regulator considers best practice in this context. Importantly, when looking to comply with the draft code, trustees will also need to consider the specific powers they have under their trust deed and rules. For example, their investment powers might not be as broad as the draft code suggests.

Where to next?

Establishing a pensions governance function and complying with minimum standards of administration, as proposed by the DWP is likely to take some time and involve a degree of cost for schemes and employers. It also remains to be seen whether compliance with the Regulator's code of practice will incur further material costs. However, it is clear that the Government is keen to introduce a level of regulation into DC schemes and the Regulator has said that it will publish its DC compliance and enforcement policy later this year, which will explain the way in which it will take enforcement action against DC schemes.

Pro-active affected trustees should take steps now to ensure that they are familiar with the contents of the Regulator's draft code and have considered its content with respect to their scheme. In addition, the Regulator will issue an updated version of its trustee toolkit relating to DC schemes in the Autumn and it will provide guidance and support on its website for those involved in running DC schemes. Employers should monitor carefully the progress of the DWP's proposals for legislation on minimum standards for DC schemes.

Of course, these are only some of the areas of importance in a complex regime. If you have any questions in relation to DC pension schemes generally or about how the new proposals or the draft code of practice might affect your scheme in particular, then please contact our Pensions Team.

Any information contained in this article is intended as a general review of the subjects featured and detailed specialist advice should always be taken before taking or refraining from taking any action. If you would like to discuss any of the issues raised in this article, please get in touch with your usual Olswang contact. This article was included in our Olswang Corporate Quarterly Summer 2013 publication.