July 10, 2013

Sea change needed to bolster contract governance

Click here to see coverage of the article in Pensions Week.

In contrast to the position for trust-based schemes, there is currently no legislative or regulatory requirement for contract-based schemes to have formal governance arrangements in place.

Increasingly, however, it appears it is only a matter of time before governance committees will be mandatory for contract-based schemes.

At present such committees do not provide the same level of scheme oversight as a trustee board. In the absence of legislation, this position is unlikely to change in the short term.

The advent of auto-enrolment and the government’s plans for pension consolidation may lead to a change of approach to contract-based scheme governance.

Already there are comments within the industry and reports in the pensions press that the governance of these plans is in transition.

Great expectations

As more individuals are auto-enrolled into contract-based schemes, member expectations are likely to increase, and schemes will come under more scrutiny with the introduction of pot-follows-member.

The Pensions Regulator and the government are likely to come under pressure to ensure that those schemes are indeed fit for purpose. One option would be mandatory governance committees.

Contract-based schemes are mass-market products where there is little or no direct contact between the provider and the member. The legislative requirements for employers in relation to contract-based schemes do not extend to governance arrangements.

In addition, scheme providers are required only to comply with the financial services regulatory requirements – for example, ‘know your customer’ – rather than any requirement for a governance committee.

This position is not helped by the fact that the regulatory regime for contract-based schemes is split between the regulator and the Financial Conduct Authority.

Finding best governance for members

Despite the fact that governance committees are not mandatory, certain employers do have some form of voluntary body like this that reviews the provider’s performance.

It is also worth noting that some providers are considering governance committees as a way to improve the way in which they operate the scheme.

But the types of governance committee currently in place for contract-based schemes demonstrate their weakness in comparison with a trustee board.

A trustee board provides the most powerful and effective form of oversight to protect pension scheme assets and member benefits, as trustees are required to act in accordance with their trust law duties.

These duties, such as the responsibility to act in the best financial interests of the beneficiaries, are well established and understood. They are overlaid by requirements of the various pensions acts as well as regulatory codes and guidance.

Limited power

In contrast, an employer’s governance committee can only review the appropriateness and effectiveness of the provider.

The most that such a governance committee is likely to be able to do is recommend a change of provider – it cannot directly influence the way in which the provider actually operates.

Put another way, a governance committee can only oversee the scheme’s operation, it cannot make up for perceived deficiencies in the benefit structure.

This is the case regardless of the particular terms of reference of the committee.

A new approach

A sea change of approach and attitude would be required to bring contract-based scheme governance committees more in line with the standards expected from trustee boards.

Employers and providers are likely to be reluctant to put in place an arrangement that may impose trustee-like duties on committee members.

The underlying reason for this is that the legal status and remit of such committees has not yet been tested.

In the current legislative and regulatory environment, a contract-based governance committee is unlikely to provide as powerful oversight as a trustee board.

The only way this situation is likely to change is for the government to legislate. The danger is that legislation can be somewhat of a sledgehammer to crack a nut.