Is professionalism the answer to the governance dilemma?

Having ploughed through hours of evidence in the spring of 2016 following the collapse of retailer BHS, which created the inevitable instability for the company DB scheme, the committee published a report into DB pensions in December last year.

It is the trustee who carries the can. Whatever happens, they are the ones who are responsible for all outcomes

David Weeks, AMNT

The report came to the conclusion that "members’ interests are not adequately protected by trustees" and "lay trustees may be insufficiently experienced to manage a scheme facing difficulties, or as an employee of the company they may suffer conflicts of interest in negotiations".

It is a damning assessment of DB trusteeship, and one that raises questions about the role of unpaid amateurs in making decisions about the future retirement income of millions of people.

Who watches the watchmen?

The way in which DB schemes are governed creates something of a paradox. Given the complexity of the topic at hand, lay trustees need the support of professionals to help them effectively run the scheme. 

At the same time, it is the trustee who must ensure third parties are doing the job appropriately, and monitor the situation and take action when problems arise. Yet this demands that trustees have expert knowledge themselves, which rather undermines the purpose of hiring a professional.

This rather uncomfortable dichotomy is made all the more unfortunate given that research from the Pensions Regulator suggests member nominated trustees are unwilling to question their advisers.

The regulator’s trustee landscape survey from July 2016 found nearly a quarter (24 per cent) of boards were unlikely to disagree with their external advisers and more than half (58 per cent) did so rarely.

This led the Pensions and Lifetime Savings Association taskforce to state concerns in its interim report 2016 "about whether the growth in the role of intermediaries has added significant value, or simply resulted in an increase in frictional costs – in other words, whether intermediation in the value chain has just created ‘value leakage’ at the expense of beneficiaries and sponsors".

This brings the question back to whether it is really worth schemes’ while paying for professional support.

Fiduciaries take-up set to increase

The regulator’s love for all things integrated – notably its desire to see trustees take a more holistic approach to calculating scheme funding – may mean schemes have little choice but to take on more professional support. Understanding how employer covenant, investment and funding risks interact and ensuring the scheme is run in such a way as to minimise these, is something even the finest pensions minds may struggle to achieve.

As a result, services such as fiduciary management are gaining popularity among DB plans. The Aon Hewitt fiduciary management survey 2016 found take-up of fiduciary management has more than doubled since 2011, when 18 per cent of respondents had appointed fiduciary providers, compared with 45 per cent in 2016.

The consultant said "adding expertise" was the main motivation for choosing a fiduciary approach, while "flight plan and derisking challenges" came second.

Melanie Cusack, client director at independent trustee firm PTL, says: “I believe [fiduciary management] will continue to gain traction as trustees are forced to focus more on the strategic decisions, as demonstrated in TPR’s integrated risk management requirements. They will be happy to delegate implementation of investment strategy in much the same way they delegate administration processes.”

Trustees remain liable

However, trustees cannot employ a fiduciary manager – or any other third-party adviser – and hope to free themselves of liability for any disasters the scheme might face.

David Weeks, co-chair of the Association of Member Nominated Trustees, says: “It is the trustee who carries the can. Whatever happens, they are the ones who are responsible for all outcomes.”

The question then returns to whether trustees are willing and able to question their fiduciary managers and appropriately monitor the service.

Patrick Disney, managing director of fiduciary manager SEI's institutional group, argues that in the absence of interrogative trustees, it is the professional’s responsibility to make the process as transparent as possible.

“It is on the provider to educate trustees and explain clearly how they go about things,” Disney says.

Hiring a professional trustee to support the board can go a long way towards unpicking this governance paradox.

Eleanor Daplyn, partner at law firm Sackers, says: “Having professionals involved as trustees can definitely make running a pension scheme easier; a client with a certain level of technical knowledge themselves may not ask to be walked through issues in the same way as a lay trustee, and they can sometimes assimilate complex issues and reach a decision more nimbly and efficiently.”

Is consolidation the way out?

Yet even though professional trustees may bring reassurance and knowledge, they mean extra cost for the scheme and yet another third party which needs to be monitored.

It may be then that consolidation will prove a more effective route than professionalism in dealing with the governance conundrum, especially for smaller schemes.

The government’s green paper on security and sustainability in DB schemes, which closed its consultation last month, takes up the PLSA's suggestion of superfunds which bring smaller schemes together to benefit from economies of scale and improved governance.

The practicalities of creating superfunds for DB schemes are questionable, however. Different funding levels, contradictory schemes rules and myriad complexities in the existing regime create significant challenges for advocates of consolidation.

Responding to the DB green paper consultation, pension consultant Redington says: “While there are some benefits to consolidation, there are not currently compelling models that are practical, protect members’ interests and crystallise the full benefits of increased scale.”

Only as strong as the weakest link

The number of professionals supporting pension schemes has increased which has in turn improved schemes governance, yet challenges remain.

Since trustees are responsible for how the scheme performs, they need to be fully aware of how it operates and be able to question their advisers. Yet in the absence of adequate training, confidence and overall engagement they may feel unable to do so.

Scheme governance can only be as strong as its weakest link and, in the event of a disaster, it is irrelevant whether that is a professional or amateur. Rather it is more important to identify weakness before it becomes a problem and ensure all parties are able to make a valuable contribution.