There is nothing more important than good governance to ensure value-for-money workplace pensions. Without robust governance in the interest of savers, the success of auto-enrolment is not a sure thing.
But there’s a problem with the governance, in particular of contract-based workplace pension schemes. That problem is conflicts of interest.
Or, more specifically, the way conflicts of interest between shareholders and customers of pension providers play out in favour of the former.
Common to all markets are potential conflicts of interest between the prioritisation of returns to shareholders and treating customers fairly. In functional markets this potential conflict is unrealised because of the customer's possession of voice, choice and exit mechanisms.
Members of contract-based pension schemes lack these weapons in the battle for value for money.
But there’s a problem with the governance, in particular of contract-based workplace pension schemes. That problem is conflicts of interest.
Or, more specifically, the way that conflicts of interest between shareholders and customers of pension providers play out in favour of the former.
Effective governance needs to be backed up by the flexibility to move assets and change administration
Common to all markets are potential conflicts of interest between the prioritisation of returns to shareholders and treating customers fairly. In functional markets this potential conflict is unrealised because of the customer’s possession of voice, choice and exit mechanisms.
Members of contract-based pension schemes lack these weapons in the battle for value for money.
In a market where the beneficiary (employee) is not the buyer (employer) of the product (a pension) one can never rely on the customer exercising sovereignty. Instead, governance must play that crucial role.
But don’t take our word for it: the Office of Fair Trading’s first-class analysis of defined contribution workplace pensions concluded that where members were getting a raw deal they often did so because of governance failures.
The OFT’s powers do, however, allow it to deal with monopoly or cartel behaviour.
The problems in pensions do not arise from either, so the OFT had a weak hand in trying to negotiate remedies with the Association of British Insurers.
Interestingly it specifically highlighted that the government needed to go further on governance than what the OFT had been able to achieve. At paragraph 9.37 of its DC workplace pension market study, it stated:
“We therefore consider it would be helpful for future policy and regulatory initiatives to be informed by longer-term principles for how the DC workplace pension market should evolve."
In our view, these principles would be the following:
Alignment of incentives
Better alignment of the incentives of employers, trustees, advisers, providers and investment managers with those of scheme members is the best way to ensure actions are taken in the interest of scheme members.
This should be coupled with clear responsibility and accountability for those making choices on behalf of savers. Regulation should promote this alignment and accountability and avoid steps that might result in misalignment of incentives.
Robust independent governance
DB schemes created strong incentives for employers to set up engaged expert investment governance, given the risks employers were exposed to.
While some parts of the market may be able to recreate robust governance for DC schemes, there is a role for policy to promote this.
Flexibility
Effective governance needs to be backed up by the flexibility to move assets and change administration.
We would expect the DC market to develop products that allow greater flexibility in investment decisions, including products for collective pooling of risk between scheme members. There is, however, likely to be a role for policy in providing the regulatory context for these developments.
The way to implement these principles is clear. Alignment is best achieved via fiduciary duties common to all in the investment chain.
Robust independent governance demands trustees to enforce it. And flexibility demands trustee-based governance committees, if they see fit, can enforce investment strategies that exclude the fund manager arm of the pension scheme provider.
The model put forward by the government in 'Better workplace pensions: Further measures for savers' of March 2014, and upon which the Financial Conduct Authority is consulting, does not meet these longer-term principles.
Or, to put it more bluntly, the government’s independent governance committee proposals are neither independent nor do they deliver governance.
They would put the home team in charge of choosing the referee.
Gregg McClymont is the UK shadow pensions minister
