by Dr. Ros Altmann
(All material on this page is subject to copyright and must not be reproduced without the author’s permission.)
BRAVE NEW WORLD FOR TRUSTEES
There have been significant recent changes which will have profound implications for pension fund trustees. Since the changes have happened so quickly, it may be that many have not yet realised how much their world has changed. There is an urgent need for all trustees to carefully assess how they are operating and ensure that they are not laying themselves open to possible legal action from members.
There are several key areas to consider. In terms of scheme governance, whether defined benefit or defined contribution, the trustee Board’s focus should be to ensure members achieve good pensions. The Myners Review and measures in the current Pensions Bill entail a major move towards ‘professionalisation’ of the trustee’s role. There is also an increased emphasis on the rights and needs of members, which applies to trustees of both defined benefit and defined contribution schemes. The requirements will differ, depending on which type of scheme is involved.
For defined benefit schemes, the trustees’ prime aim should be to ensure they can pay the promised pensions. Their role is not to maximise investment returns with minimum risk, nor to ensure that managers outperform a particular market or peer group benchmark, nor to try and minimise the employer’s contribution, but it is to match or outperform the scheme’s liabilities. The Pensions Bill has strengthened members’ rights significantly and the trustees’ role has become much harder, requiring closer focus on scheme funding levels. Perhaps the level of underfunding (on a buyout basis, as well as other measures) needs to be monitored on an annual basis – not triennially, aiming to achieve closer matching over time. In the past, trustees were concerned about ‘who owns the surplus’, but it is now important to understand ‘who owns the deficit’. Employers could wind up the scheme and leave much of the deficit with the members. Since June 11th 2003, this is no longer easily done and trustees need to negotiate funding levels more firmly with the employer to better match the liabilities. Trustees will need to document details of meetings with the employer and take written professional advice, in order to be able to prove that the funding levels were appropriately negotiated. Trustees also need to consider the strength of the employer covenant and any corporate changes. All credit to WH Smith trustees, who have shone a light down the path for other trustees to follow. .
For defined contribution schemes, the aim is still to deliver good pensions, but of course, individuals are bearing all the investment, inflation and longevity risk. Perhaps trustees need to facilitate help for members to deal with these risk, for example by providing access to good quality information and possibly advice, to help members understand and plan for their pensions. In addition, I would argue that trustees have not yet focussed sufficiently on providing really good investment options and default options for defined contribution schemes. For members who wish to choose, a good range of investment funds should be available, covering all asset classes. For those who do not want to choose, better-designed default options are required, not just balanced funds or lifestyling. For example, most members’ idea of risk is ‘not losing money’. A capital protected product would come closer to providing this type of ‘low risk’ option than either with-profits or even bond funds.
Apart from investment returns (net of fees) there are two other vital elements to providing good defined contribution pensions. Firstly, the level of contributions. Trustees could consider helping members understand financial planning to decide appropriate contribution levels. Secondly, the annuity purchase is critical. Trustees may not have devoted sufficient attention to this. Many members may be eligible for enhanced rates and impaired life products and, if trustees do not offer this option, I believe they may be open to action from members who receive the wrong annuity, but can never change it.
As regards best practice, it is vital that any conflicts of interest on the Trustee board are recognised and dealt with and trustees should perhaps assess their Board’s skill levels and arrange to fill in any gaps with appropriate training or recruitment. Sound decision-making processes and structures are important – for administration, communication and investment – with the aim of achieving well-managed implementation of those decisions. Monitoring and documentation of reasons for and results of these decisions would help to assess trustees’ own performance. Of course, the performance of their advisers also needs to be assessed – against pre-set criteria for each scheme. One area would be to insist that recommendations from investment or actuarial advisers are made in plain English– with clarity of assumptions and recommendations that ordinary mortals can understand!
In summary, the trustees’ world has changed and their job has become much more difficult. Tougher and braver negotiations with employers and improved member communication may be essential to avoid possible litigation. Trustees need to bear in mind always that their role is to help members receive good pensions and minimise any conflicts of interest, or lack of skills, which will interfere with this goal.