The terms ‘risk reduction’ and ‘de-risking’ are used frequently in relation to pensions, but usually focus on investment strategy. What other ways can pension schemes reduce risk in the administration, provision and communication of pensions to individuals?
As anyone involved in the planning of, or attendance at, trustee board meetings will know, investment management is frequently the main focus of trustees’ attention; achieving the best investment returns from assets, whilst simultaneously reducing exposure to risk, with the aim of securing a well funded future for its members. However, it could be argued that the priority is oftentimes too heavily focused on risk reduction from a purely investmentfocused and liability reduction perspective. This essay will examine the argument that, given the modern day landscape of pensions and the associated risks to pension schemes that go with this, it would be wise for trustees to also consider ‘risk reduction’ or ‘de-risking’ strategies from a more comprehensive administration perspective.
Historically, employers established ‘final salary’ or defined benefit (DB) pension schemes and adopted a paternalistic approach by ensuring their staff and their spouses were taken care of through provision of certainty of income in retirement, with little engagement required on the part of the employee.
However, as society has changed, so has the way many of us live our lives; people now demand more flexibility and choice in their financial affairs.
Since the Pension Schemes Act 2015, members are able to access their benefits flexibly, and deferred DB members have a statutory right to request a transfer quotation up to twelve months prior to their normal retirement date. As a result, over one million members have accessed their benefits flexibly since April 2015, with the risk that a proportion of these members may have withdrawn their pension savings as large lump sums which could be heavily taxed and spent without thought for the future, leaving them with little income in their later years. Additionally, with increasing longevity, it would seem that 55 is a relatively young age to access funds that may have to provide for an individual over the next 40 years. The State Pension age is continually being pushed back, and may even be withdrawn altogether in the future, with the danger that many will not have this to rely upon for additional income in retirement.
Under pension freedoms legislation, members are required to seek advice from a regulated financial adviser qualified in giving advice on transfers from DB to Defined Contribution (DC) schemes in order to transfer benefits worth over £30,000 in this manner, which should, in theory, ensure only members who are better off accessing their benefits flexibly will do so. However, high street financial advice has never been so freely available, and so members could be at risk of being taken advantage of by unscrupulous advisers. One way in which trustees could mitigate this risk is by providing members with access to a pre-vetted independent financial adviser with the appropriate advice skills in order to ensure members are only receiving advice that is impartial and appropriate, and reduce the risk that they will make a decision they will later come to regret.
This is particularly important when an employer is undertaking any wider exercise, such as bulk or enhanced transfer-out exercises, where the primary objective is to reduce DB scheme liabilities as a result of members transferring their benefits elsewhere.
Financial risk to members, however, is not limited to this.Members are also at risk of falling victim to scams, and losing some or all of their savings to fraudsters.
With the advent of modern technology, fraudster tactics are becoming ever more sophisticated and convincing, with the result that The Pensions Regulator (TPR) estimates that in 2017 alone, scam victims lost an average of £91,000 each. Trustees can play their part in minimising this risk, however, by continually reinforcing the message to members that scams do exist, and the need to be vigilant. Clear signposting is vital in all communications with members, as well as driving home simple messages, such as to ignore cold callers who attempt to discuss your pension (which is now illegal). Trustees should also seek assurances that their administrator is undertaking the required due diligence at the point of transfer. This risk could be further mitigated if administrators were permitted to share information with each other, perhaps through the use of a ‘blacklist’ which could be used to keep track of known scam suspects. Schemes may also find tools such as The Pensions Administration Standards Association (PASA) guidance is useful in this regard.
However, threats to the security and integrity of members’ benefits are not always external. Trustees are heavily reliant on good quality advice in order to effectively run the schemes for which they are responsible. There is an ever-present, albeit lower, risk to trustees of receiving misguided advice or of maladministration. A poorly run scheme is more likely to have a direct adverse financial effect on members. For example, the miscalculation of, and resulting over/ underpayment of benefits. This can result in member recourse claims down the line and the added unwelcome reputational risk to the sponsor associated with the scheme.
These risks can be managed effectively through good quality administration and governance. Good quality administration is one of the most important risk controls trustees can put in place, and therefore trustees should be mindful of the importance of this when tendering for administration services, and not only to focus on sourcing the lowest cost provider. Similarly, trustees should not underestimate the importance of good scheme governance, which helps to ensure that schemes operate according to both their own rules and within legal guidelines. Many recurring scheme events, such as the distributing of annual benefit statements, submission of scheme returns, or completion of the Trustee’s Report & Accounts, are subject to timescales by law, with consequences for non-adherence. These risks can be mitigated however, through the use of an annual planner or calendar that effectively charts the progress of the various scheme events that are required at different times of the year. From a wider advisory perspective, trustees should also ensure that advisers have implemented risk management procedures of their own; for example, regular Audit and Assurance Faculty (AAF) audits to evidence sufficient internal controls for security of member data, and having a Business Continuity Plan in place to limit the consequences from disasters. Trustees are also required to maintain a Risk Register to monitor and manage risks, and should include the risks that external advisers present with regards to investment advice, legal advice, data control or day-to-day administration. For this reason, trustees may find a helpful addition to their risk management procedures is to employ a dedicated Pension Management service to assist in the management of scheme governance on their behalf, and ensure that it is not approached merely as a ‘tick box’ exercise.
On a related note, TPR has issued guidance to trustees on cybersecurity, which represents a severe risk to pension schemes. Insufficient controls for the storage and transfer of data not only jeopardises the integrity of the scheme, but also puts members at risk of falling victim to identity theft and fraud. Trustees can reduce this risk by ensuring there are robust cybersecurity controls in place and a policy governing the use and storage of data.
Finally, there are the risks associated with poor member education and engagement. With the gradual reduction in the availability of DB schemes, and the growing prevalence of DC schemes, it is becoming more important that members become engaged with their retirement provision. However, with increasing pressures on the generation of ‘millennials’ such as rising house prices and insecure employment contracts, there is a risk that pensions are at the bottom of a long list of higher priorities.
Additionally, a recent survey by Moneywise found that the majority of young people find their workplace pension schemes too confusing to understand. A related risk to this is that members underestimate how much they need to save to provide for a comfortable retirement. This is a risk that is unlikely to be tackled by only issuing the minimum communications required by law, such as annual benefit statements or Summary Funding Statements, and requires more thought and consideration of the tone and medium used.
Trustees should therefore assess the needs of their particular membership demographic when considering how best to engage. For example, is it better for a scheme with a young membership to utilise online tools and apps, as opposed to paper communications?
However, trustees do need to bear in mind the fine line in all communications between encouraging /engaging members, and actively advising them, which is a regulated activity.
In conclusion, there are many ways trustees can reduce risk in the provision, communication and administration of a scheme. The majority of risks highlighted here can be minimised through a combination of selecting high quality scheme advisers and by performing effective scheme governance, as well as suitably engaging their members. As a result, trustees should be able to reduce the risk that a pension scheme causes its members to suffer from a loss of financial security; a clear contradiction in terms, and ultimately the most serious risk to a pension scheme of all.
Assistant Pensions Management Consultant – Barnett Waddingham