What is a good DC pension?

Pensions Minister Steve Webb has made it clear that auto-enrolling staff into a poor pension plan will not be tolerated. Employers don’t just need to follow the administration regulations; they need to make sure their staff are invested in good workplace schemes that give good pension outcomes.

Mr Webb will “name and shame” poor schemes, and employers who don’t meet the yet to be published “quality test” will need to “comply or explain”.

So far, there has been a deal of stick waving, but not much detail.

It’s time to set out what the Pensions Regulator reckons “makes for good” and to give some guidance to employers and pension trustees on what they should be doing right now to get their pension schemes ready.

In their recent Ready for Ageing? report, the House of Lords Select Committee on Public Services and Demographic Change find the nub of the problem: confidence. “While the poorest will be protected at a basic level by state provision and the richest can afford to save enough in private schemes, there is a substantial gap for much of the rest of the population,” the report says.

“Under the current defined contribution pensions system, the individual does not know what income the pension will provide and therefore what he or she is saving for.”

We need a clear statement from the Department for Work & Pensions laying out what standards a scheme needs to reach

By definition, a defined contribution (DC) scheme guarantees a level of input not output. Organisations that have agreed to give certainty about the pension benefit, as the Lords Select Committee would like, have found the cost unacceptable.

Were there a social contract, as in the Netherlands, between those funding and those receiving pensions, we might create a middle way that better shared risk between employer and employee. This is what Mr Webb wishes for “defined ambition”. As David Pitt-Watson and the Royal Society of the Arts has shown, it is possible to collectively promise better outcomes the Dutch way without ratcheting up the cost and risk to employers.

But we are not there yet. The prospect of greater regulation from Europe for UK occupational schemes accelerates the trend from defined benefits (DB) accrual to market-driven defined contribution pensions and puts back the prospect of this middle way.

So defined ambition is tomorrow’s rotation and Mr Webb needs to concentrate more urgently on today’s defined contribution schemes. He needs to put some meat on the quality bone.

In December 2011, the Pensions Regulator published an excellent discussion paper on what made for good. It defined six areas where good management made for better pension outcomes from DC schemes:

  • Encouraging higher contributions from members
  • Ensuring assets are secure
  • Offering good investment options (especially a good default option)
  • Offering value for money by keeping charges low
  • Giving people good options at retirement (decumulation)
  • Properly keeping member records.

This framework provides decent “terms of reference” for anyone setting up or managing a workplace pensions savings plan.

Since 2011, the Pensions Regulator has diluted the impact of this paper, publishing in June 2012 a muddling Six principles for good workplace DC and recently a host of documents introducing us to 32 characteristics of a good DC scheme. Sadly, more is not necessarily better; someone needs to put a stop to this before the Regulator gets to a century of measures.

Thankfully, the Regulator has now appointed Andrew Warwick-Thompson as its new head of DC. I expect him to do just that.

So I’d like to see the original “six outcomes paper” forming the basis for a “pension quality test”. If we can make these work for “the rest of the population”, who will rely on DC for much of their retirement income, auto-enrolment really will be a success.

What we need today is a clear statement from the Department for Work & Pensions laying out what standards a scheme needs to reach to be considered a Qualifying Workplace Pension Scheme – we need the meat on the bone.

This is a thorny political problem for a Liberal-Democrat minister. On the one hand, he must please his Conservative colleagues who are by nature non-interventionist and would prefer market, and not regulatory, solutions. On the other hand, he has pressure both from his fellow Liberals and from those on the Opposition benches, to give at least regulatory guidance, if not primary legislation, to protect the 11.5 million new entrants into these schemes.

Let’s hope we see government lay down clear standards in the months to come and insist that those purchasing and governing these workplace plans “comply or explain” with them. The alternative is that auto-enrolment becomes a problem for a government that so far feels it has – whisper it quietly – “a public policy success on its hands”.

For those looking to help the 1.2 million employers with their decision-making over the years to come, such guidance will be welcome. Nobody wants blind decision-making nor do we want companies choosing to contract with the National Employment Savings Trust (NEST) because they can’t find any alternative.

Britain is taking on a massive enterprise as it looks to universal private pension provision in the corporate sector. It is becoming clear that the hardest part of that task will be helping the 90 per cent of those companies who are not comfortable with workplace pension plans. We need to make them comfortable with their decisions and confidant to take them.

To score that public policy goal, we need to know what makes for good – and soon.

Henry Tapper is a director of First Actuarial and private pensions adviser; his blog henrytapper.com was described in The Times as one of “ten websites and blogs every investor should benchmark”.