Wak­ing the sleep­ing dog of DC risk

Irish Examiner - Supplement - - PENSIONS - Ian Devlin If you have any queries on is­sues ad­dressed in this ar­ti­cle, please con­tact Ian Devlin, part­ner, Ever­sheds Sutherland Ir­ish Pen­sions Group.

The last num­ber of years have seen em­ploy­ers very much fo­cused on how to man­age and ad­dress risks as­so­ci­ated with the de­fined ben­e­fit (“DB”) pen­sion schemes they spon­sor.

This has re­sulted in many DB ar­range­ments be­ing closed to fu­ture ac­crual, to con­tain the risks as­so­ci­ated with them.

Typ­i­cally, de­fined con­tri­bu­tion (“DC”) schemes have re­placed those schemes. In gen­eral, those DC schemes are tick­ing along qui­etly and most fi­nance di­rec­tors be­lieve pen­sion risks have now been largely con­tained.

How­ever, DC schemes carry with them an ar­ray of dif­fer­ent and of­ten la­tent risks which trus­tees and em­ploy­ers may not be aware of un­til years af­ter problems be­gan. Specif­i­cally, th­ese risks cover is­sues such as in­vest­ment, ad­min­is­tra­tion and retirement.

For the pur­poses of this ar­ti­cle, we are go­ing to fo­cus on risks re­lated to DC schemes and retirement.

Main DC scheme risks 1. The ad­vice gap

It is clear from leg­is­la­tion and re­lated Pen­sions Author­ity guid­ance that trus­tees are ex­pected to “make ar­range­ments for the pay­ment of ben­e­fits as” they fall due and pro­vide ben­e­fit op­tion state­ments to mem­bers when they reach retirement. How­ever, trus­tees are sub­ject to very pre­scrip­tive obli­ga­tions in terms of pre­par­ing mem­bers for retirement. At a reg­u­la­tory level, the fo­cus seems more on task­ing trus­tees ad­min­is­tra­tive func­tions as­so­ci­ated with pay­ing out ben­e­fits.

Trus­tees are also en­cour­aged to di­rect mem­bers to seek ad­vice on their retirement op­tions.

While trus­tees can and should pro­vide mem­bers with ba­sic in­for­ma­tion on their retirement op­tions, they can­not stray into pro- vid­ing fi­nan­cial ad­vice to mem­bers.

The re­al­ity is though that mem­bers will re­quire such fi­nan­cial ad­vice, not only at point of retirement but also in the five to 10 years lead­ing up to that date.

There is a de­bate brew­ing within the in­dus­try about who has the re­spon­si­bil­ity for filling this ad­vice gap.

At one level, DC schemes are about in­di­vid­u­als tak­ing re­spon­si­bil­ity for their own retirement sav­ings, so it is for them to seek and pay for any as­so­ci­ated fi­nan­cial ad­vice they may need. How­ever, that’s not the way many mem­bers per­ceive their DC schemes.

A DC scheme is a ben­e­fit pro­vided through the em­ploy­ment re­la­tion­ship.

As a re­sult, many mem­bers are as­sum­ing that the trus­tees or em­ployer are tak­ing re­spon­si­bil­ity for en­sur­ing they are equipped to make the sig­nif­i­cant fi­nan­cial de­ci­sions fac­ing them at retirement.

Ar­range­ments and pro­cesses will, there­fore, need to be put in place to en­sure mem­bers are well pre­pared when the time comes to make those im­por­tant fi­nan­cial de­ci­sions. As DC trus­tees can­not them­selves pay for the ad­vice mem­bers will need, they will need to en­gage with em­ploy­ers on this is­sue.

What those ar­range­ments should look like will vary from or­gan­i­sa­tion to or­gan­i­sa­tion.

The ar­range­ments may sim­ply in­volve em­ploy­ers pay­ing for or sub­si­dis­ing fi­nan­cial ad­vice for their em­ploy­ees at the point of retirement. At an­other level, it could in­volve or­gan­is­ing retirement clin­ics on site where DC mem­bers can meet­ing with fi­nan­cial ad­vis­ers pe­ri­od­i­cally as they ap­proach retirement.

While there is a cost to em­ploy­ers in putting such ar­range­ments in place, those costs need to be viewed in the con­text of po­ten­tial claim costs which em­ploy­ers may be ex­posed to if retirement risks are not prop­erly man­aged.

2. Age dis­crim­i­na­tion

It is gen­er­ally ac­knowl­edged that the cur­rent av­er­age level of con­tri­bu­tions to DC schemes are not go­ing to be suf­fi­cient to pro­vide mem­bers with ad­e­quate pen­sions in retirement. As a re­sult, it is likely that there will be a grow­ing theme in the years ahead of em­ploy­ees not be­ing able to af­ford to re­tire.

This theme emerges against a changed leg­isla­tive land­scape where manda­tory retirement ages must be ob­jec­tively jus­ti­fied. Where em­ploy­ers now seek to en­force con­trac­tual retirement ages and em­ploy­ees find that they can­not af­ford to re­tire this is likely to prompt dis­crim­i­na­tion claims against em­ploy­ers.

We are be­gin­ning to see this trend emerge al­ready with a grow­ing num­ber of age dis­crim­i­na­tion claims re­lat­ing to retirement ages in re­cent years. A va­ri­ety of de­fences have been used by em­ploy­ers in th­ese cases to ob­jec­tively jus­tify manda­tory retirement ages.

They in­clude health and safety, pro­mot­ing work­force co­he­sion and other rea­sons.

How­ever, the case law makes it clear that the sorts of de­fences which will work are very case spe­cific, not only to the em­ployer but also to the par­tic­u­lar role in ques­tion.

For th­ese rea­sons, em­ploy­ers are best ad­vised not to ig­nore the retirement age is­sue un­til it is too late and should in­stead put in place ap­pro­pri­ate ar­range­ments which will as­sist in rais­ing aware­ness of em­ploy­ees’ in­tended retirement plans. Depend­ing on the or­gan­i­sa­tion and the type of roles in­volved, some em­ploy­ers might also con­sider ex­tend­ing retirement ages to align them with in­creases in the State pen­sion age as a means to mit­i­gate risks as­so­ci­ated with this is­sue. How­ever, do­ing so is likely to throw up a num­ber of le­gal and other is­sues which will need to be care­fully man­aged.

3. In­vest­ment switches and out of mar­ket risk

As fund mem­bers get close to retirement, the whole area of in­vest­ment switches then be­comes an is­sue that also needs to be man­aged very care­fully.

If mem­bers in­vest­ment switches are made late or not made at all then any loss in value as­so­ci­ated with such er­rors is much more dif­fi­cult for mem­bers to re­cover from.

They will nat­u­rally look to the trus­tees to make good such losses. Also, once the pen­sion fund mem­bers have de­cided how they wish their DC pot to be ap­plied at retirement there is likely to be a gap between dis­in­vest­ment from the scheme and rein­vest­ment into an ARF prod­uct, for in­stance.

Again, any sig­nif­i­cant move­ment in as­set val­ues while that tran­si­tion from one in­vest­ment to an­other is tak­ing place may cause mem­bers to suf­fer losses they would not have suf­fered if that out of mar­ket risk had been min­imised.

It is vi­tally im­por­tant, there­fore, for all trus­tees to en­sure that they have ro­bust pro­ce­dures in place with their ad­min­is­tra­tors and for in­vest­ment man­agers to min­imise the risk of any such er­rors or de­lays.

While most peo­ple are aware that there are risks as­so­ci­ated with any pen­sion plan, many will need some ex­pert help in un­der­stand­ing the risks and their own re­spon­si­bil­i­ties with de­fined con­tri­bu­tion (DC) pen­sion schemes — a sleep­ing dog that can no longer be left asleep.

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