Work and Pensions CommitteeWritten evidence submitted by the Investment Sub-Committee of the Association of Pension Lawyers (APL)

1. Summary

The obligations of an employer in a contract-based scheme are not, in our view, the same as a trustee’s obligations in an occupational pension scheme. It is often incorrectly suggested that the two roles are analogous, whilst in practice an employer’s obligations are far more limited than those of a trustee. We have suggested that the introduction of a “safe harbour” for default investment strategies might encourage employers to engage further with contract-based schemes.

2. Introduction

2.1 This paper reflects the views of the Investment Sub-Committee of the Association of Pension Lawyers.

2.2 The APL is a not-for-profit organisation whose members comprise over 1,100 UK lawyers, including most of the leading practitioners in the field, who specialise in providing legal advice on pensions to sponsors and trustees of pension funds and others, including the largest pension funds in the UK. Its purposes include promoting awareness of the importance of the role of law in the provision of pensions and to make representations to other organisations or governments on matters of interest to APL members.

2.3 In responding to the terms of reference, we have limited our comments to the section on:

“How to ensure Defined Contribution (DC) schemes deliver good outcomes for their members including: ...

How to strike an appropriate balance between regulation, self-regulation and good governance which restores confidence and raises standards.”

2.4 We feel that an area that is often misunderstood is the differences between the regulatory and legal regimes which apply on the one hand to a DC occupational pension scheme and on the other hand a contract-based schemes. We have made the point in response to previous consultations—most recently in relation to the Department of Work and Pensions consultation on offering a default option for DC schemes—that the legal responsibility of employers for contract-based scheme are not, as is often intimated, analogous to the legal responsibilities of trustees of occupational pension schemes.

3. Legal Responsibilities

3.1 Trust-based schemes

3.1.1 As regards a trust-based scheme, the trustee is subject to fiduciary obligations as well as a number of statutory requirements.

3.1.2 When exercising any discretions under the rules of a scheme, there is a large body of case law as to manner in which trustees must act. In broad terms, a trustee must consider the best interest of all beneficiaries under the scheme and take account only of relevant factors in reaching its decision. Trustees must be diligent and prudent.

3.1.3 A trustee must ensure that any decision is in accordance with the scheme documentation. An individual trustee would be acting in breach of trust, and potentially personally liable, if he or she acted outside the powers granted under the scheme documentation. Trustees must ensure that the right benefits are paid and right contributions are collected.

3.1.4 A key role of the trustees in a DC scheme is the investment of scheme assets. This usually means the choices of funds offered to members and often includes a “lifestyle fund” (where the investment strategy changes with age) which might be the default fund in the scheme. In addition to the general common law requirements, specific obligations and duties are imposed on the trustee. Broadly, trustees must take written advice from a person qualified to give that advice before making any investment decision, having regard to a number of statutory requirements as to the suitability of the investments.

3.1.5 The trustees must then continue to monitor those investments and decide at what intervals they should take further advice on the continued suitability of the investments. The trustees remain responsible for investment right the way until retirement, including where employees have left employment with the sponsoring employer.

3.1.6 In addition, more recent legislation supplements trust law with a statutory duty imposing a requirement that trustees are conversant with various matters, including the trust deed and rules governing the scheme and the scheme’s statement of investment principles. A trustee must also have knowledge and understanding of the law relating to pensions and trusts.

3.2 Contract-based schemes

3.2.1 By contrast, in a contract-based scheme the employer’s duties are far more limited, and therefore not comparable with a trustee.

3.2.2 Unlike the trustee of an occupational pension scheme, the sponsor of a contract-based scheme does not hold DC assets on trust. The members have a direct relationship through a policy with the provider rather than the employer (although there may also be a contract regarding ongoing contributions and services between the provider and the sponsor).

3.2.3 Where employers undertake responsibility for certain functions they are doing this by way of best practice and not because of any legal requirement to do so. Unlike trustees, employers are not subject to a knowledge and understanding requirement and so are not required to possess the same level of knowledge and understanding of the law relating to pensions, investment and funding. Employers are not able to exercise discretion over the fund’s assets.

3.2.4 In respect of current employees, arguably an employer might owe obligations arising from the duty of mutual trust and confidence between the employer and its employees. However, this duty is likely to be fairly limited, and would likely not extend, for example, to monitoring the suitability of investments in the contract-based scheme once the scheme had been established. Once an employee leaves active service the employer has no role whatsoever. Employers cannot require employees to move funds built up from past contributions, as to do so will border on advice, which the employer in most cases will not be qualified or authorised to give. (Trustees by contrast have responsibility for investment all the way up to retirement.)

3.2.5 Statutory obligations on employers in relation to contract-based scheme are also limited. One example is the duty under the Pensions Act 2008 to ensure that all eligible jobholders are automatically enrolled into a qualifying scheme, into which a minimum level of contributions must be made, and which has a default investment fund, from a date after 2012.

3.2.6 Finally, it also worth noting that the regulatory requirements on the providers of contract-based arrangements are also not the same as for trustees of occupational pension schemes. Providers’ duties are set out in financial services legislation, with the main requirement being to ensure fairness between policyholders.

4. Suggested Approaches

4.1 Over recent years the Pensions Regulator, different government departments and other industry bodies have issued a number of papers and guidance concerning governance of DC pension schemes. It has been recognised that greater employer involvement in contract-based schemes is important for improving member outcomes. However we are concerned that to date these have largely failed to address the differences in governance between trust-based and contract-based schemes. (For example, the employer has no duty to monitor the suitability of investments once contributions have been made.) We think that it is important that the differences in the regulatory and legal regimes are recognised.

4.2 In 2008, the Pensions Regulator issued guidance aimed at improving employers’ engagement in contract-based schemes. We are aware that a limited number of employers have set up management committees (which are committees that has been voluntarily established by an employer to perform a monitoring and advisory role in relation to the scheme). Whilst we think that management committees are a good idea, in practice employers who wish to engage more are often reluctant to do so fearing that more engagement might leave them exposed to the risks associated, for example, with giving unregulated investment advice.

4.3 There is a real risk that by trying to be “good” employers, employers are exposing themselves to more legal risk that they would have if they had not taken any steps to introduce good governance for the contract-based arrangement.

4.4 One practical suggestion we have previously suggested is that the Government should consider the introduction of a “safe harbour” for default investment strategies, similar to that used in the United States. This may be helpful to trustees and employers (that operate contract-based pension schemes).

4.5 Under a safe harbour, if a particular investment strategy met certain broad investment requirements, the fund would automatically be considered suitable for members, and would not expose the trustee or employer to legal risk. This would help reassure employers, in particular, that in becoming more engaged with contract-based arrangements they are not at risk of breaching regulatory requirements.

24 October 2012

Prepared 11th February 2013