Work and Pensions CommitteeWritten evidence submitted by Dean Wetton Advisory Limited

This response covers the following issues:

How to ensure defined contribution (DC) schemes deliver good outcomes for their members including:

How DC scheme members can be supported to make investment decisions and assess risks, including when converting to annuities.

Managing investment risk and security of returns.

Whether greater economies of scale within the sector could produce better value for money for members and if so, how this can be achieved.

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

The implications of the changing balance between defined benefit (DB) and DC schemes including:

The scope for collective DC schemes and other risk-sharing schemes.

Summary

1. The benefits of good governance are high but difficult to measure. We, like the Cooper Review think that engagement is not the answer, but implementing better governance of the scheme will deliver tangible improvements for members. Key elements of this are:

Managing the asset allocation of the default, in which 80% of members typically invest, both strategically and dynamically.

Assisting members with the annuitisation process.

Good governance will reduce the overall costs for members.

2. Collective DC delivers some of these benefits but is fundamentally unfair. Some of the best global examples of good governance already exist in the UK in the form of master trusts which are already delivering the benefits expressed above.

3. Dean Wetton Advisory (DWA) was founded to provide conviction-led, proactive investment advice to small and large clients. Our primary focus is on defined contribution pension plans, which we believe are the future of pensions, and we offer the underlying members access to large scale solutions by working with large providers to scale down solutions. Prior to founding DWA, Dean Wetton was Head of the Manager Evaluation Function at P-Solve, the investment consulting arm of the Punter-Southall Group. Before joining P-Solve, Dean was a senior member of Hewitt’s Manager Research Team, leading the Hewitt global practice in usage and development of third party risk models. Stephan Breban, Advisory Board member and co-author of this submission has over 20 years experience in the pension investment consulting market, advising UK and global pension plans on all aspects of investment. He has advised DC plans of all sizes.

4. DWA have in place, and already operational, a competitor to NEST (National Employment Savings Trust), Pensions Umbrella Trust (PUT). We believe it is as robust from both an investment point of view and from a scheme governance point of view and it is probably cheaper (although the way NEST has priced itself makes direct comparisons difficult). PUT is aimed at smaller employers and is easy to join. It is designed to be a cooperative of employers once there are enough employers to make it self-sufficient. See further notes on PUT at paragraph 15.

5. We also have another two defined contribution master trust clients that we advise on investment issues that could be regarded as competitors to NEST.

6. We have been conducting research into global best practise in pensions fund governance. There is a paucity of hard research into the costs and benefits of good governance in pensions and indeed other areas. However our understanding for the research is that good governance should add 1%–2% to performance, although we and the OECD Pensions Report think this is probably an under estimation.

7. Most current advice around DC schemes seems to focus on getting better member engagement through improved communication to help members make more appropriate choices and the typical measure of this is reducing the number of members in the default fund, typically 80%. While this is a laudable aim, we believe there are other areas that can provide better impact. Rather than solely on trying to engage members, we look at ways in which scheme fiduciaries can improve member benefits by improving scheme governance, without having to rely on engaging members. This is consistent with the Cooper Review in Australia which states, “Financial literacy is an important long term goal, but a compulsory superannuation system cannot depend on all its participants having the skills necessary to comprehend complex financial information or being investment experts.

8. Asset Allocation of the default funds: It’s not good enough to “set and forget”. We can demonstrate that it is dangerous to simply go passive lifecycle and not review it again. Scheme fiduciaries, and indeed employers, owe it to their members to review the defaults and ensure they are fit for purpose. They need to manage both the strategic asset allocation, derisking as members approach expected retirement and manage dynamically according to market conditions within that. If they have a limited governance budget they should look for solutions that still ensure that someone is looking after members.

9. Under most contract arrangements manager section effectively happens at the outset of the product life. Members’ contributions are directed to the initially selected managers and remain with that manage, regardless of changes in the managers relative strengths. Members, who are unable or unwilling to make fund choices and asset allocation choices are still expected to make active manager selection decisions. Clearly this is counter-intuitive, and the actions of members demonstrate that this is not a practical arrangement, with few members moving funds away from underperforming managers despite the information provided to the by the contract provider or any trustees in place. It seems apparent to us that there is a compelling case for a suitable Fiduciary to take this decision on behalf of members.

10. Annuitisation process: The NAPF (National Association of Pension Funds in the UK) has recently commissioned a paper on treating DC members fairly in retirement. It makes the point that this is a very important issue in the members’ life, and good governance in this process makes a big difference. It estimates that good governance at this point adds about 8% to members’ outcomes. We endorse this paper and the views it expresses. They are consistent with our experience.

11. The same paper expresses the view that contract schemes are more difficult to govern and as a result members outcomes tend to be lower. Again this is consistent with our experience.

12. Cost and governance: The OECD Pensions Report states that generally smaller schemes have poorer governance and higher costs, so the combination of scale and good governance can significantly drive down costs passed on to members. Our experience in setting up a multi-employer master trust is that it is harder, although not impossible, to reduce costs without scale but that good governance is the key driver.

13. Collective DC: We see governance and scale benefits as they key advantages of collective DC. The risk sharing aspect seems to be fundamentally unfair to us, as this is yet another subsidy of the “old” by the “young”. The experience in the Netherlands is that benefits have been reduced as a function of increased member longevity, inevitably there is a lag on the application on this, to the benefit of the older cohort at the expense of the younger cohort. So this does not deliver certainty or fairness. The current demographic change the UK is experiencing, namely an aging population, exaggerates this problem as the cohort of younger members is smaller than the older cohort.

14. Our research suggests that some of the best example of good pension’s governance already exist in the form of established mastertrusts in the UK. They deliver proper asset allocation of the default, good annuitisation processes and the benefits of lower cost.

15. We would be happy to meet with your Committee either formally or informally to offer any further insights if you would find this useful.

Notes on Pensions Umbrella Trust

16. Pensions Umbrella Trust is a multi employer master trust which has only defined contribution members and no guarantees. It therefore cannot have a deficit by definition. The scheme uses independent providers, carefully sourced for all activities, including the trustees. Within the scheme these are all accountable to the trustees and can be replaced should they not perform to requirements and, in turn, the trustees are accountable to an elected Governance Committee and can be replaced should the need arise, providing far greater accountability. As the Governance Committee is elected by the sponsoring employers it effectively makes it a cooperative of employers.

17. PUT’s investment philosophy, similar to NEST, is to allow choice for those that want it and choose for those that don’t. It actively manages what it believes to be the best default and allows governed choices for those who want it. This contrasts to the market norm which is to offer choice and assist members to make those difficult choices. It is however different in the level of risk it targets for members over their life, in that it will take slightly more risk in order to achieve higher returns. It also offers a more diversified Sharia fund lifestyle offering. PUT is operational and holds members funds.

13 April 2012

Prepared 11th February 2013