We show how four pension schemes are meeting standards set by the Pensions Regulator.

A mountain of regulation and guidance for pension schemes has been published over the past three years, much of it from the Pensions Regulator, which has issued a steady stream of reports and recommendations. Not everyone will have had time to read all of this, or if they do, to take it all in. The following case studies show how employers are adapting to the new environment and setting standards that others will follow. With each case study we have selected a relevant piece of advice issued by the regulator over the past year.

1. Communicating change

Can a pension scheme be successfully communicated and launched for 900 staff in three weeks? This was the challenge faced by a semi-conductor firm carrying out a private equity buyout from its parent company Phillips, and in doing so losing membership of a final salary scheme.

The suddenness of the deal meant a new pension scheme had to be set up at short notice. Employees had to move into a defined contribution (DC) scheme, for which many were unprepared. The employer is in a competitive recruitment environment and did not want to lose skilled employees simply because they were unhappy with their new pension scheme. One of its first steps was ensuring employees were not financially disadvantaged. This meant the large contribution that went into defined benefit (DB) was replaced with an offer where members could take part of this in cash or put it all into their new DC pension.

The new group stakeholder provider, Axa Life, was given responsibility for communicating the changes along with the firm's adviser, Hewitts. Axa Life communication development manager Pete Holman says: "The employer needed to convince staff that their pension was not going to be cut in any way. They were really keen to replicate the membership of the previous scheme."

Holman felt that clarity of purpose was helpful in putting together a bespoke plan at speed. The roll out included letters, rebranded literature with photos, guides, email addresses, call lines and banner adverts. This was followed up with 21 presentations to 800 members in four locations over one week, and then more than 200 follow-up, one-to-one information clinics.

"We needed to provide face-to-face advice to prevent the rumour mill of any negative comments on why the firm were 'reducing' the benefits," he says. "The employees also needed to grasp the concept of becoming investment managers. We used our behavioural finance models to present choices in different ways to different socioeconomic groups."

Eight months on and, according to Holman, the company’s expectations have been exceeded in both membership and employee contributions.

_

"Good quality, relevant and timely information is vital if individuals are to make the best-possible decisions about their DC pension provision. While a good deal of help is already available, lack of member engagement remains an issue, and we expect those involved in providing and running schemes to work towards improving member understanding and involvement. Ensuring the right level of contact between parties should also contribute towards ensuring members receive their correct pension entitlement as it should aid accurate record-keeping and reconciliation."

Extract from the Pension Regulator's proposed rules on defined contribution schemes, published 2006

2. Tackling the default option

What responsibility is there to ensure staff make active investment choices? Many trustees fret that too many staff are not bothering and instead plump blindly for the default option.

One leading employer has decided that educating employees is too much of an uphill battle, so is instead opting for an innovative and desirable default fund on its trust-based DC scheme. The scheme's consultant says it will allow the employer to embrace the fact that members choose the default option. Mercer Investment Consulting senior consultant Patrick Race picks up the story: "Our client had been through a de-risking process on their closed DB plan by reducing the reliance on equities to outperform the liabilities and making their bonds more in keeping with the duration of their liabilities. The question they asked was 'if there is all this innovative work on the DB scheme, what about the DC scheme?'"

Most DC trust-based funds offer their employees a default fund made up of equity tracking funds, on a lifestyle approach, which moves the employees' pension pot into bonds five years before they retire. However, Race says: "If you apply the same thinking from DB to DC, you would ask 'why am I in global equities until I am 60, which is a pretty volatile asset class, if it is not good enough for the DB assets and why should I use it for DC?'"

The client in this case is now in the process of choosing a modern investment fund called a diversified growth fund, which promises low volatility and steady, if not spectacular, growth. These funds, which are offered by most of the leading fund managers, are invested in a mixture of equities, private equity and property. They also allow managers to have an exposure to the most exotic asset classes, such as hedge funds and commodities, when the time is right. Ironically these funds were set up to meet demand from DB schemes eager to hold on to gains they had made in equity markets.

"These are arguably better than the traditional balanced funds, as those were mainly equities and there was limited scope for the manager to avoid an exposure to an equity collapse," says Race. "There is a far lower level of risk because it is more diversified across the asset classes that are not correlated to each other. They also access the full range of skills that global fund managers have."

According to Race, this steady growth is what his clients' employees will appreciate best. "The nature of this workforce is that they are not financially sophisticated and the idea of seeing equities fall over 10pc in a couple of weeks is very unappealing." This situation keeps the employer happy too, as it sees the main purpose of its pension scheme as aiding recruitment and retention and does not want it to become a source of bad news.

_

"It is vital that members understand that, as well as bearing the investment risks of their DC pension throughout its lifetime, they also bear the risk of selecting the most appropriate post-retirement product for their personal circumstances. Members need to understand, and trustees and providers should make clear, the options that are available."

Extract from the Pensions Regulator's proposed rules on defined contribution schemes, published 2006

3. Reducing errors and fraud

The life of a trustee has become so onerous over the past few years that many have started to wonder why they bother. New legislation has increased the scope for members to hold trustees responsible for a list of misfortunes to their pension scheme.

The 20bn pounds industry-wide railways pensions scheme has sought to protect its trustees by tightening up its controls on the collection and payment of pensions. It believes that the best way of doing this is through automating as much of the process as possible and then having a series of special checks for this automated process.

Not stopping here, it also favours as much straight-through processing as possible, so data is passed straight onto another system, limiting the scope for human inputting errors. It is doing this through its new management company RPMI, a merger of its two existing operations Railpen Investment and Pensions Management, which looks after both final salary and DC schemes, with 90,000 active members and around 250,000 other deferred members or pensioners.

Managing director Michael Goy says: "This minimises the risk that someone might individually calculate or key something in incorrectly, but it means that if someone programmes the computer slightly incorrectly in the calculation routines, everybody gets paid incorrectly instead of one person. So there is a huge amount of effort that goes into the testing and retesting of calculation routines."

To this end, RPMI is looking to attain the international standard for managing the security of IT systems - ISO 27001. This might seem a lot, but RPMI does not stop there. It also has something called a risk register, listing all of the likely problem areas and has a risk management committee, which includes trustees, to look after that, as well as internal audits too.

One of the other key areas that this committee looks at is the risk of fraud, ensuring that bogus members are not being added to the payroll and that pensions are stopped when a member dies. All of this goes a long way to meeting the Pension Regulator's recommendations that trustees assess risk within their pension schemes. Though as Goy says, this is not only about removing risk, but about giving reassurance to trustees - given that they have new responsibilities - and that the administrators of their fund are taking this new legal climate seriously.

_ 

"The regulator recommends that trustees carry out a risk-based review. It recognises that such an approach will initially focus on those areas where the impact and incidence of a failure relating to internal controls is high... where the effect and wider implications of not having in place adequate internal controls are likely to be materially significant, the regulator would expect to receive a whistle-blowing report."

Codes-related guidance - internal controls, published by the Pension's Regulator, February 2007

4. Governance committees

Stakeholder pensions are often seen as a scheme that can be paid into and forgotten about, while the employer gets on with their business of making widgets. However, advice from the Pensions Regulator over the past year says that this attitude constitutes negligence and is leading to low standards.

To get round this many consultants are recommending that employers set up governance committees to check the running of their scheme and monitor their providers. Watson Wyatt senior consultant Helen Dowsey says: "The regulators report, in April, had a whole chapter on stakeholder [pensions], which said that there should be a tightening up of governance. Typically these schemes have been set up at arms length and providers now need to up their game."

One firm where Dowsey has helped set up a governance committee, is Elexon, the firm that manages the balancing and settlement of electricity in Great Britain. Elexon was keen on the idea of a committee that would maintain high standards, as it switched to a stakeholder pension after the closure of its parent company's final salary scheme to new members.

It wanted to offer a scheme that would go some way to equalling the paternalistic nature of a DB scheme. The committee now meets twice a year to monitor Elexon's contract with its stakeholder provider Axa Life, which gives Elexon a bundled deal of investment, administration and communication. The committee is made up of Dowsey, Elexon’s head of HR, the chief finance officer, an in-house lawyer and a regular member of staff.

Dowsey says: "Elexon is very keen that its employees join the scheme and that they value it, contribute enough to it and make active investment decisions, so that they have sufficient income in retirement. The governance committee comes from this caring environment.

"The first priority of the committee was to ensure that Axa is communicating the scheme well, so they are getting them back in every year to emphasise the important messages to staff."

To prepare for this first meeting an employee questionnaire was sent out to see how the scheme was perceived and what changes, if any, were wanted. The results were then discussed by the committee, and fed back to Axa.

"The first meeting also set up a terms of reference: a governance structure around what would be reviewed, how it would be reviewed and when it would be reviewed," says Dowsey. The second committee meeting, six months later, looked closely at the investment options Elexon employees had chosen and judged where Axa had adhered to their service level agreements. A report is produced at the end of each meeting to be shown to Axa and to record the actions recommended.

_

"The administration of DC schemes is complex, requiring high standards of reconciliation, record-keeping and communications. Administrative errors can be time consuming and costly to put right. As regulator, we want to see robust internal controls and effective Service Level Agreements in place between trustees and service providers, such as payroll providers, to ensure that administrative standards can be monitored and maintained."

Extract from the Pensions Regulator's proposed rules on defined contribution schemes, published 2006