Lessons learned from integrated risk management can lead to better outcomes for DC savers, says expert

One way of doing this could be by considering the interaction between the new requirement to carry out regular value for money (VfM) assessments, contribution rates and retirement choice right from the start. This involves learning from developments in DB and operating along the lines of a DC version of integrated risk management.

We're already part way there, but still playing catch-up.  VfM is designed to do a similar job to the regular employer covenant reviews required of defined benefit (DB) trustees by providing context for a lot of the big picture decisions that a board of DC trustees will have to make.

It took nearly 10 years for the concept of IRM to emerge in DB, following the introduction of employer covenant reviews as part of the 2004 Pension Act. Since then it has probably been an unwritten part of trust law to think along IRM lines, by placing the covenant in a triangular relationship with investment and scheme funding.

Unfortunately, we cannot simply apply DB style IRM to DC.  But there are still risks to manage. Millions more people, newly enrolled into DC schemes by virtue of automatic enrolment, bear the direct risk of poor outcomes in retirement in a way that the previous generation of DB pension scheme members did not. Statute now requires  DC trustees to take responsibility for checking that the scheme represents good value for members but we're in the early stages of determining what that really means – and how it interacts with things trustees are not directly responsible but can potentially influence.  Using VfM in the right way and alongside other key considerations is essentially IRM in a DC context.

Essentially, employer covenant reviews in DB provide context for a lot of the big picture decisions that a board of trustees will have to make. When originally introduced, there was a great deal of variety in what these assessments looked like – but the IRM approach, formalised in the Pensions Regulator’s 2014 code of practice for DB schemes, recast this as an assessment of one of the three main risks to scheme sustainability, along with investment and funding risks.  Get this wrong, and member benefits will be under threat.

Leaving aside the DB ‘lifeboat’ that is the Pension Protection Fund (PPF), it occurs to me that in the DB context the point of IRM – and the covenant review that sits within it – is to protect scheme members from the risk of poor outcomes. If funding and investment aren’t aligned with the employer covenant, there is the risk of poor outcomes for members if the employer becomes insolvent.

Similarly, VfM assessments will ultimately provide a lot of the context for the big picture decisions DC trustees will need to make. VfM is, in the main, determined by member-borne charges and investment returns (relative to objectives)  and benchmarked against the market. But VfM cannot provide the entire context in isolation.  The development of something along the lines of a DC version of IRM seems likely at some point and sits well with the general trust law duty to act in member interests.

Although outcome risk in DC is addressed, in part, by the VfM assessment, we cannot ignore the role played by other factors in driving DC outcomes. Ultimately, just as there is in DB, there is a triangular relationship between the main DC outcome drivers. To make best use of their assessments, DC trustees should think about an integrated approach to risk management: weighing up the relationship between VfM (ie primarily charges and investment)and other factors; contributions; and retirement choice.

Tom Barton is a pensions expert at Pinsent Masons, the law firm behind Out-Law.com.