Small schemes, big changes: how to tackle the UK governance problem

There are 5,000 to 6,000 defined benefit (DB) schemes in the UK. The mean size is around £300m but the median size only £30m. This suggests half of all DB schemes have assets of less than £30m. The ongoing UK governance problem presents a challenge for these small schemes in that they must provide the same value to their members as much larger schemes – without the resources and scale to ensure sufficient governance to meet their obligations.

The Regulator takes a risk-based approach for applying its resources, typically focusing on larger schemes which, through their scale, represent a more serious risk. However, its corporate plan for 2019 through to 2022 states clearly that it will increasingly start to put pressure on smaller schemes.

‘Comply or explain’

The Regulator has mooted two new ideas. The first is “comply or explain”. Thousands of small schemes will need to comply with the Regulator’s funding requirements, or provide reasons for non-compliance that it deems logical, well thought out and acceptable.

With what exactly will schemes need to comply? From what we know so far, the Regulator will provide the firmest steer to trustees on what it believes prudence looks like as part of the assumptions for actuarial valuations. This will drive the funding level and the rate of deficit recovery.

If trustees want to deviate from the Regulator’s views, they will need to explain their rationale. The issue may well be that the guidance is uniform across a wide range of schemes, each with their own idiosyncrasies. Will expensive advice be required to navigate that guidance?

Professional trustees on every trustee board

The second idea is to include an accredited professional pension trustee on all trustee boards. The Regulator’s analysis shows that schemes with a professional trustee have higher standards of governance than those without. As a professional trustee myself, I have first-hand experience of the work professional trustees do on schemes of all types. It is clear to me that the input from a good professional trustee has the potential to greatly enhance member outcomes.

However, there are two potential issues with using a professional trustee – cost and capacity. On costs, my experience is that professional trustee fees are a fraction of adviser and investment costs. If they help control scheme spend, they can represent added value rather than added costs.

On capacity, a key factor will be how quickly the requirement to have a professional trustee is implemented. My view is there will need to be a transition period. During that time, the professional trustee market will be able to grow to meet the demand. There are many pensions professionals interested in working as a professional trustee; if the demand is there the supply will grow.

I believe professional trustees will be part of the overall solution. Tackling the issue of cost so that employers are not forced to pay in more money will be tricky. The best idea I have seen is for the Regulator to raise additional funding through its administration levy to help support the cost for these small schemes. A small increase in the levy, used to support the use of professional trustees, will go a long way to improving the UK governance problem for small schemes.