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Defined contribution trustees can inadvertently create a default arrangement if they move members without consent, as happened to the trustees of TUI, but there are ways to manage and avoid the issue.
The trustees of the TUI Group UK Pension Trust, which has two DC and three AVC sections, recently found that one of its funds – the BlackRock Market Advantage Fund – “is considered to be an additional default arrangement for governance purposes, and must meet the charge cap restrictions”.
The trustees had made a bulk transfer of assets without member consent on 24 June 2019, transitioning assets from the Standard Life Global Absolute Return Strategies Fund.
The creation of inadvertent default funds came to the fore last year, when several property funds were gated and member contributions destined for those funds needed to be diverted into other options. Default funds are subject to strict requrirements, such as the cap on charges of 0.75% and several disclosure statements, including chair's statements and a statement of investment principles.
Last year the Pensions Regulator issued guidance for schemes in that situation, saying that a default arrangement would not be created if members were made aware before they selected the original fund that contributions could be diverted to another fund in certain situations and agreed to this when choosing the original fund; or if the trustees contacted the members before diverting contributions and obtained their consent.
Does the original choice still apply?
The problem does not stop, however, when members are moved out of a gated fund; once a gated fund has reopened, should trustees redirect contributions into that, or would that create a further default fund?
The regulator’s view is that schemes need to consider if the existing expression of choice will still apply or whether any further action or member consent is needed. It said the original choice would still apply where members have consented to the redirection of the contributions on a temporary basis or been informed by the trustees that the diversion of contributions would be corrected when the original fund reopens.
But in the turmoil of early 2020, when the Covid-19 pandemic took hold, trustees may have been more concerned with acting rather than communicating with their members about it. Chris Harper, a senior associate at law firm Squire Patton Boggs, said fund gatings left trustees of DC and hybrid schemes needing, quickly, to implement alternative, often temporary, investment arrangements for member contributions.
This is partly because legislation requires that trustees invest DC contributions promptly. Harper said guidance from TPR and the Pensions Ombudsman suggests this could, in some circumstances, mean “a matter of days”, and not doing so could leave members exposed to market volatility.
Although TPR reassured trustees that it would take a pragmatic approach to default arrangements which have been created unintentionally, he points out that "trustees would still need to ensure that charges are within the cap and that reporting requirements are met”, particularly as fines for chair’s statement failures are mandatory.
How can you avoid creating a DC default fund?
If the original fund choice was a property fund, before switching contributions back to the that fund, trustees should consider giving members an opportunity to agree to that change to reduce the risk of the fund becoming a default arrangement, said Harper. That would also enable members to confirm their preferred option for whether sums which were built up in the temporary fund should remain there or transferred elsewhere, he noted.
He advised trustees to take this opportunity to review their communications with DC members, in particular those who opt for self-select funds, and update them to reflect the possibility of such scenarios occurring in future.
But the issue will have been exacerbated for schemes that experienced delays in receiving information about the gating of funds, he believes, saying that the time and costs put into dealing with the consequences of unintended default funds - adding to a growing governance burden including value for money assessments - “may give weary sponsors and trustees reason to look ever more closely at what consolidation options are available to them for their DC arrangements”.
Was 2020 the year of inadvertent DC defaults?
The unusual situation last year with the pandemic meant that the approach “in a lot of cases was to find a solution and communications were a bit of an afterthought”, agreed Steven Leigh, associate partner at consulting firm Aon.
He said the picture was mixed as to whether most DC schemes have managed to avoid creating defaults. Of those that were affected by property fund gatings, about half have had this issue, he estimated. While some may have prepared communications up front to work around it, others managed to avoid the problem because they were using a white-labelled property fund that allowed them to hold cash under the same white label.
It’s not just property fund gatings that have led to inadvertent defaults, however. Whenever DC trustees close a fund, perhaps for performance reasons, they need to consider if the same would not apply when moving assets to a different fund.
“Most schemes prefer now to map everyone to an actual default and make it very clear in communications what’s happening,” he said.
Should self-select members be moved to the default from time to time?
Leigh also noted that some trustees are now considering whether to periodically move all self-select members back into the default arrangement, not just those affected by fund changes.
“There is an argument that says that a lot of people make investment choices and don’t keep them under review,” he said.
It could be in their interest to be moved into the default from time to time as the default option enjoys the strongest governance and is considered appropriate for the largest number of people, he suggested, saying a type of re-enrolment into the default every three years with an opt-out “might not be a bad thing”.
How should trustees deal with issues around inadvertent defaults? And should self-select members be re-enrolled into the default periodically?