More U.K. companies turn to contract plans

LONDON — U.K. defined contribution plan sponsors are increasingly trying to wash their hands of any investment and fiduciary risks by adopting what’s called a contract-based arrangement, consultants said.

Contract-based plans usually require no investment monitoring and no manager selection — beyond hiring a single provider that offers these services — and little employee education.

But such an arrangement might not safeguard companies from their responsibilities as plan sponsors. Indeed, regulators issued new guidelines earlier this year that push for an internal governance arrangement for contract-based plans.

Furthermore, such plans might be fraught with stumbling blocks in the way they are structured — offering what some say is too many investment options and not enough investment education and guidance. For example, one plan that was not identified had as many as 97 U.K. equity fund options for participants, according to a paper written by Maria Gouvas, a member of the governance and operations team in Mercer LLC’s London office. Best practices generally call for fewer than 20 options, consultants said.

“Employers are assuming that they’ve offloaded their risks once they’re in contract-based (arrangements),” Ms. Gouvas said. “But that might be a premature conclusion.”

The latest company to announce a shift is Philips Electronics U.K. Ltd., Guilford, which on April 1 will move all new defined contribution assets into a contract-based plan run by BlackRock Inc.’s London office.

Alan Lakin, assistant pensions manager at Philips, said the change is a “simple solution” that allowed the company to efficiently separate its defined benefit and defined contribution plans. Both had been administered under one trust, with about £2.3 billion ($4.6 billion) in DB assets and about £70 million in DC assets.

“There was no single reason for the change (to a contract-based plan), but a number of contributing factors,” Mr. Lakin said. “One of them is that we felt there was some difficulty in dealing with the trust arrangement.”

Contract-based DC pension plans usually involve hiring a single provider such as an insurance company or an asset manager to run what’s essentially a series of individual pension policies. Unlike the trust-based system — which is what many companies set up in the past decade as they shifted to DC from DB — the company is not required to provide any oversight of the assets and investment strategies. In contrast, at the center of the trust-based system is a board of trustees appointed to monitor performance of fund options, make decisions relating to assets and generally look after the interest of plan members.

“The requirements — including the time and level of training needed for trustees over the last few years — have made trust-based (plans) less attractive. As a result, there’s a demonstrable shift to contract-based arrangements” among small and midsized companies, said Paul Macro, senior DC consultant at Watson Wyatt Worldwide based in Reigate, England.

According to the 2007 annual survey released by the National Association of Pension Funds, 56% of the U.K. DC pension funds surveyed were trust-based plans compared with 89% two years earlier.

“This might suggest that some of the employers who have most recently closed their DB schemes to new entrants have substituted contract-based DC arrangements,” according to an analysis of the survey by the NAPF, a London-based industry organization representing more than 1,000 pension funds in the U.K.

U.K. defined contribution assets totaled about £550 billion at the end of 2006, the latest data available from the NAPF. Assets in contract-based plans are not known because managers often do not separate group contract-based and individual personal pension assets. The majority of DC assets remain in trust-based plans because larger companies have tended to maintain such pension vehicles, consultants said.

That may be changing.

“A lot of smaller (plan sponsors) have already done this, and more and more of the larger ones are looking at this,” said Mercer’s Ms. Gouvas, referring to corporate sponsors’ move toward contract-based plans.

In a separate survey released by Watson Wyatt last November involving 94 FTSE 100 companies, 33% said they offered contract-based plans, compared with 22% a year earlier.

Some 68% of the contact-based plans surveyed offer more than 20 options, vs. 6% of trust-based plans. At the same time, communication materials such as regular newsletters were available to members at 81% of the trust-based plans and only 39% of the contract-based plans.

“Effectively, there are no requirements to provide any sort of governance in a contract-based plan,” Mr. Macro of Watson Wyatt said. “Some do have (voluntary) informal groups of individuals that get together and monitor the investments, among other governance duties. But the concern is that without a formal, legal structure for that group, it is unclear whether they’ve acted in a prudent way and what the legal consequences are of those actions.”

Officials at Britain’s Pensions Regulator, the government agency that oversees all U.K. employer-sponsored pension plans, are also concerned about a perceived lack of governance structures within contract-based plans. In January, the agency issued guidelines that encourage contract-based pension sponsors to voluntarily set up their own governance arrangements. However, the agency stopped short of requiring companies to follow its recommendation.

“The Pensions Regulator was basically saying ‘enough is enough,’ Mr. Macro said. “If you’re going to provide a pension, then you’ve got to take some responsibility. … Whilst it’s not mandatory (for companies) to follow the Pensions Regulator’s guidelines, anyone who doesn’t may be named and shamed. So in a sense, the difference between a trust-based and contract-based plan has narrowed.”

Some fund managers are responding with DC products that attempt to solve certain problems linked to both trust-based and contract-based plans. In 2007, SEI Investments’ London office launched a master trust DC product, which allows sponsors to take a hands-off approach while retaining some of the advantages of trust-based arrangements, such as having a board of trustees. The SEI DC Master Trust provides internal governance, asset management through a multimanager platform and other services such as investment education.

“Neither the contract-based or trust-based (plans) were offering the right answer,” said Ashish Kapur, DC product specialist at SEI, “so we went for a half-way solution.”

Contact Thao Hua at [email protected]