Governance: the Regulator's 2007 survey

Summary

The Regulator considers that good governance is at the heart of a well-run pension scheme and it is one theme which underpins each of its statutory objectives. While the Regulator continues to develop governance good practice guidelines, it is keen to understand what schemes are actually doing governance-wise on the ground. To this end the Regulator has published its second annual governance survey.

According to the Regulator, the results show evidence of improvement in certain governance areas it has focused on most heavily over the past 12 months: trustee knowledge and understanding, management of conflicts of interest and monitoring the employer covenant.

This briefing note considers the results of the 2007 governance survey.

Why does the Regulator conduct a governance survey?

The Regulator is concerned about governance for all types and sizes of work-based pension schemes. However, the intensity with which it regulates different schemes is risk-based. It depends on the risk they pose to the Regulator's objectives rather than on the type of scheme in question. As a result, the Regulator has decided to conduct an annual governance survey which is designed to:

• Ensure that the Regulator's approach to governance is evidence-based.
• Identify emerging issues that might impact on members' benefits.
• Provide an independent evaluation of the usefulness and effectiveness of the Regulator's governance activity.

Key drivers of good governance: trustee learning activities

Trustee training to strengthen knowledge and understanding is a key governance priority for the Regulator. The survey shows that:

• The proportion of schemes offering no trustee training has fallen significantly over the last year from 44 per cent to 34 per cent.
• Smaller schemes meeting less frequently are most likely not to provide training. However, 82 per cent of schemes encourage trustees to undertake their own learning activities even if only 66 per cent overall have induction programmes.
• At least one trustee in 70 per cent of schemes has used the Regulator's online trustee toolkit.
• Significantly more training occurs in defined benefit schemes than in defined contribution schemes.

The Regulator comments that the results reinforce the findings of the 2006 survey. Going forward, the Regulator considers that there is still need to increase the level of trustee training. It is concerned that one third of schemes have not conducted any trustee training in the last year. The Regulator will continue to promote the trustee toolkit.

Key drivers of good governance: TKU

The Regulator considers that TKU deals with the causes of poor governance rather than the actual behaviour demonstrated by schemes. The survey showed that schemes where trustees have completed training have a stronger collective understanding and higher level of confidence.

The Regulator considers that there is a clear association between trustee understanding across key topics and their confidence levels in managing the scheme. The Regulator intends to publish more guidance to continue to try to change trustee behaviour.

Key drivers of good governance: potential barriers to governance

The survey found that only 10 per cent of schemes have difficulty in retaining trustees and only 12 per cent had problems recruiting new trustees. The main reasons given for any retention and recruitment problems were increasing responsibilities and workload. The Regulator comments that this is an issue it intends to monitor.

Trustees were also asked about what barriers they considered would prevent them from conducting their role effectively. Fifty-six per cent of trustees identified the risk and additional responsibilities which they are being required to undertake. The Regulator comments that it is addressing these concerns by increasing knowledge and awareness of trustees' role and responsibilities.

Governance activities: monitoring the employer's covenant

The Survey found that the majority of defined benefit schemes have investigated their employer's covenant over the past year. In particular:

• 42 per cent of schemes took professional advice to help the trustees understand the strengths and weaknesses of the employer.
• 49 per cent of schemes took professional advice to help the trustees assess the employer's ability to make pension deficit contributions at an agreed level.
• 47 per cent of schemes took professional advice to help the trustees in funding negotiations with the employer.

The Regulator comments that employer covenant assessment is essential for trustees. It considers the high level of monitoring activity very encouraging, given the emphasis already placed on this activity. However, Regulator guidance will be published in relation to this in the future.

Governance activities: decision-making and conflicts

The survey found that there had been a notable improvement over the past year in formalising conflict management arrangements. Schemes are increasingly maintaining a register of trustee interests or having a specific conflicts policy. While the proportion of schemes which maintain a policy/register does not vary significantly by size or benefit type, the survey shows that the bigger the scheme the greater the chance that a policy/register will be in place.

The Regulator notes that 66 per cent of schemes still do not have any policy/register in place. At the same time it is interesting to note that the survey found that 85 per cent of schemes claim that they manage conflicts effectively and 44 per cent of schemes (up from 34 per cent in 2006) consider they have appropriate conflict management processes in place.

Overall 30 per cent of schemes have dealt with an actual/perceived conflict in the past year. This was higher for defined benefit schemes. The survey comments that there was evidence that schemes with boards which meet more frequently are more likely to experience/identify conflicts. The most common conflict was the dual role of trustees and director/finance director of the employer. The most common action taken to deal with the conflict was to exclude the trustee from the discussion or vote.

The Regulator is going to publish guidance on conflicts in the future.

Governance activities: internal controls

The survey found that 60 per cent of schemes have a process in place to identify risks but only 49 per cent are very confident that they have identified all potential scheme risks. The Regulator comments that this may reflect the fact that only 38 per cent of schemes perceive risk management practices as a factor which contributes to governance improvement.

Despite this 64 per cent of schemes review internal controls at least annually. The Regulator comments that schemes which conduct regular risk reviews are the most confident that they can control as well as mitigate risks.

Governance activities: scheme administration

The majority of larger schemes include administration as an agenda item at every trustee meeting. Larger schemes are more likely to be confident that they manage scheme administration effectively and are more likely to have documented service level agreements in place which are monitored. The Regulator is concerned that standards are lower for DC arrangements despite the fact the complexity of DC scheme administration.

It intends to publish guidance on this.

Governance activities: review of investment strategy

The Regulator considers that investment strategy is integral to good governance. The survey found that open schemes are most confident that they regularly review investment strategy. However, the Regulator is concerned that there is a gap emerging between open and closed schemes, as well as between defined benefit schemes and defined contribution schemes. Investment strategy is an area the Regulator is going to monitor. It is also considering providing guidance to trustees on reviewing investment strategy. In the case of defined contribution schemes there will be specific guidance on default investment funds.

Comments

Generic statements about pension scheme governance are difficult. Appropriate governance arrangements for one scheme may not be appropriate for another scheme. Large defined benefit schemes have different concerns and risks to a small fully insured defined contribution scheme. At the same time there are governance issues which apply to all schemes, for example, TKU. Despite this the Regulator is keen to monitor what trustees are doing in relation to governance and will be looking for year-on-year improvements in governance standards. This is why the annual governance survey will be a useful tool for the Regulator.

The survey findings support the Regulator's governance priorities as set out in its governance discussion paper published in April 2007. This paper sets out areas of good practice which trustees should aim to achieve. The annual governance surveys will show how much progress schemes have made to live up to the best practice required.

The announcement that the Regulator will be publishing guidance on governance issues is to be welcomed. In particular, guidance on conflicts of interest will be helpful for trustees. Up to now, the Regulator seems to have been reluctant to provide such help for trustees (other than basic statements in the toolkit and statements in passing in the funding code and clearance guidance).

The key for trustees is to have appropriate governance arrangements for the scheme and then to monitor that governance. Yearly monitoring of the scheme's governance will help to secure the improvement the Regulator is looking for. It will also reassure scheme members about the security of their benefits.

This briefing note is based on the Regulator's "Occupational pension scheme governance: a report on the 2007 scheme governance survey" published on 12 July 2007