What happens when you take the fiduciary out of the pensions equation? Paul Lawrence, an associate, and James Borshell, a senior associate, at law firm Dentons, share the US experience.
If you want to see where the law on pensions is going in the UK, the US is usually a good place to start.
Part of this is down to similarities in economic models, political influence and common language. The UK Government copied the best bits of the Pension Benefit Guaranty Corporation when it set up the PPF.
There are also “structural” similarities created by the existence of a sizeable private pension sector. Both systems have a basic divide between schemes with a third party subject to a fiduciary duty looking after pension savings (in the UK a trustee in the US, a fiduciary) and contract- based schemes. Both systems also have a divide between defined contribution and defined benefit pension schemes.
In general both markets have moved away from the fiduciary responsibility/defined benefit model towards the laissez faire approach of contract-based defined contribution pension provision with the US marginally ahead at this time.
This has led to a problem. Once you remove the fiduciary from the pensions equation as has happened in the contract-based defined contribution model, it pushes responsibility down to the individual saver looking after himself. Trustees and fiduciaries in the UK and the US have duties to look after their members’ best interests and the resources to obtain professional advice. Individuals only have what they personally bring to the table and a limited ability to seek out investment and product advice in their spare time.
Individuals do have two strengths which governments cannot ignore:
- They can bring political pressure on the State to step in and support them in their retirement.
- They can go to court. In the US this has led to lengthy court battles with employers and advisers over bad pension outcomes. In the UK we have pension mis-selling scandals and variants of the Equitable Life debacle.
This makes regulating personal pensions a fun problem for governments on both sides of the Atlantic.
In the US the Department of Labor (DoL) regulates pension relationships. It has just released a contentious proposal to impose a fiduciary relationship on investment advisers acting for individual pension savers. Full analysis from my US colleagues is available at:
Currently you will only be a fiduciary as an investment adviser if you meet a five-stage test that dates from 1975, when large-scale schemes formed the bulk of US pension provision. Practically there is no fiduciary relationship between an individual pensions saver and their adviser. DoL has suggested that this means US$17 billion a year is diverted to investment advisers from individual’s pension pots due to inappropriate or self-interested advice from the investment advisers.
DoL may not adopt the rules and reaction from the investment adviser community has unsurprisingly been negative. However, it does raise an interesting question for the UK.
Following a 2012 review of fiduciary relationships in the investment arena by the Law Commission, the UK Government adopted a scatter gun approach to regulating the adviser/pension saver relationship particularly in the auto-enrolment field. We have Independent Governance Committees. We have management fee caps. We have the retail distribution review removing commission charging. We even have a ban on active member discounts to look forward to.
But is this just tinkering around the edges? Personal pension saving in the UK needs two basic things, more saving (obviously!) and protection for savers.
Perhaps in three years’ time we will go down the American road again towards a fiduciary relationship between savers and their advisers. If the industry wants to avoid this it would be sensible to make the existing system work in the best way possible.
James Borshell is a Senior Associate at Dentons
Paul Lawrence is an Associate at Dentons