The 'governance deficit' in DC arrangements - particularly contract-based schemes - is a matter of great concern, says Spence & Partners' Neil Copeland.

A bit like papal guidance on contraception and EU limits on government borrowing, defined contribution (DC) pension scheme governance has tended to be a custom more honoured in the breach than in the observance.

There are a number of reasons for this, not least of which is that contract-based DC arrangements were sold to many employers precisely because there was an absence of governance requirements. Governance has also taken a back seat where DC schemes were set up under an occupational scheme regime. Indeed, even in hybrid schemes, the DC section often struggles for agenda time alongside the defined benefits (DB) section with its complex funding issues.

However, we are beginning to see an increased focus on DC governance from both the Pensions Regulator (TPR) and some employers, both of which see the DC governance deficit as unsatisfactory.

The Regulator's focus was initially on DB governance because these schemes were, rightly, seen as having greater and more complex issues than DC schemes. However, TPR has increasingly recognised that, with more and more people coming to rely on DC arrangements to save for their retirement, the DC governance deficit needs to be addressed.

It has published guidance on a number of DC-specific areas such as investment and employer engagement in contract-based schemes. The biggest barrier to improving DC governance is that sponsoring employers of contract-based DC arrangements are not directly party to these arrangements, and the statutory requirements for governance are, to all intents and purposes, non-existent.

With many employers moving to contract-based pension provision to escape the perceived onerous duties associated with trust-based schemes, they now run the risk of creating a mismatch between the level of governance that most members assume is in place and the amount that is actually in place.

We are increasingly being approached by clients for whom the lack of involvement with their sponsored pension arrangement, initially presented as a benefit, is now being seen as a negative. Those who bought into the hands-off approach are finding that contract-based schemes are not delivering for their members or, from an HR perspective, for the employers.

These employers are coming to realise there is a role for them in helping employees engage with the pension provider to ensure the arrangement delivers for its members. There is a degree of self interest, regardless of the distance some employers have attempted to put between themselves and their contract-based pensions schemes, as many members of such schemes view them as endorsed by and associated with the employer.

A disgruntled employee often will not understand the legal distinction between a workplace contract-based DC scheme - which, in legal terms, is solely their responsibility - and a workplace occupational DC scheme with its trustee board and governance requirements. The reality is that the employer is in line to take the blame for any failure to deliver on a pension scheme.

As a result, we are now seeing a convergence of the interests of TPR and at least some employers in terms of the need for improved DC governance. However, the fact employers have no direct legal relationship with the contract-based arrangements imposes some limits on how they can act, even where they wish to be more proactive.

TPR has identified three broad categories of activity where employers can engage more greatly in DC governance. This includes addressing member concerns, which essentially revolves around educating and communicating with them, as well as providing support at key decision points.

Another area of engagement is through HR to ensure the design and operation of the scheme remains consistent with the employer's broader business objective and complies with any legislative requirements. The final category falls under monitoring, where the employer can keep investment levels, administration requirements and the costs of the provider under review.

TPR is also keen to encourage employers to establish management committees to oversee contract-based arrangements. The key role for these bodies - whose very existence sends a positive signal to the employees - is to provide a structure for employer engagement and ensure there is a clear contact for any members wishing to raise a pension-related query.

Governance committees have a role to play in helping employers address some of the concerns they are raising about contract-based DC schemes. Some may argue greater engagement carries risks for the employer. However, as noted above and given that most members perceive employers as engaged with the pension arrangement already, the greater risk could arise from the mismatch of this expectation and the reality.

We hear a lot about deficits in pension schemes - usually large, monetary, highly volatile and associated with DB schemes - but the governance deficit in DC arrangements, particularly contract-based schemes, should be as great a concern.

Neil Copeland is head of Spence & Partners' trustee advisory practice