Bad administration processes can lead to contributions being calculated inaccurately and put in the wrong funds. Michael Klimes explores the pitfalls and how to avoid them
A defined contribution (DC) scheme member hopes that after decades of saving they will have a large enough pot to retire on. This is determined by solid contributions, appropriate fund strategy and investment returns. If at any stage the contribution levels are miscalculated or they are put into the wrong fund, the member will miss out.
They will also miss out if investment units held at the manager level are not reconciled with the scheme holdings and individual member.
Therefore, the administration process, which connects the information chain between the member, contributions and fund, must not break. The risk to a DC member arising from awry administration is arguably greater than that to a defined benefit (DB) counterpart.
In a DB scheme administrators can make errors with records until the scheme has to pay out. The data is then reconciled and the money leaves the scheme. But with a DC transaction every contribution and fund switch has to be executed correctly along the way, as the cost and work involves in going back to correct the broken link is considerable.
Is there much evidence of poor DC administration and what measures can be taken to address any issues?
According to KGC Associates director Lesley Carline, there are no hard figures of how widespread the problem might be, yet she is aware of cases where contributions have not been invested properly or at all.
Furthermore, she has concerns about the attitude trustees have towards data in DC schemes compared to DB.
"It surprises me that trustees still don't realise that the data standards apply to DC as well as DB data. The importance of getting DC data right can't be under-estimated, particularly as DC is very process-driven and relies heavily on accurate and correct data.
The fact DC is very process-driven increases the likelihood something can go wrong in the information chain - either at the employer or administrator level.
"DC is about timeliness and continuous activity, processing numbers and interacting electronically with multiple systems - employers payroll, administration systems, straight though processing (STP) to investment managers, online banking for reconciliations," says Carline. "These activities occur daily, even sometimes several times a day, and need controls and processes in place to keep it accurate and working."
Where it can go wrong
At the employer level there is a possibility for the company to inaccurately calculate how much salary should be deducted each month for pension contributions. It can also fail to sign up new employees to the company scheme.
In both cases the administrator would not have been told the key part of information it needs to serve the member. If a member's contributions are not invested in a timely manner, their pot size might not grow.
When it comes to administrators, an error can occur where someone has programmed a mistake into the system or there is an unforeseen gap in the programme. That mistake can be compounded by insufficient testing of the system.
For example, Capital Cranfield independent trustee Allan Course knows an in-house administrator, which serves a big scheme, failed to rebalance the lifestyle fund nine times over a three-year period.
"For 27 months the administrator did remember to manually rebalance the asset allocation but simply forgot to do it sometimes," he explains. "So members could be in pocket or out of pocket depending on what happened to the fund they were in until it was rebalanced. Often it is the little things that can trip up DC administration."
Administrators can check their processes by running two tests. The first involves checking how the system would fare against expected problems. The second test, which is more subtle, asks how the system would cope with unexpected Black Swan scenarios.
Course adds: "I would suggest most administrators should periodically do their own 'Black Swan' testing. They should meet periodically and identify what unforeseen things could go wrong. For instance, if a lifestyle fund rebalances on the last day of each month, a Black Swan test might ask 'what happens on 29 February?' Does the programme cope with it? Does it do something wrong? Does it do nothing?'"
Where trustees are concerned, they should frequently monitor the investment chain, says Hymans Robertson DC administration specialist Jonathan Papier.
"Trustees should be tracking the investment chain in a monthly cycle. They should try to understand what is happening in the end-to-end processes and how this breaks down."
Trustees and administrators should bear in mind that DC members short-changed by poor administration are likely to want compensation. It is better to get administration right the first time round in order to avoid a foul-up.
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