C. How are Pension Scheme Moneys Invested?
1. Retirement Annuity Contracts (Self-Employed and Non-Pensionable Employment)
2. Occupational Pension Schemes
Who Does the Investing?
Why is Investment so Important?
What Kind of Investment Vehicles Are Used?
Pooled Funds
Direct Investment
Information on Scheme Investments
1. Retirement Annuity Contracts (Self-Employed and Non-Pensionable Employment)
Retirement Annuity Contracts or Personal Pension Plans are primarily for the self-employed, but are also designed for people who are not members of pension schemes in their places of employment. The investment position under these contracts is fairly straightforward. The person who is paying the pension premiums can choose the insurance company that is to manage or invest them.
In the first place, the individual must decide what kind of investment he needs - for example, a traditional with profits endowment / deferred annuity policy, or an alternative unit-linked fund. If he chooses the traditional with-profit policy, this narrows that range of providers available to a small number of insurance companies.
If he selects the option of a unit-linked fund, this will certainly open up much wider variety of choices. Some insurance companies offer a very wide range of funds in which the money may be invested - and the choice rests with the individual who pays the premiums. Other insurance companies offer, not only a range of funds within their own management, but also the services of other investment managers, including investment banks. Once the manager is selected, the individual can then choose whether to go for a "mixed" fund, in which the manager is investing in different kinds of assets, including ordinary shares, government and other fixed interest stocks and possibly property. There can be further choice available when it comes to ordinary shares (equity) investment, as the manager may offer a range of funds that invest in different markets, such as the UK, the United States, Japan, and so on.
There is often considerable freedom to switch between these funds as time goes on, so that control of the investment remains with the premium payer. Funds can now be moved freely from one investment manager to another, though there may be some costs incurred when this is done.
2. Occupational Pension Schemes
In occupational pension schemes, the trustee is always responsible for the investment of the pension scheme moneys. Although it was always accepted that this was the case, the Pensions Act 1990 specifically mentions this as a responsibility of the trustees. How this actually works in practice depends on the nature and size of the scheme concerned.
Although the trustee is responsible for the investment of pension scheme moneys, they rarely perform this duty themselves, in practice. Most trust deeds give the trustees some discretion to delegate the conduct of the investment to an investment manager and the choice of manager will, again, depend on the nature and size of the scheme concerned.
There are two basic types of pension scheme - defined benefit and defined contribution. In a defined benefit scheme, the employer has promised a given level of benefit. If the investments do not perform well, the money to meet these benefits has to be made up somewhere, and this usually takes the form in an increased contribution from the employer. Therefore, the employer is particularly interested in the success of the pension scheme's investment policy.
The second kind of scheme is a defined contribution scheme. The benefits to be provided under a scheme of this type depend solely on the amount of money available when a person comes to retire, leaves service, or dies. If the investment policy followed by the trustees is not successful, this will mean that the member gets less by way of benefits than he might have hoped or expected. In this kind of scheme, therefore, the member is vitally interested in the performance of the investments.
This depends on the type of scheme and its size in terms of numbers of members and total contributions. Most smaller schemes nowadays are defined contribution schemes. So are most of the arrangements designed to accept additional voluntary contributions (AVCs). The pattern of investment is very similar to that adopted for Retirement Annuity Contracts (see above), except that trustees are legally responsible for the investments. Therefore, the individual scheme member may have little or no say in how his money is invested. Sometimes the trustees will allow members a choice between a limited number of investment options - at times including a choice of different investment managers. The contributions made for and by individual members must be "tracked" so that each receives a fair return on his investment.
Defined benefit schemes include most of the biggest schemes in terms of membership. Trustees will decide how they wish to invest the money in conjunction with their appointed investment manager. Insurance contracts are not as widely used now as they once were. Most schemes use shared or pooled investment vehicles, and the largest are "directly invested" - often called "segregated".
Shared investment vehicles include the wide variety of managed funds offered by insurance companies and unit trusts offered by the investment banks and specialist fund managers. They are similar to the funds used for individual investment. The main advantage of pooled investment vehicles is that they offer even smaller pension schemes an opportunity to spread their investments over a wide range of assets. A scheme that could never consider buying a property, for example, can still benefit from property investment by buying units in a managed property fund.
When the value of a scheme's assets reaches a certain size, trustees often feel that they can add value by moving away from shared investment arrangements and asking their investment manager to invest in stocks, shares and other assets that are owned directly by the trustees. Even these schemes, however, may not hold direct property investments, but purchase property fund units instead. Because a scheme is investing directly, it may follow an investment strategy that is closely designed for its particular needs. Without going into too much detail, it should be clear that a scheme that has a lot of pensioners, for example, and therefore needs cash to pay benefits, may invest differently from one whose members are far from retirement age - and there are many variations in between those extremes.
The annual report of the trustees of each pension scheme will contain information on how the assets are invested, the name of the investment manager and how he is paid. It will also include information on the investment policies followed by the trustees during the scheme year and on any changes made to those policies. The report should give details of any significant financial developments (such as large movements of money in or out of the scheme) and comment on the performance of the investments during the year.
Other information that must be given, if it applies, is whether there is what is called a concentration of investment - that is, whether more than 5% of the assets are invested in a particular asset or asset type. If there is significant "self investment" (this means investment in employer-related assets or property) it must also be reported.