DWP research has shown that the vast majority of jobholders auto-enrolled into a defined contribution (DC) pension arrangement are unlikely to make an investment choice (they don't have to), which places a heavy burden of responsibility on those charged with selection of the necessary default option. This refers to the investment vehicles that are selected automatically for a member joining a pension scheme who does not specify an alternative.

Following a consultation last winter on draft guidance (see Aries article) for the default option, the DWP published a response on 24 May together with official guidance.

Developed with the support of the FSA and the Pensions Regulator (TPR), this new principles-based guidance sets out standards for default options in automatic enrolment DC schemes. It includes separate sections for trust-based occupational schemes and workplace personal pension (WPP)* schemes, because of the differences in governance and underlying responsibilities.

* an umbrella term covering Group Personal Pensions (GPPs), Group SIPPs and Stakeholder Pensions.

In a WPP arrangement the ongoing responsibility for the default option may vary between provider, adviser, fund manager, employer and governance committee. The key point is that decision makers should consider who is accountable, and assign responsibilities as appropriate. In a trust-based scheme the trustees are responsible for everything, although some functions may be delegated. In every kind of arrangement, roles and responsibilities should be documented and available to members.

This guidance suggests that initial communications to members regarding the default option should include the following, clearly stated:

• a description of the default option;
• a statement of the overall objective of the default option with an indication of the risk profile;
• a disclosure of the charging structure; and
• clear signposting on how to request further information.

Provision of information on the default option is a statutory obligation for WPP providers. Occupational pension scheme trustees are clearly expected to do the same, although it is not a legal requirement.

Additional information should be available to members on request. (A further consultation on the existing disclosure legislation is promised for later this year.)

Naturally, the scheme’s default option should be designed with the likely membership in mind. It should adhere to the following standards:

• Objective: the default option needs a high-level objective explaining the broad aims and strategy, including a simple description of how the investment strategy will manage risk and what it aims to achieve for member outcomes. The strategy should be reflected in its name.
• Suitability: in terms of the ongoing characteristics and needs of the membership.
• Affordability: the default option should be appropriately and competitively priced, depending on scheme characteristics. There should be clear disclosure of charges and their effect on members' outcomes.
• Managing Risk: to achieve the best outcome for members, balancing risk and return. Risks should not be considered in isolation. Members should not be locked into the default option.

In preparing the guidance DWP has deliberately avoided giving hostages to fortune by including examples which might become outmoded and yet taken to be de facto standards. Instead, we have quite broad brush stuff which should provide the flexibility that employers will need to tailor their DC schemes.

The design, performance and continued suitability of the default option and its investment strategy should undergo a full review at least every three years and when certain events occur which might make the default option less appropriate (eg a change in the charging structure, or significant economic or legislative changes). Whatever the outcome of the review, members should be informed.

The performance of the funds within the default option should also be checked informally at regular intervals throughout the year.