Pensions World

Auto-enrolment presents great opportunities for the defined contribution market says Allison Plager.

There is no escaping the fact that pensions are big news. This time last year, when the last Pensions World defined contribution (DC) pension schemes survey appeared, it was BBC journalists who were striking about changes to their schemes. This year, it is head teachers who are threatening strike action as changes are proposed to their public sector pension scheme.

In reality, all employees are facing changes to their pension schemes and this is particularly so in the private sector where valuable defined benefit (DB) schemes continue to close as they become too costly and risky for the employer to maintain. Instead, employees are invited to contribute to a DC scheme, where the risk lies with the member. Usually, a DB scheme will produce a better pension than a DC scheme and all the effort lies with the scheme sponsor rather than the member. With DC schemes, the member should take more responsibility for the investment of their contributions and therefore should be taking an interest in the economy as this will affect their investment.

Investment woes

Certainly, the unpredictable stock markets are not helping members of DC schemes. Analysis from PricewaterhouseCoopers (PwC) suggests that “plummeting stock markets” have left “many DC members feeling they are in a worse position than if they had kept cash savings”. PwC gives the example of a 40 year old who has been paying 5% of his gross salary, say £250 a month, for the past five years into his DC scheme. If he had opted for equities, he would have invested around £13,000 of contributions which still only give him a current value of £13,000 (his original investment), although the effect of charges levied by the scheme would have probably reduced the amount. The example says that since the start of August approximately £2,000 would have been wiped from the size of the pot. While noting that this should be temporary, PwC says that “it highlights how vulnerable people’s DC pensions are to market swings”.

Peter McDonald of PwC feels that the example shows that the “problem is not with pensions but with ensuring people get the right balance of investments so that they do what they’re supposed to do, plan over the longer term and are not overly alarmed by market volatility. Employers, trustees and pension providers have a vital governance and communications role to play here.” He also notes that it is incumbent on employers and trustees to “ensure charges are kept to a minimum at a time when they will be felt acutely”.

Stock market falls are particularly worrying for individuals who are approaching retirement, says Mr McDonald, “with a danger pension pots are crystallised at the wrong time, it may be appropriate for some to defer retirement decisions until markets recover”. At least employees with several working years still ahead of them have time to consider their options, perhaps deciding to increase their contributions.

The volatile nature of investment is one of the main problems for DC members, but there are other issues and these were highlighted by the new chairman of the National Association of Pensions Funds (NAPF), Mark Hyde Harrison, in his inaugural speech. He pointed to the following key flaws:

• DC pensions are too small scale, and too numerous which leads to higher costs, weak governance and poor administration. The UK has 42,000 workplace DC pensions, and the average scheme has just 20 members.
• Information about costs and charges is far too opaque.
• Savers’ interests are overlooked because employers and pension providers are not really batting for them.
• The average worker has too many “pots” and finds it difficult to pool them together, often resulting in pensions languishing in low performing funds or being eroded by high charges.

Instead, Mr Harrison suggested the creation of super trusts. These would be pensions run on a large scale that would permit a small employer to join an existing pension structure, rather than setting up its own small scale scheme. He said they would have stronger governance measures and high quality trustees to oversee investment performance and charges with the saver’s interests in mind. He added that the NAPF would help to develop the right regulatory framework for super trusts and look at ways of incentivising consolidation in the pensions market place. A few multi-employer DC schemes already exist and the idea of “collective DC” is explored by Hamish Wilson in “Collective bargaining”, Pensions World, November 2011, page 24.

Currently, however, employers have to make do with what is on the market and the Tables provide information on group personal pension (GPP), DC and stakeholder schemes. At the moment, Mercer’s David Barker feels that GPP schemes seem to be in the ascendant. Friends Life’s Malcolm Robinson reflects this, saying that “the majority of schemes continue to be set up on a stakeholder/GPP basis due to the reduced costs and governance requirements”. He notes, however, that some more paternal employers “request trust based arrangements which provide greater control”.

Seeing demand for trust based money purchase schemes, Standard Life relaunched its trust based pension in 2010 and has added to this a new master trust pension, a multi-employer arrangement for companies which cannot appoint their own trustees. The scheme sponsor will be able to select customised investments solutions, depending on the investment funds it wishes to offer members. A packaged investment solution will be available in 2012. As Jamie Jenkins of Standard Life said: “Many employers are still keen on the benefits associated with having trustees in place, but want to avoid the responsibility, cost and complexity of appointing them. This new DC master trust not only gives employers the reassurance that scheme governance requirements will be met, it helps relieve employers of some of the work involved in running a trust based scheme.”

Real advantages

The pensions scene is changing, not just in terms of products, but also in terms of regulation. As all in the pensions industry will know, auto-enrolment is just around the corner which, given that fewer people than ever are paying into their occupational pension scheme, will be a timely way of reminding people who do not yet pay into a scheme about the advantages of doing so. This year’s occupational pension schemes survey by the Office for National Statistics showed that the number of people paying into a pension is the lowest since 1956: in 2010 there were 8.3m people saving into an occupational pension of which 5.3m were in the public sector. The figure for 2009 was 8.7m (3.3m private, 5.4 public). Commenting on these results, Joanne Segars, NAPF chief executive, says that while unemployment is a contributing factor, many employed people are so concerned about their day to day finances that “unfortunately, saving into a pension is being seen as a luxury”. She adds that reluctance to pay into a scheme “is especially noticeable in the private sector, where confidence in pensions is running at a record low. People are being put off by stock market turmoil, falling annuities and mistrust of the pensions industry’s fees and charges.”

Interestingly, the Towers Watson FTSE 100 DC pension scheme survey showed that overall DC membership remained unchanged during 2010, with around half of all employees of FTSE 100 companies being members of a DC pension scheme. However, new employees are less likely to join, with non-joiners increasing to 23% from 18% the previous year. As Towers Watson’s Paul Macro says: “It is alarming to note that almost a quarter of FTSE 100 employees choose not to, or are not eligible to join, their company’s pension scheme, particularly in light of the 2012 pensions reforms and auto-enrolment legislation. With less than 18 months to go until the phased introduction of the requirement for companies to auto-enrol employees into a qualifying scheme, some firms will need to give serious consideration to their benefit provision. They also need to decide whether they will update their scheme design to become a qualifying scheme, use Nest or use a mixture of both of these options which could bring administrative headaches for payroll and HR teams.”

Engaging people

So is auto-enrolment going to provide the boost to pension awareness that some, especially new, employees need? Mr Jenkins believes: “We are genuinely on the cusp of a great opportunity to effect real change in the level of savings in the UK. Pension reforms and, specifically, auto-enrolment have the potential to bring anything from 4–8m new savers into the system. However, it will not simply happen of its own accord. The rules put the onus on employers to auto-enrol eligible employees – they do not make it compulsory for those employees to stay in. In fact, auto-enrolment relies on people’s apathy towards pension saving. People do nothing to be enrolled, have an investment choice made for them and have a contribution level set. So, to engage people in such things will need a lot more than just following the ‘rules’.

“Engaging people in a subject such as pensions is no easy task, with the natural barrier being for so many people that it is very low down the priority list. So, communications will need to be more targeted to people’s individual circumstances. They should take account of other needs, such as the repayment of debt or the need to save a deposit for a house.

“Others will need to consider their ‘rainy day’ fund or the ability to fund long term care. But none of that precludes the need for pension savings: long term saving should still be at the heart of financial planning over the long term.”

Referring to research commissioned by Standard Life, Mr Jenkins said this had provided some helpful insights into how communications could be improved. For example, there is a pivotal age at which people consider long term savings needs, viz age 30. Many people consider it too early prior to 30, but getting too late afterwards. In addition, he said that “there was significantly more attraction to simple round numbers, such as £50 a month, rather than more difficult definitions. Where percentages are used to describe contribution rates, people associated much more strongly with even numbers, eg more people would choose a 2% or 4% increase, rather than 1% or 3%.”

Overall, he concludes that good member communications will be vital for auto-enrolment to work and “to come out of the next five years or so with a positive feeling that it is a ‘social norm’ to save – not a tax”.

Running the scheme

The beauty of money purchase schemes is that they are less hassle for companies to run, particularly contract based ones which are operated by the provider. However, as already mentioned, many employers run trust based schemes, providing a board of trustees to make decisions relating to the scheme’s investment. The Pensions Regulator (TPR) recently released more guidance for trustees of DC schemes (see www.lexisurl.com/dctrguid) which, says Mr Barker, “equals more and more work and changes the balance between trust based and contract based schemes”. While the guidance is very useful, he feels that it says little that is new. Overall, he suggests that the role of trustees “changes the balance between contract and trust based schemes” with employers, especially small businesses, often opting for the former because it is easier and cheaper to run.

But Mr Barker thinks that a “well run trust scheme should be better” for members in the long run. For example, the trustees should be able to understand the importance of selecting the most appropriate default fund for their workforce or the impact the wrong choice could have on members’ retirement incomes.

Plenty to do

The next few months are going to be important for all employers. Money purchase schemes may seem a simpler option for the employer than DB, but as TPR takes an increasing interest in trust based schemes and members, it is to be hoped, become more aware of the income they will need in retirement, the pension scheme is not something that employers will be able to leave on the back burner.

Table 1 GPPs – Plan minima and charges

Table 2 GPPs – Commission, terms and investment

Table 3 Defined contribution – features and minima

Table 4 Defined contribution – charges and investment

Table 5 Stakeholder – features and minima

Table 6 Stakeholder – payment and investment