Pensions World

Dave Lowe, Zurich Financial Services, highlights some key considerations for DC scheme design in readiness for the introduction of Nest

With the slow demise of defined benefit (DB) schemes and the shift to defined contribution (DC) schemes, together with the introduction of auto-enrolment and Nest, challenges remain for ensuring positive retirement outcomes. This article seeks to address those challenges and outline some key consequences for DC design in the light of an evolving market.

While providers may take time analysing the minutiae of regulatory requirements, the main opportunity over the next 12 months, before Nest and auto-enrolment arrive, is to refocus on retirement outcomes:
ensuring we understand what good outcomes look like
refining our schemes to deliver them.

Answers to these points do change, both as a result of the regulatory changes and as a result of wider social and environmental change. The regulations mean that the DC schemes that we run today will have to be appropriate to a much wider audience.

For many employers, schemes will be opened up to workers with very different experience and knowledge of retirement savings. For example, short term workers may never have joined pension schemes due to the operation of waiting periods – many will now be eligible to join pension schemes for the first time and will have no idea what to expect.

Moving into the post-Nest world, the design of the DC scheme has to be relevant to these potential members as well as to existing members. A well designed scheme should be seeking to achieve success both in terms of the creation of meaningful retirement savings and of getting employees to value those savings.

This second point highlights the need for schemes to be designed so that all members understand what they have joined: their costs, what their employer is paying in for them, how their savings are invested and what the savings will mean to them in retirement.

All of these points of understanding are very personal. It really is all about what difference the scheme will make to the individual. However, getting this message across will only be achieved if the wider proposition is simple and understood. Understanding will follow simplicity.

Too much choice

We all know that giving too many choices to people in areas in which they are not expert can lead to decision paralysis. We also know that not making enough choices available can be frustrating. For retirement saving in the future, the need to design and present options that are appropriate for members is crucial.

In practice, this is most relevant in the context of presenting investment options.

Where trustees make decisions about providing a limited investment range, this challenge is usually addressed. It is unusual for employees to want anything more than the options selected by trustees. This becomes more of a challenge for group personal pensions (GPPs) where the norm has been to present a wide range of funds on the assumption that this level of choice is good.

If an objective of a DC scheme is that their members understand, providing too much choice is not the right path.

Equally, GPPs do have the opportunity to provide wider investment options for the few who really do want them and have the capability to use them. Provided the member who neither wants nor needs these options can avoid them, it seems sensible to provide this level of flexibility to ensure a proposition is the right solution for the employee over their lifetime membership of the scheme.

Clarity in charging

It is not really just about charges. Particularly as we see more and more GPPs, getting members to understand is dependent on being clear on who is doing what – and this is directly linked to the charges. A simple approach to charges with clarity of the services being provided by the charge and who is levying it will be crucial elements of designing a proposition.

In the long term, understanding and trust will only develop if there is clarity in the charging and association between charges and services.

Risk of surprises

If the investments are not understood, there is always the risk of surprises. Members will not understand if the value of their savings does not behave in the way they expect. It is in this area that the reason for the need for understanding and the need for simplicity become absolutely clear.

Most individuals do little to really plan for retirement until quite close to the moment it actually happens. In this planning process, most will get a snapshot of their current savings and extrapolate to their expected financial position in retirement. Chances are, this prediction will simply be on the basis of no growth, no loss which is fine if that is what happens – but usually something else will happen.

If the something else is a substantial fall in retirement savings due to a credit crunch, this is likely to be a surprise for anyone who did not understand where their savings were invested.

Some would argue that this is why lifestyling or de-risking is so important. And they would be right. But this is not the whole answer as we see today how often people are retiring later than their selected retirement dates. For these people, lifestyling is not achieving what it should, with the de-risked investment position possibly occurring years before the actual retirement. If there is real understanding of the proposition, perhaps these situations could be avoided.

At least with simplicity, there is a real opportunity to drive understanding through an effective engagement strategy. So having defined the key traditional criteria for a post-Nest DC arrangement, it is time to refocus on the element that has been central for most involved with pensions over recent years – how to get member engagement and how to deliver an effective communication strategy.

And it is in the area of communications that Nest really does force change. As the potential membership population changes, the need to communicate with these previously disengaged individuals emerges. In the long term, new members might become familiar with pensions as they continue to be auto-enrolled and re-enrolled, but in the early days of Nest many employers will need to consider the design of their DC scheme with an eye on the communication strategy required for these new individuals. In this regard, careful thought will be required.

To make auto-enrolment work, new joiners will need to understand the implications of becoming members and to make decisions that might impact on them in the short term and in the long term.

In the short term, employees need to understand the impact of pension contributions being deducted from pay. Being surprised or shocked by a deduction from pay is not a good route towards achieving long term engagement in savings. Equally, creating an environment where individuals lose out on valuable employer contributions is just as unacceptable.

Process of change

The correctly designed DC scheme must give enormous emphasis to this joining stage. This is where communications do need to become personal: What is the impact on me of joining? What is the impact on me of opting out? Without answers to these important questions, wrong decisions will be made which will have material consequences.

Good decisions will be made if DC schemes are designed so that their simplicity makes understanding easy. The communication strategy must build on this.

For now, DC scheme design will be about simple choices, charges and investments with a strong communication strategy. But the design also needs to have some level of future proofing.

Auto-enrolment and Nest do not represent the end of the process of change for retirement provision. The achievement of positive outcomes in retirement will require more action. The realities of retirement will change in the coming years. For instance:

• expectations of retirement will change
• retirement will happen later
• retirement will not be a single, one off event
• care needs are likely to be greater later in retirement.

Auto-enrolment and Nest start the process of building security by accumulating savings. Society is changing and this will mean that the way in which retirement saving is applied is likely to have to change, too.

A good proposition will, for now, be one that addresses savers’ need for simplicity, transparency and growth with no surprises. A good proposition, however, will also have to deliver different solutions in the not too distant future, so today’s propositions must also be able to flex to adjust to changing circumstances.