In the light of auto-enrolment, trustees need to look again at their default design suggests Saqib Hussain, PricewaterhouseCoopers
With the introduction of auto-enrolment, one of the biggest challenges that trustees are going to face is ensuring that their default investment option (DIO) continues to be suitable for members.
A key principle of auto-enrolment is that employees must not be forced to make any investment decisions. It is likely that trustees will already have a significant proportion of members investing in a DIO, but numbers could increase with the introduction of auto-enrolment. This is why it is important that trustees take a considered look at their current DIO and the investment options of the wider scheme.
Firstly, trustees should try to establish whether the employee and contribution profile of the scheme is likely to alter after auto-enrolment. Therefore, it is important to know whether the sponsoring employer intends to use the scheme as its auto-enrolment vehicle going forward. Understanding this key issue will help trustees think about how they may need to adapt their scheme.
For example, if the intention is to auto-enrol all eligible employees into the scheme then some consideration needs to be given to:
The pay profile of auto-enrolled employees – studies have found that those on lower incomes tend to be averse to investment risk and market volatility. Indeed, this is one of the assumptions behind the investment model that Nest is adopting for their members. Likewise, if the existing scheme is only going to be used to enrol a section of the eligible population then you do need to consider what their attitudes to investment risk are likely to be and how appropriate the investment risk in the current DIO is for them.
Suitability of current DIO asset allocation – many schemes still use a traditional global equity approach for the growth element of their DIO. However, some consideration needs to be given as to whether this remains appropriate, particularly in light of recent investment innovation and developments in this area, eg the use of target date and diversified growth funds that an ever increasing number of investment providers are looking to offer.
Lifestyle design – trustees are going to have to consider the suitability of their current lifestyle design. Many schemes have a lifestyle structure targeted at matching an inflation linked annuity at retirement. However, trustees will need to look at the population being auto-enrolled and take a view on the type of annuity these members are likely to purchase when they retire. Indeed the introduction of flexible retirement may mean that there are a number of employees who may not want to purchase an annuity at retirement. Therefore, some consideration will need to be given as to what an appropriate lifestyle design may be and what impact this may have on the DIO. On the basis of current experience, the most popular type of annuity purchased by DC retirees is a nil-increasing annuity. Therefore, the decumulation phase of your lifestyle design may need to reflect this.
Engaging employees – one of the key challenges that trustees will face is engaging employees with the investment options on offer. In particular, trustees will have to help members understand the DIO that is being offered. Again, trustees will need to consider the profile of employees who will be auto-enrolled and think about how they can best engage with them. This will usually be through a combination of written, verbal and visual communications.
Author: Saqib HussainSaqib Hussain is head of DC consulting (north) at PricewaterhouseCoopers.