Simplicity is at the heart of increasing confidence and for too long complexity overruled the industry, much of which has come from pension schemes offering members an over-extensive range of funds. What's more, this choice does not appear to have increased engagement with pensions. With auto-enrolment being phased in from October 2012, employers need to be looking for schemes that operate efficiently and cost-effectively, whilst not overburdening them with extra responsibilities that affect the running of their businesses.
According to the DWP, more than 80% of members in defined contribution (DC) schemes opt into a default fund and typically stay there. Experience shows that this is no bad thing: in the mid 2000's ATP (the Danish state pension provider) offered a DC plan to 3.5 million members, 10,000 of whom made the investment decisions themselves. However, these members were shown to be taking excessive risk that was out of sync with markets, and our research in both the UK and other countries certainly indicates similar results.
Lack of understanding around pensions, along with the overwhelming choices available and the relative poor performance of default funds, has led many to become distrustful. Many members lack sufficient investment knowledge to make the right decisions, yet the basic DC offering still provides them with an overwhelming amount of choice. People need a scheme that manages itself and produces strong and stable returns in the long run.
Another issue is the heavy weighting towards equities, to which the typical UK default fund has an allocation of nearly 80%. Equity markets are highly volatile in the short and medium term and everyone has watched the equity markets in Europe and the US yo-yo over the past five years. Peoples' savings are being hit hard with every dip, and it could take years for pension pots to recover. A recent OECD report revealed the UK has some of the worst returns from default funds, with the average saver having lost money every year from 2001-2011 by investing their retirement savings in default funds. This highlights the need for a change of thinking throughout the industry, because the current structure of default funds has proved time and time again that they are failing members.
With the introduction of auto-enrolment and the number of savers in default funds set to increase dramatically, we need a structural overhaul of default funds to more diversified asset funds. Members need an actively managed fund that mitigates risk by diversifying investments across various asset classes. This diversification strategy, coupled with active management, can provide the risk framework to ensure the value of a portfolio is less drastically impacted when there is a shock to the system. This enables the fund to produce more stable returns than the simple traditional funds that are used in the UK.
As the staging dates for auto-enrolment loom closer, employers need to ensure they comply with the requirements set out by The Pensions Regulator. The uniqueness of each employer has added to the complexity of the new legislation; and new systems have had to be created to ensure compliance is met and the correct employees are enrolled. Research has indicated that many payroll providers are insufficiently prepared to deal with the implementation of auto-enrolment, with many lacking the required technology and resources, which has added further concern for employers.
Implementing a pension scheme can be a time-consuming process, so getting it right first time is essential. For those employers yet to choose an auto-enrolment scheme, the vast choice of providers and lack of understanding can add further burden in a time of economic stress and uncertainty, and many employers have had to seek advice from financial advisers. Conducting rigorous due-diligence of pension providers will become an important part of the process, and employers need reassurance that schemes have governance frameworks set up with clear accountabilities and responsibilities.
Offering a scheme that puts the onus on members to make investment decisions unnecessarily increases the workload for everyone involved. The introduction of auto-enrolment will bring a new group of savers into the UK pensions system, some of whom will be saving for the very first time. It could add overwhelming strain if companies are then required to support their employees in the decision making process. Companies operating simple pension schemes that require fewer decisions from members are likely to benefit in the long run.
The real obstacle for employers will be engaging workers in the process. At the heart of these reforms is a need to engage those who are not saving for their retirement, therefore avoiding needless jargon and further complication is the key to building a stronger savings culture in the UK.
Morten Nilsson (pictured), CEO of NOW: Pensions