In the second DC Debate of 2017, seven defined contribution specialists discuss why schemes will look for more delegation, whether member engagement can be counterproductive, and if auto-enrolment should be extended.
From diversified growth funds to target date funds, mastertrusts, and even fiduciary management, how will delegation evolve in DC?
Simon Chinnery: We see mastertrust as the outsource solution for DC schemes. Since ‘freedom and choice’ we have seen a DC revolution with recent and ongoing reforms and initiatives encouraging flexibility and longer working.
‘To and through’ retirement solutions are needed: derisking too early, or on the wrong path, is now a much bigger risk to outcomes, and at-retirement decisions are complex and involve different pots of money. Greater governance is required, with more holistic administrative and engagement programmes. It is not going to get any easier, and many schemes are looking to outsourcing as a fiduciary future-proof model.
While mastertrusts are popular with the smaller end of the DC market, large DC schemes will consider TDFs in the future
Laura Myers, LCP
Neil McPherson: The seductive nomenclature and alphabet soup of our industry can hinder communications with members, and these are all forms of delegation. There are a number of drivers behind this trend towards delegation – the need for scale, increasing complexity and a rising governance bar being three key ones.
The trend towards mastertrusts – and the mooted consolidation within the mastertrust sector – evidence these drivers. On the investment side, delegation is helpful in addressing the key weakness in our DC system, which is the member not only bearing the investment risk but also the investment choice and decision. Very few are equipped to deal with this responsibility.
Laura Myers: Over the next few years I expect mastertrusts to increase in size, but a number of them will cease to exist, not only because of the sheer volume in the market but also the fee pressures (with these products basically competing on price), so careful selection is required.
TDFs have been less popular here than in the US, but that is likely to change. While mastertrusts are popular with the smaller end of the DC market, large DC schemes will consider TDFs in the future – especially those TDFs that can tailor asset allocation to the needs of the scheme and manage the derisking period to retirement in a dynamic way, adding value above the commonplace, mechanistic process done by administrators.
Alistair Byrne: It is a challenge for schemes to keep up with changing regulations, member needs, and investment markets. As a result, it seems inevitable that delegation will grow.
Target date funds represent one approach, where the manager can evolve the strategy to reflect changing member needs, as with the introduction of pension freedom and choice, and evolve asset allocation and introduce new investment strategies (such as smart beta) to improve the portfolio. An increasing number of schemes value this type of delegation as they attempt to ensure good outcomes for members.
Laurie Edmans: It will depend on the extent to which the primary focus of the industry and policymakers continues to be on hard product features of DC plans, such as investment media, charges, administration, compliance of communications (rather than their effect), as opposed to the outcomes for members. The latter are predominantly driven by contribution levels, which result from soft factors. If assessment of hard factors dominates, then ‘mass production’ will become the norm.
It is perfectly possible to have all hard factors assessed as first class, but still end up with members gravely disappointed at retirement. The more distant from the member the provider of service becomes, the more difficult it will be to really meet member needs, which vary hugely from person to person.
And at modern levels of charges, the difference made by economies of scale is hardly relevant to outcomes.
John Reeve: There seems little doubt that the influence of mastertrusts will grow in the future. There is no doubt that members are going to want their benefits delivered by the new technology and, if pensions are to remain at the forefront of technology, significant investment is going to be needed now and in the future.
On the investment side, innovation and development is also needed. I am not convinced that the current range of DGFs meet the needs; but some form of cost effective, diversified solution will undoubtedly be the future, and this can only be delivered with scale.
It seems that individual DC trusts are going to struggle to develop the investment solutions and deliver the service solutions that will be demanded by members at a cost which is acceptable.
Andy Dickson: We continue to see interest in mastertrusts, partly driven by the increasing regulatory burden on individual trust-based DC schemes and potential cost savings for the sponsoring employer. I would expect this trend to continue in a backdrop of DB plans closing to future accrual and the expansion of DC membership as a result of auto enrolment.
Pension freedoms presents a new dynamic as well, as most individual trust-based DC plans have yet to support and offer drawdown within the trust-based plan to retired members. By outsourcing, the providers of mastertrusts and other group pension plans can offer support to retiring members and post-retirement solutions and services.
Is there a limit to member engagement?
Chinnery: There is of course a risk that members may make ill-informed decisions if they have access to short-term information, such as daily values of their DC pots, but evidence from the US on investor flows post-2008 showed that many retail investors did not move their funds in a knee-jerk reaction to macro events.
The reality will be that, through multiple sources of information and opinion in the media, individuals will have the ability to act. However, the majority of members are likely to remain defaulted, so our focus should always be on clear and helpful engagement with the willing, and strong stewardship of the rest.
The day that member engagement starts to be a problem because of too much of it, our job will be done
Laurie Edmans, Trinity Mirror Trustees
McPherson: There is no limit, and technology will lead the way in the evolution away from a blunt one-size-fits-all member engagement approach.
Trustees and sponsors now have more sophisticated software available which can break down the member population by demographics and pot size. This can facilitate targeted communication campaigns which can enhance engagement. Members are much more likely to absorb and respond to communications that they feel has been specifically targeted to them.
These technology solutions are likely to bring pensions information together with other financial data (life/health insurance, other savings etc.) to give a more holistic picture for individual financial planning. This, and better availability, could help draw in members who are generally disinterested in pensions until approaching retirement.
All this costs money though. And who is going to pay for it? The member in the end.
Myers: I really think more engagement from members would be a fantastic thing for the industry. At the moment we are in a world where members are defaulted into their pension scheme, into the default investment strategy, at the default contribution rate.
However, when they reach retirement, we expect them to engage and make a highly complex decision about how to take their DC pension pot. We need to educate members in small chunks, at the right time in their lives, to help them make these key decisions.
Byrne: There is a limit to engagement. It is fairly clear from behavioural economics that the key to increasing savings is to use nudges such as automatic enrolment and auto-escalation of contributions to help people save. Engagement can help people understand the reasons for these nudges and to be confident to stick with the programme and not opt out.
Education itself is however unlikely to result in better investment choices, as most people are not well equipped and do not want to make these complex decisions. In investment issues, good, well governed default strategies will be key.
Edmans: I am reminded of an old golf story. Professional golfer Jack Nicklaus was asked, 'How do I learn to stop the ball?' by an amateur. ‘How far are you hitting an 8 iron?' asked Jack. 'About 130 yards' said the amateur. 'Your problem isn't stopping the ball' said Jack.
The day that member engagement starts to be a problem because of too much of it, our job will be done. Once people have a reasonable idea – just a reasonable idea, not expertise – of what matters most, they just about invariably act sensibly. Has anybody actually produced any evidence, rather than hypothesis, to the contrary?
Reeve: There is undoubtedly a limit to engagement and I think there are examples where this is already showing. For example, telling teenagers that they should be saving for retirement is largely counterproductive in that, if they cannot afford to save, it may put them off pensions at an early age.
The need for engagement is often confused with the need for a full understanding of the details. So while I have no idea how my car works, I can drive it and get to my destination.
We need to move from trying to get people to understand the detail of pensions to getting them to look at how they get to their destination. What do they need to do to get to a comfortable retirement? What are the levers they need to pull? They do not need to understand how the lever works. Engagement needs to be outcome driven and easy to use.
Dickson: There are some areas that really do need care when communicating to members, such as levels of contributions needed. A simple, well documented approach is to save half your age into a pension, meaning a 30-year-old should save 15 per cent, which is almost double the planned auto-enrolment default of 8 per cent.
However, try communicating to a 50-year-old they need to save 25 per cent – you do risk putting them off altogether. A better approach may be to suggest members gradually build up the level they save at.
Does auto-enrolment need to be extended?
Chinnery: We need to keep to the plan as there will always be reasons to chop and change. Eight per cent is not going to lead to a sufficient replacement rate, but we need to at least get auto-enrolment to that number first.
My fear is that when people begin to retire and take benefits, the inevitable disappointment at what they get will undermine auto-enrolment forever; I hope I am wrong
John Reeve, Cosan Consulting
McPherson: No. That lemon has been squeezed dry. Anything further would need a mandatory system run through the state.
Myers: Yes, the scope of auto-enrolment needs to be broadened by phasing out the qualifying earnings lower limit and earnings trigger, so ultimately all employees are automatically enrolled and all earnings will qualify for pension contributions.
Also, to ensure members get a retirement that is adequate, contribution rates need to increase significantly.Having said that, we should be proud of what auto-enrolment has achieved now that the gradual roll-out is coming to an end, with all those businesses with pay-as-you-earn schemes that existed before April 2012 now having passed their staging date.
The Pensions Regulator made clear last month that for new businesses which start up from October 1 2017, the employer duty will be instant, meaning that finally, providing pensions for employees is part of 'business as usual' and many millions more will be saving for retirement.
Byrne: Yes, we need to think about how the self-employed and those with multiple jobs that in aggregate exceed the earnings threshold can be included. Both of these groups will benefit from help to save.
We should also consider whether the earnings threshold – which has risen with changes in tax policy – is at the right level. But the principle of not enrolling those on very low earnings, whose contributions would be minimal and who may have better current uses for the money, remains a good one.
Edmans: Extension of coverage or of contribution rates requires looking at peoples' lives holistically, not just through a pensions lens. Most analyses of contribution adequacy look only at resources labelled 'pensions' and, even then fail to acknowledge – for example, in comparisons with Australia – that UK state pensions are not means-tested when others are.
In terms of coverage, extending auto-enrolment to people who are ostensibly self-employed, but are really employees, feels right, but compelling the genuinely self-employed is doubtful.
Reeve: We need to recognise that we live in a political environment where this will only happen if it can be sold to the voters. In the current environment it seems unlikely that voters would welcome an extension of auto-enrolment even with the expectation of 'more tomorrow'. With salary increases limited, people will not welcome a further deduction from their take-home pay.
We need a period for auto-enrolment to settle down and for the planned increases to work through. Once this has happened, and if people can see the benefits, then perhaps they will be better able to accept increases. My fear is that when people begin to retire and take benefits, the inevitable disappointment at what they get will undermine auto-enrolment forever; I hope I am wrong.
