DC Debate Q4: Mastertrusts, AE and more

What should employers consider when comparing different mastertrusts?

Laura Myers: With nearly a hundred different options in the UK market, choosing a mastertrust is not straightforward. If you have decided that a mastertrust solution is right, the three key things to think about are, first, commitment to market: regulators have said there are too many mastertrusts in the UK, so you need to ensure the one you pick is here for the long term.

Second, look at the investment strategy: contributions and the investment strategy will determine if members can afford to retire. I often see people focus on returns, but the level of risk in the strategy will be key if we head into a recession.

I often see people focus on returns, but the level of risk in the strategy will be key if we head into a recession

Laura Myers, LCP

Finally, consider member experience: communications and administrative strength will be key to ensure your pension offering is seen in a good light by employees – particularly as pension contributions form a large component of the overall benefit spend.

John Reeve: In assessing the mastertrust that best suits the needs of an employer and their members, the employer should first assess what it is trying to achieve. Some will merely be looking to meet their regulatory responsibilities under auto-enrolment. Others might be looking to offer their employees the best possible vehicle and the best possible tools to help them avoid poverty in retirement.

Once the aim is clear one can start to consider which mastertrusts meet these needs. In doing this it is important to see beyond the sales spin and understand the strategy and business model of the provider. Those that have a mastertrust just to protect or grow funds under management may not have the same focus on the member as those with a retail or member-centric strategy.

Helen Ball: Employers have considerable choice at the moment, but should be careful to select a provider that they consider to be financially secure, who they believe will be in the market for the long haul, in some shape or form.

Once the Pensions Regulator’s new authorisation regime comes into force in autumn 2018, this aspect of an employer’s due diligence will be taken care of for them. In the meantime, they should look at the regulator’s website for the latest guidance and consider factors such as:

• Whether the proposed mastertrust will accept all of the employees it needs to enrol (particularly if it is to be used as an auto-enrolment vehicle);

• Whether a mastertrust’s processes are compatible with the employer’s payroll software;

• Any costs and charges payable by both employers and staff;

• The mastertrust’s investment options, especially the default strategy, and whether their objectives and performance will match member expectations;

• The level of support and choice given around retirement options;

• What add-on services a scheme provides and the likelihood that these will be valued by its staff;

• Whether the mastertrust communicates with its members regularly, the format of the communications, and whether messages are easy to understand.

Maiyuresh Rajah: Governance is one of the most important things to consider when selecting a mastertrust. Employers need to ensure that the mastertrust they choose has a robust, transparent and clearly documented governance framework in place.

The governance framework should include ongoing monitoring of the administration services and the investment options available in the mastertrust, particularly the default investment strategy, which needs to be able to adapt quickly to changes in the investment markets, legislation and member behaviour.

The employer also needs to focus on how members’ assets are protected by the mastertrust in the event an investment manager or the provider itself fails. The mastertrust should also have effective communication packages to help members engage with their pension.

Simon Chinnery: With the regulator’s laser-focus on the sprawl of mastertrusts, it is a given that many will not be around in the years to come. The first rule is therefore to select one that has long-term commitment to this market and has the credentials to prove it.

Operational factors are also important considerations, including cost transparency and flexibility. Communications and engagement with members via innovative use of technology are signs of quality, but most importantly, employers need to look for robust, independent and transparent governance.

After auto-enrolment, should the next step be compulsion?

After auto-enrolment, should the next step be compulsion?

Myers: In the UK it would be politically difficult to take away the basic choice of how, and if, to save for retirement, especially as, unfortunately, pensions are not trusted by larger parts of the population. However, auto-enrolment in its current form is not enough. We have a crisis on our hands where millions of people will be going into retirement without saving enough for their pension.

We urgently need to address the key pitfalls of auto-enrolment. Significant sections of society are not included, such as the self-employed or those on modest incomes that have multiple jobs. And we urgently need to have a plan to increase the 8 per cent contribution level in the future – as we all know it is simply not enough.

Reeve: No. Compulsion will lead to a continuation of the low rates of contribution and low engagement from members.

Politically, compulsion would have to be at a very low level. Such low level of contributions lulls members into a false sense of security. Compulsion also allows members to abdicate the responsibility for their savings more easily.

A better approach is to use behavioural finance and better communication to help members make informed decisions or to push those less willing or able to engage into beneficial behaviours. Pensions are not right for everyone, despite what the industry will try to tell us, and the use of artificial intelligence, data and intelligent communications should be available to help members use their money in a way that best suits their circumstances.

Sophia Singleton: Compulsion is one way to ensure that everyone is saving towards their retirement. However, it is also important to consider the rate at which people are saving. The average 25-year old male should be saving 18 per cent of salary to maintain his standard of living in retirement. Under current auto-enrolment regulations, people are still not saving enough.

One of the key challenges of introducing higher savings rates is that some people may not be able to afford these contributions. One way around this scenario could be to introduce auto-escalation, where contributions are increased when set milestones are reached.

Financial education from a young age about the importance of pensions could also assist in delivering a successful strategy.

The issue is now not one of coverage but adequacy – minimum contribution rates are not high enough to provide the vast majority of savers with an adequate retirement pot

Maiyuresh Rajah State Street Global Advisors

Ball: A move to compulsion would represent a sea-change in government policy. The concept behind auto-enrolment is nudge theory, which sits alongside the move towards better financial education and guidance.

The idea is that we should encourage the current and future generations to understand the importance of long-term savings, get them into schemes and hope they stay there and contribute as much as they can afford.

For that reason, we are currently following a path that focuses on a staged increase in minimum contributions and changes to the eligibility requirements to bring more people within scope. Whether this works in practice will only be clearer over time.

The increase to auto-enrolment contributions next April will be the first real test of this policy – if many more members opt out, then it may give some cause for a rethink.

Rajah: Auto-enrolment in the UK has been a success so far with opt-out rates at about 10 per cent and an additional 8m people now saving for their retirement. The issue is now not one of coverage but adequacy – minimum contribution rates are 

currently not high enough to provide the vast majority of savers with an adequate retirement pot.

We should focus on implementing the planned rise in contributions to 8 per cent and then further escalation to a level – say 10 per cent or 12 per cent – that will give the average earner a reasonable replacement rate in conjunction with the state pension.

Chinnery: Hold fire would be my suggestion. Auto-enrolment has been a success story to date. Workplace membership from private medium-to-large firms has increased from around 50 per cent to 85-90 per cent in 2015 and will have increased further with the inclusion of small firms and micro employers, with auto-enrolment awareness among employees consistently above 80 per cent.

Of course there are challenges; insufficient levels of savings, stagnant wage growth, increasing demands on savers’ income and a perception of pensions as a cost rather than a benefit, as well as increased employee contribution levels in the next two years.

Evidence to date suggests inertia remains a powerfully benign force. When we do get to 8 per cent combined contribution, we may well have agreed on strategies such as auto-escalation to get us to a more realistic replacement level.

What can we learn for DC from experience elsewhere in the world?

Myers: In many other countries, such as Australia and the Netherlands, there is already much more scale in DC pension provision, which is benefiting members in comparison with the UK. An area this really impacts is administration and investment costs. Because of the volume of assets in the schemes in these countries, they are able to constantly reduce fee levels.

The DC pension landscape in the UK is consolidating, supported by the Pensions Regulator’s focus on small DC schemes, and this could be beneficial to many members. Increased scale would also open up more asset classes for DC schemes to invest in and, therefore, offer members access to different return drivers, like the illiquidity premium. This is something we are beginning to see in the UK.

Reeve: I would suggest that we can learn three key lessons: starting low and gradually increasing levels of contributions under auto-enrolment type vehicles works. Voters will accept this.

Pensions are not right for everyone, despite what the industry will try to tell us

John Reeve, Cosan Consulting

The second lesson is, scandals and bad press kills the good work instantly. Any suggestion of excessive charges and funds being used inappropriately will stop saving quickly and undo the good work of many years.

Third, the question of compulsory annuitisation will come up on a regular basis and will need to be reconsidered every time.

Singleton: Members agree to contribute more via auto-escalation when set ages or milestones are reached. This has proved to be successful; it is estimated that 47 per cent of employees with auto-escalating DC plans will retire with enough assets to cover their projected needs, compared with only 22 per cent of the full career-contributing members overall.

The retirement income system needs to be right to improve outcomes for retirees. In particular, the Australian government is looking at ways to manage longevity risks better so that individuals can improve their standard of living by feeling more comfortable to draw higher incomes without increasing their risk of outliving their retirement savings.

Ball: In New Zealand, respondents to a survey related their non-membership of KiwiSaver to uncertainty about the scheme structure and a belief that further changes were likely in the future, according to the Pensions Policy Institute.

The PPI explains that this was in the context of default contribution levels having changed twice since KiwiSaver was introduced, along with other changes being made to the wider scheme.

The PPI concluded that this is a lesson for the UK in relation to auto-enrolment. We should avoid making too many changes too quickly.

In a similar vein, the constant changes to the pensions infrastructure and tax system seem to have deterred saving in general, something auto-enrolment alone cannot remedy.

On a more positive note, another PPI report indicates that we should adopt a more holistic approach to saving, taking every chance to educate people about financial wellbeing. With DC, the amount that is invested and the time over which contributions are made are crucial. We need people to be aware of this as early as possible and to treat their employment savings in the same way that they would the purchase of a new house or a car.  

Rajah: While the UK has introduced freedom and choice for its retirees, some of the other more mature DC markets are heading the other way. Both the US and Australia are looking at whether they should encourage retirees to purchase annuities.

Giving members choice as to what they do with their retirement pots is positive so they can align how they take out their money with their lifestyle needs.

However, we do need to help them make the right choices so they do not run out of money in retirement or conversely spend too frugally and leave a large pot behind. This creates a role for hybrid products that combine flexible drawdown with secure annuity-based income – something that is being developed in the US and in due course could be valuable here.

Chinnery: Each market is different and there is no long-term saving silver bullet. The challenges of accumulation in the workplace and drawdown in retirement are different, but to-and-through designs have some benefits. Contribution levels vary (Australia 9.5 per cent rising to 12 per cent by 2025, Netherlands 16 per cent, Denmark 12 per cent, Singapore 15 per cent) as do replacement levels.

Providing freedom and choice to the masses – many of whom are ill-equipped to make complex financial decisions and manage their money – is a huge intergenerational challenge, but so is compulsion in the workplace and then freedom in retirement. DC is still relatively young; we are all learning and evolving. Communication and simplicity are the elusive keys.

Click here to read part 1 on which investment vehicles work for DC