In the latest edition of Informed Comment, State Street's Nigel Aston looks overseas for clues on how employers and schemes offering defined contribution benefits can improve their provision.
As government, schemes and the industry seek ways to help members be better financially prepared for life after work, measures to increase savings and develop smarter investment default choices are essential starting points.
We do not need to completely reinvent the wheel – we can look to developments in other mature DC markets for inspiration.
To fulfil the potential of the new DC pensions regime, we do not just need members in the schemes, we need them to save more once they are in.
The question is, do we leave this entirely in the hands of members, or are there active ways regulators and employers can influence a move to higher contribution rates and get the savings path onto a better trajectory?
Looking to mature markets
In Australia, minimum contributions were originally set by legislators at 3 per cent of employees' income in 1992, but this has been gradually increased to 9.25 per cent at July 1 2013.
One advantage of being relatively new to the world of DC is that we can pick and choose the best ideas of other markets
Further increments will be applied over coming years, when the superannuation guarantee rate will be set at 12 per cent from 2020.
Given that Australia operates a compulsory DC system, strategies like these can be adopted without the risk of members opting out altogether.
However, even in an essentially voluntary membership environment like the UK, there are still options.
Auto-escalation of contribution levels, a feature of some US DC plans, is designed to push employee contributions beyond the initial minimum as their income increases.
Such nudges appear to be necessary in voluntary schemes, and data even show that members welcome them.
In our 2012 DC survey, 71 per cent of US respondents wanted their employer to increase their savings rate by 1 per cent a year.
And 39 per cent said they would like their employer to auto-enrol them with high enough savings rate so that “I don’t need to think about it”.
Savings are just one part of the equation. How those savings are managed is also crucial and it is here we can see some overseas trends beginning to catch on in the UK.
Improving the default
The Department for Work and Pensions has calculated that up to 90 per cent of employees enter their plan’s default fund when joining a workplace scheme.
That makes for a powerful incentive to ensure default fund investment solutions are intelligently designed to meet the needs of a broad member base.
Increasingly, lifestyle and target date funds are becoming the defaults of choice. While still relatively new in the UK, TDFs appear set to play a significant role in the quest for a stronger default.
The US experience is compelling: 81 per cent of DC plan sponsors offer TDFs and 78 per cent use them as the default.
Why have these solutions proven so popular in markets like the US and how does that relate to the UK experience? Schemes are increasingly recognising that default fund design needs to be more multi-dimensional than has perhaps been considered in the past.
This is because the key investment risks members face in relation to their retirement savings – shortfall, longevity, volatility, conversion and inflation risks – have also proven to be multi-layered.
TDFs aim to address this by constructing asset classes and intelligent allocation to reflect the behavioural characteristics and risk tolerances of members within given age groups. They can adapt the portfolio over time to take new information into account.
While the UK DC sector continues to evolve and implement best practice within the constraints of our own system, overseas experience can be a useful reference point.
One advantage for the UK of being relatively new to the world of DC is that we can pick and choose the best features or ideas of other markets and adapt them for our own.
Nigel Aston is head of UK DC at State Street Global Advisors
