News analysis: Focus on the design of default funds has sharpened following government and industry plans to explore new minimum standards, but the process presents challenges, industry experts have said.
The National Association of Pension Funds' Pension Quality Mark announced this week that it wants to add default fund standards to the requirements that applicants and existing holders of the badge have to meet.
Determining a good default
Questions to ask your workforce:
How are their future careers likely to look?
Might they have gaps in employment?
Can they afford to increase contributions if things don’t turn out as planned?
How much of their expected pension might they get from the state?
How much risk can they afford to take?
In July, the government issued a call for evidence on the investment and default options to ensure schemes meet quality benchmarks, given the majority of members are expected to use the default option following auto-enrolment.
Will Aitken, senior consultant at Towers Watson, said a good default requires employers and schemes to focus closely on the ‘defaulting population’ and what their future careers are likely to look like.
“All of these questions [see box] and others need to be answered for the population identified as likely defaulters,” said Aitken. It can be a struggle to put an effective option in place if these areas are not covered, he added.
The answers can lead employers in very different directions, for instance someone receiving high employer contributions might be able to take less investment risk than might be the case if contributions were lower, he said.
Investment process
A diversification approach that takes into account both short-term and long-term objectives could be an effective way of managing a default, according to Stephen Budge, head of DC investment at consultancy KPMG.
“So, we really take the three to five-year investment horizon approach, your market cycle period, and look at the risks at that point,” he said.
The way investments strategies are communicated is also a key part of the process. “This means setting out your investment beliefs and setting out what you believe is appropriate for your membership, and then using that to create your strategy, but allowing for choice in those strategies," Budge added.
Members in a default expect “someone on their side”, with good governance playing a crucial role in this, said Tim Banks, head of DC sales and client relations at AllianceBernstein.
“Good governance around the investment default plays a critical role in evaluating what ‘good’ looks like, in a market where collective buying decisions are made by the few for the many,” he added.
Recent research by the Pensions Regulator showed schemes that offered only one fund had continued to fall, with fewer than one in five schemes now offering a single fund.
While some choice is good for those who wish to be proactive about their investments, providing too much choice would be overwhelming for many people, said Aitken.
“Defaulting is normal, and in a confusing market like pensions, frankly, it’s an entirely sensible and rational approach for many members to take. That in turn increases the need for the default to be specific for the population,” he added.
