Maggie Williams (MW) interviews Sophia Singleton (SS), head of defined contribution consulting at Aon, about the consultancy’s latest pensions survey
(MW) In your survey 57% of respondents said that member outcomes, and their link with the default fund, were a priority for pension schemes. Given the recent changes how are they defining member outcomes – and crucially, how is that then feeding back into their default options?
(SS) Not everyone has really thought about member outcomes in the DC context. The survey showed that better member outcomes was a core objective – but only 16% monitor them or get any information about them.
In terms of defining a member outcome, at the most basic level I see this as the replacement ratio [the proportion of their salary] they can get from their scheme.
When we think about that in the context of the default fund and investments, that becomes more than just the return – it’s also about the risk members are facing at each point in their membership, and having a risk budget at each point.
You can then make that journey smooth and at different points in time you have different elements of risk in the cycle.
We’ve mentioned ‘replacement ratios’, but the Aon survey shows that two-thirds of schemes have no idea what the replacement ratio of their scheme would be for someone who had worked for their company all their lives.
(MW) Given that people now have multiple jobs, does that really matter?
(SS) A lot of schemes and employers say ‘we only have our members here for a few years, is it our responsibility to deliver a good outcome?’
But for members it is about their whole career – we need to start looking at pension savings as a whole, even if a particular employer is only responsible for a small part of it.
It’s difficult to make assumptions about the past, but you have to assume that an employee will stay with you for the whole of the future. You need to look at the long term and what the replacement ratio would be if they were to stay with you for their whole career, rather than using the excuse that it’s someone else’s problem. The savings elements won’t add up otherwise.
Trustees and providers can only deliver the best outcome within the contribution structure of their scheme – typically they don’t have power over that contribution structure. However, understanding what your scheme can deliver to a typical member is really important.
(MW) A scheme or employer’s willingness to understand risk appetite and focus on member outcomes can only be as good as the products that are in the market to support them. What trends are you seeing there?
(SS) The good news is that there is a lot more sophistication coming into DC pension strategies. I don’t think that they need to involve a huge amount of extra cost – we are seeing a lot more diversification within passive investment (i.e. investment in funds that track an index, such as the FTSE 100) and more low-cost, multi-asset funds becoming available.
That is good and gives more choice, but it’s important for trustees or others running schemes to understand what’s inside those funds and whether they are offering good value for the extra costs.
(MW) Every single member of a pension scheme will be different in terms of their aspirations, their attitude towards pension savings and their level of engagement with the scheme. How can a scheme hope to address all of those different approaches in a single strategy?
(SS) We see members in three broad categories. The largest is a ‘do it for me’ approach that is typically upwards of 80% of the membership. The best thing a scheme can do for those members is build a good default fund.
The second group is ‘I can do it’. These members typically want to make some choice, but in a guided way with funds that are clearly described and relatively easy to understand.
A third, much smaller group can be described as ‘I want full control’ – they have the time and the willingness to manage their own investments, but this is where we have seen a real disconnect between group personal pensions (GPPS) and trust-based DC schemes.
Typically, GPPs will offer 20-plus self-select funds, but trust based schemes often offer between six and 10. Our research has shown that to offer the ‘I want full control’ members what they want, you need 10 to 12 funds, based on particular asset classes and a few special ideas.
My view in terms of communicating is that the default fund is the right place for almost everyone. We’ve seen statistics from the US showing that people who self-select their funds tend to do around 3.3% per annum worse than those in a managed or advised fund, such as the default.
(MW) What about the ‘freedom and choice’ changes? What effect are these having?
(SS) At-retirement is one of the biggest challenges schemes have at the moment, and even the Pensions Regulator’s new DC code of practice doesn’t really address this.
What should schemes and trustees do? Should they be trying to offer flexibilities [such as income drawdown] within the scheme or not? What is best practice in this respect? This is a really big area of uncertainty.
Currently people aren’t forced to go out to the market and compare drawdown providers in the same way as they have been with annuities. The drawdown market is a pretty scary place at present – but people don’t want to take advice either. To address this around 40% of schemes now have a preferred provider, or are putting one in place.
That’s important, otherwise members are going out to the open market on their own, unadvised. There is a gap at the moment in terms of supporting trustees and schemes in how to identify that preferred provider.
From a member point of view, technology will play a huge part in freedom and choice. Members may not engage with their pensions, but if you can bring all of their financial awareness together and start looking at it in one place, that can really get people thinking.