Following recent changes in regulation, now is the time for schemes to focus on improving outcomes for members, says John Foster
At a glance
• Although most UK defined contribution schemes say they desire better outcomes, relatively few monitor their targets.
• Outcomes should be considered against the individual needs of each scheme.
• Ultimately meeting the objective means finding the right operating model.
Aon’s DC Survey 2015 found the apparent contradiction that 57% of UK schemes had better member outcomes as an objective in their business plan, but only 16% received regular management information to help them monitor this objective. With all the regulatory changes of the past 18 months, defined contribution (DC) pension schemes have had a lot to cover in a short time. But there is now an opportunity to focus DC scheme planning on improving those member outcomes.
However, without having some kind of baseline, how can the measurement of outcomes be gauged? This may sound obvious but in our survey, 68% of respondents did not know what the replacement ratio (that is the ratio of retirement income as a proportion of pre-retirement earnings) was for a member who stayed with their scheme for their whole career.
The chair’s statement, required for all schemes offering DC benefits, is a great opportunity to take stock before pushing on with the journey towards better member outcomes. (There is a chair’s statement exemption for defined benefit (DB) only schemes that offer DC additional voluntary contributions). While there are specific areas identified in the chair’s statement that schemes must consider (see Framework for chair’s statement), schemes can turn this from compliance into something that adds value if they think a bit more broadly (see Exceeding the chair’s statement to give the process increased value). Last year’s draft DC code of conduct from The Pensions Regulator also supports this wider view – although we await the guidance supporting the code.
1. Framework for chair’s statement
• Governance of the default:
– Understand membership;
– Document aims and objectives of default in Statement of Investment Principles;
– Review performance.
• Monitoring administration of core financial transactions:
– Investment of contributions;
– Transfers between asset classes;
– Transfers out of the scheme.
• Charges and transaction costs:
– Understand structure of scheme charges and decide what data to collect;
– Collect information, for example on total expense ratio, transaction costs, any other charges paid by members;
– Decide whether information that cannot be collected this year should be sought in a future year and how;
– Assess the extent to which these member charges represent value for members.
• Trustee knowledge and understanding:
– How trustees are meeting the trustee knowledge and understanding requirements;
– How this enables them to properly exercise their functions as trustees.
Consider specific membership: the outcomes will be different for a member who has legacy DB benefits, compared with one who has had DC for their whole career. It will be different again for those who have only just started saving under auto-enrolment. It takes some effort to understand what members have accrued so far, how much they are contributing, where they are invested and what they might expect to receive in the future. But progress achieved can be compared against what members need. By way of reference, our 2014 research with Cass Business School showed that DC members expected, once retired, to receive about one-third of their pre-retirement salary from their DC pension.
Our survey confirmed that respondents saw employers (77%) and trustees (59%) as key sources of communication, education and support for members.
The key questions for members included:
• How much should I save?
• What can I afford to save?
• How does the tax work? (especially for high earners)
• How should I invest my pension fund?
• How do I decide when I can afford to retire?
• What decisions do I need to make at retirement?
• Do I continue to make decisions during retirement?
As the needs of members vary at different stages of their lives, so should the focus of communications.
Pension schemes need to get investment structures right for members, whether or not they are willing to engage on investment strategy. First, schemes should get the investment default right. More broadly, schemes may also consider providing alternative strategies that target different benefits at retirement, as well as self-select options that give choice but are not overwhelming.
2. Exceeding the chair’s statement to give the process increased value
• Understand the membership more widely than just considering the default.
• Monitor all administration – not just financial – because if members find things difficult, they will do less.
• Assess overall value not just value for members. Just because the company pays for services rather than the member, it may not necessarily make them efficient or effective.
• Decide what you are going to do next. What would success look like in a future annual chair’s statement?
Schemes need to consider how to support members’ access to the new flexible options. This includes a decision on what a scheme wants responsibility for. Our survey shows that about 30% are allowing members to draw down one or more cash lump sums – known as Uncrystallised Funds Pension Lump Sums.
Where members want income drawdown in retirement it is often impractical for the scheme to provide this. But schemes can use a preferred drawdown provider (where preferential terms have been negotiated, and/or there are some easy transition arrangements in place) as long as it is made clear to members that this is only one option and others are available from the open market. Some 43% of respondents either have this type of arrangement or are developing one. On both these points, there is likely to be pressure on the rest to reconsider their position.
About one-third of respondents felt comfortable that they had enough time to spend on DC matters, with larger schemes having generally better resources. These schemes need to embrace the challenge of improving member outcomes.
However, for the two-thirds of respondents that felt they were not spending enough time on DC, there is the need to consider how to focus their governance time, or whether there are aspects they could more effectively outsource to specialists, or whether to shift responsibilities into a master trust or a group personal pension.
Ultimately, the objective to improve member outcomes is about finding the operating model that makes the most effective use of resources. This should optimise the balance between in-scheme and third-party involvement in design, governance and investment options, and provide focused and engaging support for members.
John Foster is principal consultant and defined contribution specialist at Aon
UK Defined Contribution: Mastering the master trusts
- Currently reading
Member Outcomes: Time to get it right