GLOBAL - Improvements could be made to lifecycle strategies within defined contribution pensions if trustees were to base their default designs more on the needs of "guided-selector" members who might already engage in decision-making, suggests research conducted by consulting firm Watson Wyatt.
A review of lifecycle strategies by the company's Thinking Ahead Group found lifecycle strategies are "still sound" for the needs of DC pension scheme members are recognised to provide an appropriate balance of risk and return - as intended - rather than judged to be designed as achieving "the maximum possible savings growth for an individual".
Watson Wyatt's analysis noted 91% of DC schemes use a lifecycle strategy as their default, at least according to a survey of FTSE 100 DC pension schemes conducted earlier this year.
That said, the study also found all schemes would benefit from improved member communication and a shift in focus to what officials say is a better understanding of ‘Group 2' members - know as "guided-selectors" - rather than the general practice of looking either at ‘Group 1' or "true-defaulters", who tend to be "entirely disengaged" with pension savings or ‘Group 3' - the "self-selectors" - who are motivated and financially literate enough to take appropriate investment decisions.
The ‘guided-selectors' generally respond well to improved engagement, said Watson Wyatt, so by designing a default and a flexible framework which contains "a number of carefully selected and communicated possible modifications which the member could choose", it might be possible to make the most of the member's own limited financial knowledge without overloading them with information.
"This group of members would benefit from better DC design which enables them to consider their own circumstances more when structuring their DC assets," said the report.
Elsewhere, TAG stated: "Fiduciaries could provide a framework for members to be able to tailor the default slightly to allow for personal circumstances and beliefs" the TAG paper suggested.
"While lifecycle is often thought of as a ‘set and forget' approach, modifications are likely to be valuable if the outcomes along the journey differ significantly for that expected."
Trustees and DC plan managers should of course make sure they fully understand who their members are and their limits in any design, said the Group, but could achieve this by looking at:
The level of expected return required over the member's life until retirement to achieve their realistic target retirement outcome;
The variability which can realistically be accepted in that return, and what the variability would therefore be on that target, and
The level of year-on-year volatility in the DC account value the member is realistically prepared to accept throughout their investment.
"Understanding the profile of a typical member of the plan is an important factor for fiduciaries to consider when designing and measuring the effectiveness of both the default strategy and additional funds and the tools they provide to the more financially literate members," said TAG.
This latest research is published just a day after both Ros Altmann and Watson Wyatt agreed more must be done to improve communications to members about the investment potential ahd limits of DC pensions. (See earlier IPE story: Pensions insurance might work long-term - advisers)
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