UK: The promise of the future
The regulator, associations and funds themselves are increasingly grappling with the issue of defined contribution pensions, writes Nina Röhrbein
Within the private sector, defined contribution (DC) schemes are now the norm in the UK and only a handful of defined benefit (DB) schemes remain open to new hires. The Towers Watson 2010 survey of FTSE 100 DC schemes showed that 48% of FTSE 100 employees are in DC schemes against 34% in DB, and 18% non-joiners.
The first move in the DC industry was a transitional move from DB to DC with many companies setting up a separate section of their DC scheme within the same trust. The secondary movement within DC has been about switching from a trust-based environment - which is bound by certain rules and regulations - to a contract-based bundled approach with a mainstream pension provider.
"The contract-based approach provides more efficiency from the sponsoring cost perspective - although many contract-based schemes have set up their own governance committee - and arguably it also enhances the overall member experience so in many cases it can be a win-win," says Lee Hollingworth, head of DC consulting at Hymans Robertson. "Smaller employers were first to move from trust to contract schemes but over the last 12 months we have seen significant DC schemes - such as the BT scheme - move to the contract-based approach and we would see that trend continuing."
There have been two main trends in DC in recent years: contributions have gradually been increasing and there has been an increasing focus on DC governance.
"The average employer contribution rose from 6.8% in 2007 to 7.25% in 2009 while the average individual contribution increased from 3.6% to over 4.5%," says Steve Charlton, principal at Mercer. "This increase is driven by DB schemes that have closed and members that are migrating from DB to DC probably getting a larger DC contribution than those that may only ever been offered a DC scheme in the past."
"The increase in governance has manifested itself in major improvements in communicating with members, demand for better administration and in innovative investment solutions," adds Will Aitken, senior consultant at Towers Watson.
Consolidation - between group pension (GPP) and stakeholder plans and occupational DC schemes that are bundled into a buy-out - is another big issue in the UK DC market.
As of today, lifestyle funds - which switch people from growth funds into more defensive, bond and cash funds as they get closer to retirement - dominate the UK DC landscape. Target date funds exist but are less popular. "However, with the National Employment
Savings Trust (NEST) schemes likely to come out with target date funds, they will certainly be part of the consideration for any pension fund in the UK going forward," says Emma Douglas, head of UK DC sales and communications at BlackRock.
The biggest problem facing UK DC schemes is low contribution rates.
"As it stands DC is destined to fail," says Hollingworth. "It is destined to fail because individuals join DC often with very little thought to their investment choice and the contribution levels they pay. Therefore many DC scheme members are sleepwalking to an unsatisfactory position at retirement age. Individuals who cannot afford to pay a certain level of contribution to get to their target have to accept that they need to take more risk in their investment."
Many employees are happily taking a shorter term view and trade pension contributions for additional taxed salary. But this is a societal problem, according to Aitken, which to some extent is being addressed by the Pensions Act and auto-enrolment.
Around 90% of members opt for the default fund option where available irrespective of the type of DC fund, according to a Mercer survey. This suggests that trustees, providers and sponsors should be spending far more time looking at the constitution of a default fund, which often has a high degree of volatility attached to it, and perhaps some of the others, says Charlton.
The concept of a guarantee in a DC scheme - as often seen in mainland Europe - would be appreciated by members because employees tend to think of pensions more like savings than investments. "However, a guarantee is probably only useful as members approach retirement because the cost and the administrative complexity of providing a guarantee during the whole of the members' working life is probably a bridge too far," says Douglas.
"We see little or no appetite from employers for guarantees at scheme level, so we are talking about guarantees from investment products only," says Aitken. "It is worth remembering that there are already products that offer minimum guarantees in the UK - many with-profits funds operate in this way, and that market has gone from the mainstay of DC provision to a marginal legacy issue in little more than a decade.
"The recent economic downturn has reignited some appetite for guarantees. CPPI products are being developed in response and are gradually making their way to market. But it remains to be seen whether members - or fiduciaries - will be prepared to sacrifice upside for the sake of protecting downside."