UK DC pensions are too ‘risk averse’, with lifestyling potentially damaging member outcomes, according to a new report.
This study aims to look at how the UK DC market can emulate the success of pensions in Australia. It found that one potential major problem was lifestyling, which it described as a potential “Achilles’ heel” of the industry.
There report Growing Pension Capital – Lessons From Australia was authored by Christopher Mahon, head of dynamic real return at Columbia Threadneedle, with James Vitali of the Policy Exchange. Pension campaigner and former minister Ros Altmann wrote the foreword to the report.
The report points out that lifestyle derisking remans the “accepted orthodoxy” in the UK, despite Pension Freedom scrapping the annuity requirement back in 2015. In contrast other DC pension systems, notably Australia, do not ‘derisk with age’ making the UK something of an outlier.
The report’s analysis says that the cost of this “excessive de-risking” is twofold. For savers it calculates that the average performance drag is 2.3 per cent per year, or around £12,000 to a typical £100,000 pre-retirement pension pot. It says that for every five-year period (2013-2018) has seen lower returns to the de-risked/lifestyled cohorts.
But it also adds that there is a cost to the UK economy. The report says that tackling excessive derisking could deliver a £10 billion-£25 billion boost to UK capital markets and investment. It says this de-risking contributes to the outflows and related decline of UK financial markets, and the lack of capital to support domestic growth.
Mahon says: “The report highlights the steps the UK will need to take for DC to emulate the success of Australian superannuation.
“One key observation was that the UK DC system is too risk adverse, a hangover from the ‘safety first’ approach of the DB system. By contrast, Australia adopts a more proportionate approach to both risk and return. The embrace – and overreach – of lifestyling and the resultant de-risking exemplifies the risk aversion within the UK DC system.
“In the days of compulsory annuity purchases, derisking and lifestyling had some logic. But with Pension Freedom the approach looks increasingly misplaced. UK trustees and regulators should consider diluting or scrapping lifestyling and replacing the default requirements with something closer to the Australian model of staying invested for longer.
“For this change, trustees and regulators can take comfort from Australia as a best-in-class DC system that does not cut equity allocations as savers age. Superannuation was created without the ‘safety first’ influence of DB. It has a more outcome-orientated culture that UK regulators have started, at long last, to emulate.”
He adds: “It is time to encourage regulators, trustees and all involved in the DC system to take a more proportionate view of risk and return. There is an opportunity to create a virtuous circle. More savings means more economic robustness, more capital for economic investment and all underpinned by better investment outcomes for savers.”