Encouraging employees to save for their retirement remains a holy grail of the pensions industry and practitioners are increasingly looking to behavioural finance techniques to improve employee take-up of defined contribution arrangements.
There is a wealth of evidence to support the view that staff who value their benefits packages tend to be happier, harder working and more loyal to their employers.
But a significant proportion of workers remain blinkered to the fact that they are turning down ‘free money’ by failing to participate.
Behavioural finance research has identified a number of often irrational types of behaviour that affect people’s decision-making and many advisers and providers are looking at ways of harnessing these in order to better get their message across.
Simon Tyler, senior associate at Pinsent Mason says two of the most powerful behavioural types inhibiting sound financial decision-making centre upon the way in which information is presented to the decision-maker and the inertia that leads many people to believe it is easier to do nothing and maintain the status quo than to act.
Research shows that face-to-face consultations with staff consistently provide the best results (see box 1). At personal consultations the information can be presented in such a way as to convince the majority of the logic behind joining the scheme.
Where this is not available, whether through a lack of funding or impracticality, such as for disparately located workforces, the corporate adviser has to look at alternative methods.
Tyler says that in these cases apathy or inertia is the main barrier to overcome and the most effective way to achieve this is through adopting a paternalistic approach, such as auto-enrolment.
“Automatic enrolment works. It overcomes the psychological barriers members may have about joining a DC scheme. And inertia stops members opting out once they’re in a scheme,” he says. “The Government supports automatic enrolment, as shown by its successful lobbying of the European Commission. The Government now has the green light to allow companies to enrol their employees into contract-based DC schemes automatically. The Government will take advantage of this from 2012 to tie in with the introduction of personal accounts.”
“The danger of auto-enrolment into DC schemes is that members assume that the default investment option is the recommended option. This may put members off actively deciding what investment option is best for them.
Information about the risk profiles of the different funds available helps members narrow down the range of funds that may be appropriate for them,” Tyler says.
The growing imminence of the personal accounts regime, due in 2012, and the fact that companies have now been cleared to build auto-enrolment into their occupational arrangements is already starting to influence corporate behaviour.
Julian Webb, head of DC business development at Fidelity, believes that positive paternalism is the only way to overcome inertia to the extent that schemes have 90 per cent plus take-up rates and many clients are starting to take this on board.
“All employers will have to deal with auto-enrolment from 2012 whether they opt for personal accounts or not,” he says. “A number of our clients are already starting to auto-enrol staff and we have seen an increase in interest from others, with many asking us about how it operates.”
Around half of Fidelity’s new DC clients are now adopting some form of auto-enrolment, Webb adds.
Many firms are not yet geared up to support full auto-enrolment and for many of these a streamlined application process can provide a valuable halfway-house. It can be seen as a form of soft paternalism and while it typically does increase employee take-up, it will not improve it to the extent that it creates a massive payment shock to the sponsoring employer ahead of personal accounts.
Jarrod Parker, technical and product development manager at Alexander Forbes Financial Services, says his firm mainly provides this service to employers that cannot provide face-to-face advice for logistical reasons.
He says instead of the usual lengthy application process, the form is condensed down into a single page.
“We prefer to do group presentations and follow these up with individual sessions but where this is not possible, the streamlined application process is the next best thing,” he says.
“It focuses employee’s attention and although you do have to give them the option of not joining by streamline, it does help increase take-up and is growing in popularity.”
The streamlined application process is enhanced if the forms are pre-populated and so only need a signature, says Michelle Cracknell, strategy director at Skandia.
She points out that if employees have to go away and track down their national insurance numbers and other personal details, the likelihood is that the form will disappear into their in-trays indefinitely as inertia takes over.
“The sooner you give the application form to the employee the better. Ideally, you give it out along with the bevy of other paperwork when the person joins the company because it is much more likely to happen in the first week than six months down the line,” she says.
Encouraging new employees to join the company pension scheme when they start out in their role is of course standard practice but advisers are encouraging clients’ human resources departments to better integrate this into their initiation procedures.
“It is important that HR departments are more pro-active if they want to increase employee take-up,” Parker says. “We are encouraging clients to make it part of the induction process.”
He says the use of DVDs can be a good way of bringing the issue to life and these can be tailored to effectively target new recruits of different age groups.
Cracknell also advocates a carrot and stick approach whereby the HR department reaches out each year to staff that have not joined the scheme and re-presents to them.
She also suggests adopting a ‘tough love’ approach, highlighting how much money the employee has passed on by not joining.
“The company can also say that it will only make contributions once the member completes the application process and do not backdate the payments,” Cracknell adds.
If getting employers to sign up to a company pension scheme is seen as the war, getting individuals to become active members is certainly the battle (see box 2). It is oft-reported that 85 per cent or more of scheme members remain in the default fund and opt to continue paying the default level of contributions.
Tyler says evidence from the US suggests that auto-enrolment does not improve this with employees effectively assuming that the default options are the recommended ones by their very nature.
He says one way round member inertia to increasing contributions could be the ‘Save More Tomorrow’ plan, a behavioural economics program developed in the US. Under the arrangement, new members agree to their contributions being automatically increased as their salary rises.
Webb says that Fidelity has found only around 10 per cent of US clients have adopted this approach, however. It is still very much in its infancy in the UK and some employers could struggle to administer it.
There is also the risk that this level of commitment could scare new members away from the scheme, Parker warns. “People may be happy to make a 4 per cent contribution in the first year but if that goes up to 5 per cent the next year and so on, there is a risk that individuals could be priced out of joining the scheme at all,” he says.
This is particularly true of younger recruits, such as graduates, who are often better off making minimum contributions while paying off their student debts, Parker adds.
As a base level, contributions should be quoted as a percentage of salary rather than cash amounts, he says, which will ensure at least a minimum ‘indexation’ of contributions.
Attempting to engage members about their investment choices can be even more difficult where there is no individual advice. Too much choice can again encourage apathy by inhibiting decision-making but opting for the default fund can be a potentially damagingly conservative choice for some members, Tyler warns.
Webb also favours companies using benchmarks that employees will understand when presenting funds, such as cash plus, rather than index they most likely have never heard of.
This is easier with some funds than others but should be considered as part of an effective communications programme devised to challenge most investors’ at times unduly cautious nature.
Tyler says that if there was an easy answer to DC retirement planning then lottery ticket sales would dry up. There are certainly a number of common behavioural traits that can act as barriers to increased take-up of occupational pension schemes. But if advisers try to turn these often predictable behaviour patterns on their head, they may well be able to use them to their advantage.
expert view – Effective communication
Greg Thorley, Communication & education development manager, Standard Life
The value of face-to-face advice has long been recognised, but internal research from Standard Life underlines just how powerful a tool it can be as a means of increasing scheme take-up. The insurer found that effective education and communication programmes can more than double the number of employees signing up to their occupational arrangement.
After surveying over 1,000 employees of clients, Standard found that 45 per cent of workers rate their knowledge of pensions as ‘low’ or ‘very low’. However, after listening to presentations from its employee communication team, 97 per cent said they had a better understanding of their employer’s scheme and take-up on average soared from 40 per cent to 88 per cent. At the same time, 87 per cent of employees also said they valued their employee benefits package more.
Greg Thorley, communication and education business development manager at Standard Life, says: “The findings really do drive home the importance of implementing an effective employee communications strategy. Nearly half of employees say their understanding of pensions is low or very low but after a presentation from our employee communications team, we have seen take-up more than double.”
This trend was found to be in evidence across the board. Even industry sectors with traditionally higher take-up levels saw massive increases in member interest. For example, average take-up among employees of financial services companies rose from 63 per cent to 90 per cent after employee presentations, while the results were even more marked among manufacturing companies where average take-up rocketed from 33 per cent to 88 per cent.
spotlight – Boosting employee take-up
John Jory, Deputy chief executive, B&CE
Attempting to increase employee take-up of workplace pensions in industries dominated by low to medium-earners can be challenging enough, but encouraging members to increase their contributions can be even more difficult.
B&CE Benefit Schemes, which provides employee benefits for the construction industry, has recently begun piloting a scheme of supplementing its worksite visits by talking members through their retirement savings over the telephone.
When workers ring B&CE to enquire about their pension statements, the firm will inform them of what their pension pot is currently worth and the level of income this will provide in retirement. B&CE staff also asks members about the level of income that they want to retire on and inform of them of how much they would need to contribute to achieve this.
John Jory, deputy chief executive of B&CE, stresses that the firm is not authorised to give advice but has found that presenting the facts related to savings in its own pension scheme can still have a profound effect on members’ behaviour.
“This group of people tends not seek financial advice but we have found that presenting the facts about saving in our pensions is very helpful to members,” he says. He notes that B&CE records all telephone calls to ensure no advice is given and refers members to independent financial advisers where appropriate. “The initial results have been encouraging to the extent that we need to train more people to be able to explain to workers what our pension scheme is,” Jory adds.