Communicating the benefits of auto-enrolment will be essential if high opt-outs are to be avoided when contributions increase, says F&TRC director Ian McKenna.
It’s easy for the industry to consider auto-enrolment to have been a huge success. Over five million employees are now saving for retirement, most of whom had never previously done so. Millions more are due to join them by the time all employers have staged.
The reality is these individuals are only contributing 1 per cent of salary. In less than two years’ time, however, they face the prospect of a threefold increase in contributions, without increased employer contributions. Payments will increase to five times the original level 12 months later.
To people who have never saved before, these increases are likely to appear excessive unless they have clearly bought into the value of the contributions they are making well before the increases start.
Say it quickly enough, as someone who understands the value of pensions, and it’s easy to think that a 2 per cent increase in payments, followed by a further 2 per cent 12 months later, sounds perfectly reasonable. But from a member perspective, imagine signing up for a product or service that increases fivefold in cost within 13 months. Who wouldn’t be looking to find a cheaper alternative? Of course, in the case of auto-enrolment the cheaper alternative is opting out.
The challenge these levels of increase represent is further exacerbated by the fact that behavioural finance teaches us that humans, when considering the value of a future asset in 20 years’ time, even if it is for their own benefit, mentally discount its value – the behaviour technically known as hyperbolic discounting. All these factors combine to make it essential that these new savers really value the benefits that contributions will deliver before these increases take effect.
There is general acceptance in the market that these increases will be the danger point at which we risk far higher levels of opt-outs. So are we doing enough to address this now? Helping consumers understand the value of long-term savings is not going to be something that can be achieved overnight. On the contrary, it should be a process through which we build customer education and understanding over an extended period.
The need to develop strong relationships with individual members also raises significant questions
about resources. Given the pricing constraints imposed by the charging cap, how many organisations can afford to deliver such a communication programme?
This must particularly be an issue for those low-cost pension providers who are offering schemes priced significantly below the cap. Such pricing will clearly only work if they can achieve and maintain significant scale. Will their pricing be sustainable if suddenly faced with high levels of opt-outs?
Where the scheme is run by a proprietary organisation with other income streams they might be able to see out any significant short-term reduction in income, but this could be a serious issue for small master trusts having to cover their costs only from the revenue achieved by the auto-enrolment scheme.
Paper communications are simply uneconomic for fostering the sort of ongoing consumer education process needed to build the right sort of relationship with the members.
Conversely, the vast majority of the population now walk around with a smartphone in their pocket. It is the ideal platform for such a dialogue, yet how many auto-enrolment providers obtain the individual’s email address as a matter of course in their enrolment process?
Those pension providers that have not put in place the mechanisms of services to build members’ understanding of the value of the contributions need to do so urgently if they are to avoid a significant reduction in income in less than two years’ time.
Advisers setting up schemes for employers that are keen for their employees to benefit in the long term from the contributions they are making should consider the level of education and communication services delivered to the member on an ongoing basis.
Failure to do so risks resulting in auto enrolment becoming a short-term and unsustained savings exercise that will benefit no one.